Challenges for Australia as China reforms point to slower growth

Despite recent signs of modest economic improvement, Australia is likely to remain on a tightrope for quite some time as the country’s mining boom slows down. Recent economic data from China shows strong improvement, but that could change as leaders are set to implement significant reform measures that could slow growth in the near-term. The market is well aware of the challenges ahead for Australia, and several important risk factors suggest that the Australian dollar is likely to remain subdued, especially as it struggles to sustain a rebound off summer lows.

China’s Third Plenum matters

A four-day, closed door meeting between China’s leaders to discuss the economic and political agenda for the next decade just concluded and expectations are high for significant reform. China must pave the way towards a market economy that will redirect credit away from inefficient state-owned-enterprises (SOEs) to much more efficient private enterprises. The new agenda should loosen the state’s control over capital allocation, which starts with reducing the limits on wealth transfers.

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Australian economy modestly improved but still fragile

The Reserve Bank of Australia (RBA) softened its dovish view on the economy after the summer when headlines of a possible soft landing in China and declining terms of trade shifted the focus onto the vulnerable Aussie dollar. AUDUSD sustained a nice rise after recent China data came out ahead of market expectations, but domestic data did not suggest that Australia was out of the woods.

That could be changing now as recent confidence and employment data point to a modest improvement, which could keep the RBA satisfied for the remainder of the year at least.

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Aussie declines amid broad slowdown, but could stabilize

The recent slew of global PMI data suggests that business confidence is declining. The problem is not unique to Asia, and fears of a hard China landing are too premature to judge. The broad slowdown coupled with domestic concerns in Australia has placed significant weight on AUD. We could see some stabilization soon as we approach the second test of support in the AUD/USD pair, but expect some nail-biting below 0.9000.

June PMI figures shouldn't start a panic. Although China's HSBC manufacturing PMI continues to decline off  Dec-2012 highs, and move deeper into contraction territory, it does reflect the broader economic shift. Recent reports show a slight average improvement in China's service PMI's, but average manufacturing confidence is declining more strongly. Chinese data will disappoint amid the government's agenda for economic reform instead of short-term stimulus. With an inflated housing sector - as property companies now post larger losses - stimulus could further exacerbate the problem. Also the growth in credit is still ripe, with the recent spike in SHIBOR rattling the shadow banking sector. Thankfully conditions have calmed, and Chinese policy seems more structural and concerned for the long term. On the flip side, Australia is facing reality, especially with recent RBA comments shedding light on its economic vulnerability.

Australia ranked the lowest in service PMI output in June against other major countries, and the manufacturing side is not stellar. The recent moves in AUD/USD are very telling. Wednesday's batch of data sparked an early rise in the pair even amid weak Chinese PMI data, disappointing Aussie retail sales and housing prices were released. The focus was on the trade print which marked a May surplus to $670M, but the AUD rise was short lived. The pair continues its descent, struggling to recover from that significant drop off 0.9550 after the FOMC event last month. The first test of support around 0.9300 failed, and now we're below 0.9200 with a clear eye for the next test of support around 0.8500. At that point, we could see some stabilization as the pair becomes increasingly over-sold. But keep in mind that a strong rebound amid the macro strain is not likely. The market should get comfortable with these levels after the glory days of the AUD rise have now come to terms.

Even though the May trade print was good, showing a solid 4% gain in exports, comments from RBA Stevens supports a more dovish view. It's quite possible that the RBA had a rate cut on the table at the past meeting, which was longer than usual and had Steven's speaking out about the need for fiscal responsibility and assuring that the RBA would "cut rates further if necessary to support an economy transitioning from a mining boom." With that possibility, expect further weight on the pair. As weaker Chinese data lingers and the resource boom peaks at home, the RBA seems confident in the weaker AUD as sentiment fades. Moves below 0.9000 could make the board happy, but maintaining a dovish tone is needed to cap those moves.

Rumble Down Under: Australia will soon face reality.

Raging bushfires ripped across southern Australia, soon matched with heavy rain and tornadoes. The extreme weather events of January were as heated as the political turmoil that will place the country on a shaky path full of uncertainty. Australian summers are always a bit wild, and its politics follow the same type of disorientation. The long campaign season leading up to the September election is likely to steer conversation away from critical economic matters for the sake of a popular agenda that is common on all sides of the political spectrum. Like the US, Australia will face long-term fiscal problems and will lack the right leadership necessary to grow an economy that's actually in a better condition than most. This has some near term market implications which will hopefully be a signal for responsible leadership.

 Political Uncertainty

The political turmoil began in the summer of 2010 when then Deputy PM Julia Gillard was elected unopposed as Prime Minister after the former PM Kevin Rudd lost the support of his party and resigned. Despite weathering the global economic storm of 2008 by avoiding a negative hit to GDP, Rudd's controversial policies regarding climate change and a mining tax were largely opposed by both opposition and members of his own Labor party. At this point, it was assumed that Gillard's administration was better able to correct those unpopular moves and get the job done. In the words of her right hand man Treasury Secretary Wayne Swan: returning to a budget surplus will be done "come hell or high water."

The Labor party is riddled with failed promises after implementing a complex mining tax and a continuous budget deficit. Much of this has been blamed on the high value of the Aussie dollar and external pressures on commodity prices which weighs on mining activity. Tax revenue is on the decline, but there has been little effort to get a handle on spending. PM Gillard has called an election for September 14th in order to allow more time for a healthy political debate. In what will mark the longest campaign session in Australian history, this leads many to believe that the real reason is for the Gillard administration to show economic proof in hopes of a better turnaround. While no one expects a budget surplus in time for the election, there are some hopes for a pick-up in economic activity abroad during the latter part of this year which can have a positive effect on Australian output. So far, voters are not buying it.

As the Labor party looks more unstable, polls are showing a greater preference for the current opposition leader Tony Abbott. The polls are a blow to Gillard and shows that there is a growing mistrust for the Labor party on key issues such as the mining tax, immigration policy, and the economy. Rudd is more popular than Gillard, and there is some speculation that he might be drafted to lead the party despite his expressed lack of interest to do so. Throughout all of this political turmoil, the market response has been largely muted; guidance has been provided from a mix of risk appetite and the slump in commodity prices. However, the market is not quick to lay its hand off the economic pulse.

Economic Risk

It's clear that Labor hasn't held up to its promise. The Australian economy is largely held up thanks to the limited downside during the 2008 crisis under Rudd's leadership. Housing prices are still high and haven't seen a significant correction yet. Structural issues are evident and unemployment is still elevated for the nation.

The more pressing issue that will likely stem out for a long time is the looming budget crisis. Treasury Secretary Swan revealed a collapse in tax revenues of nearly $4bn mainly due to a slowdown in mining activity. Swan stated that the government will need to raise revenue and cut expenses, but spending cuts are essentially part of an austerity agenda. "Delivering another deficit is driven by Gillard government's core values about jobs or working Australians" said Swan. The RBA has already taken measures to offset future austerity measures by cutting its official cash rate.

Hopes for a pick-up in mining activity are complicated. The latest mega-project Origin Energy's Australia Pacific LNG project amounts to a whopping $2bn development budget while also freeing up expenses by slashing 850 jobs. The fact of the matter is that costs are building up and there is a capital strike. Similar to the US, Australian shareholders are demanding dividend income. Shell's plans are on hold for its Gorgon LNG project in hopes of getting a hold on higher capex expectations. A Dec FT article warns:

"If these issues are not addressed then new investment in Australia’s LNG industry could dry up in 2017, warn industry executives and analysts, and new suppliers based in Canada, east Africa and the US will move to capture a lucrative prize: 90m tonnes of annual uncontracted Asian LNG demand. 

Australia is poised to overtake Qatar as the world’s biggest LNG exporter as seven colossal projects reach full capacity over the next five years. But the industry is also facing serious headwinds as a consequence of its rapid growth. A second wave of developments and project extensions, worth an estimated A$150bn, is at risk from rising labour costs, infrastructure bottlenecks and the strong Australian dollar." 

Tony Abbott has a plan to boost productivity by way of a major infrastructure-spending boom if elected in September. This is not the way to go as the government will just break even with a return through tax revenue. It will just swell the deficit to another low level with no long term objective of fostering sustainable business activity. But Gillard has no star plan of her own and will likely keep some form of the mining tax with no efforts to offset lower revenue with spending cuts. Australia cannot continue to rely on the sways of its offshore trading partners to dictate economic conditions at home.

The economy is still relatively stable despite these looming fiscal troubles. The recent lift in consumer sentiment could indicate more breathing room for the RBA. The rise in share prices is also welcomed. However, lower commodity prices and concern that risk taking has gotten too far could stall significant  growth. Consumers are still cautious about taking on more debt despite the pick-up in household wealth. Consumer spending and unemployment expectations have leveled out. Australian households are cautious about job prospects which is keeping the consumer on the sidelines - and businesses are taking note as well by holding onto cash.

More room for an Aussie decline, but expect a bumpy road

AUD/USD is trading along a declining channel, with a recent slump attributed to a Reuters report on chatter in global markets that a hedge fund had been liquidating positions in commodities. RBA members have also expressed concern about the effects of a high AUD. These concerns were actually brought up at the start of this year when AUD/USD traded around 1.0590, and has since declined off those levels. Concerns about an overvalued currency are also seen in New Zealand where RBNZ Gov Wheeler stated that the NZD is still too high and that the RBNZ is ready to intervene if necessary despite some signs of a stronger than expected economic rebound.

The recent decline in AUD/USD is also correlated to lower risk appetite following the latest FOMC Minutes which suggests some unease among Fed members about a scale-back in asset purchases.

Moments ago, AUD/USD was given a boost after RBA Gov Stevens expressed confidence in the current level of interest rates. He went on to state that the high AUD/USD was weighing on the economy which inspired the previous rate cuts. However, Stevens did reiterate that rate cuts are more likely than increases. The recent lift in AUD/USD might be the result of over reaction from the markets given the lower outlook by the RBA. The central bank lowered its growth and inflation forecasts and pointed to concerns that mining investment could reach a crest this year. Lower hiring demand from resource companies could also lead to a softer labor market. Additionally, the strength of the Aussie is being watched for indications of higher inflation.

The lengthy political debate and fiscal issues deserve great attention. Investors should keep an eye on Australia especially given the recent evidence of declining money flows. FT Alphaville published an insightful article which cites data from the Japanese Ministry of Finance showing that Japanese investors were selling Aussie assets at an increasing rate. Japan holds about 20% of Australia's national sovereign debt, according to FT.

Facing Austerity. Head-on.

Assuming this isn't outdated by the Mayan calendar, 2013 will be the year of austerity. It's already here, but its impact will be more apparent in the coming year as it dampens the extent of a full recovery as governments continue on with an unbalanced check book. This process is inevitable and in some cases necessary to break out of an economic slump with some sort of fiscal sanity. The problem is not just in the US where this coined term of  a 'fiscal cliff' is actually what has been planned; its just the extent and distribution of the scale-back that's up for debate. As expected, the developed world is set for a stalled recovery with room for only modest improvement that will still lie below full  potential, especially given the new Fed thresholds on employment and inflation. Emerging countries will continue to face some struggles, but they will be busy stimulating during this time.

Some form of the fiscal cliff is inevitable. The fiscal framework of our nation is designed with limits to be  amended as we go to ensure that we are somewhat responsible to continue running the country on a balanced footing. This is why Congress has the power of the purse, but constant partisanship never gets us to that ideal point of leadership. In this case, we see extreme political strategy that surprisingly hasn't seen the kind of backlash that Europe has. The fact of the matter is that each proposal includes spending cuts that target many entitlements that we have grown accustom to but are clearly unsustainable. Our complex tax code deprives us of key revenue while the spending outlook will continue to dig us deeper into deficit. Whatever is agreed upon will still decrease our potential to accelerate economic growth.

We must address the political strategy, because this will determine whether or not we will ever get it right. The White House has cleverly used this 'balance' myth by shying away from real reform and spending cuts. If you really dig into the budget, many of those line items are highly sensitive because so many people rely on entitlements especially during these times. No one is willing to take bold action, and would rather gradually scale down the effects of costly programs that truly have a demographic mishap such as social security and medicare. When Republicans pressure spending cuts and reform, the White House has blamed lack of revenue as the reason for imbalance and then automatically factor in tax hikes and cuts on the middle class to show the 'only' way to balance the books. This type of thinking is a far step-back from reality.

Governments Ready?

Elsewhere in the developed world, governments have realized the problem and are cutting their forecasts. Canada, which relies on a US comeback in order to fully push on with full potential, has pushed its expectations back by one year to around 2015 when the country should return to surplus. The country also decreased its revenue projections over five years, and will essentially rely on decreased government spending in order to balance the books. In the UK, the Autumn Statement called for a decrease in welfare entitlement spending which caused quite a stir among its dependents. The ECB decreased its growth forecasts for the eurozone, and Germany is set to feel a pinch with declining industrial production. Lastly, Australia's Finance Minister Swan admitted during an unscheduled press conference on Thursday that the country is unlikely to achieve a budget surplus this year, breaking the major platform in the Labor Party's election pledge. Meanwhile, Australia's Prime Minister Gillard is on vacation; once again shying away from addressing fundamental issues.

Greece is a special case. Yes, we all know this. But it has essentially become the hallmark of austerity, and could set precedent on how its done (whether the country is proceeding in the right or wrong direction is a separate discussion). The fact is that Prime Minister Samaras is quick to work on structural reforms and grow the economy as part of the strict terms of its long awaited aid tranche of short term rescue loans. Closing in on its  sixth year of recession and +20% unemployment, Greece's real problem is demographic. Greek youth are fleeing the country, choosing school over work, or are busy protesting austerity in the streets of Athens. The country is one of the worst in the world for setting up a businesses given the impending legal costs, and the businesses that do come to fruition are short lived. Most of the people are employed by the government; and working for a broke employer disrupts the dependent system to begin with. Austerity at its finest. Or maybe just pure socialism.

Central Banks Prepared?

Central banks are ahead of the game, but it still won't provide a full cover-up of the underlying fiscal set-back. The Fed removed its 2015 guidance and agreed on additional asset purchases which suggests that the US economy is still under performing. The RBA cut rates and hinted at a mining peak which should help prepare for some fiscal tightening down the road for Australia to eventually reach a budget surplus.

The bottom line is that fiscal tightening is ahead, and this will force us to struggle along the recovery stage, performing below our full potential. Banks may have access to easy capital thanks to the easing mechanisms of central banks, but that money will remain stashed on the balance sheet until the political storm passes. Businesses will not invest unless there is some certainty on corporate taxes and the consumer's ability to be productive. We will all be a bit shaken with a change in the status-quo.

Check out: Rising stars of the fiscal cliff - Maya MacGuineas of Fix the Debt

Long term troubles for the US and Europe despite year end breather. Who will win?

The events of the past few weeks suggest that a forceful attempt to get things right by year end will only last for so long. The authoritative approach by frustrated central banks; Germany's clever stalling strategy with Spain; and corrections in Canada's housing market, all point to a much awaited year-end breather. This is what we want to see, but the long term outlook is still troubling.

Let's start with Spain.

On Thursday, Spain announced its budget and economic reform measures which includes planned spending cuts for 2013. The government stated that the 2012 revenue target will be met, but plans to tap 3bn euros from the Social Security reserve fund to cover pension payments was quite the shocker. 

The fact that the demographic make up of Spain skews towards the elderly, coupled with high youth unemployment means that these crucial reserve funds are not growing at a sustainable rate to accommodate the pace of payouts.  Austerity measures will lead to further slowdown with no major growth in employment, and Spain will need to find a way to meet its liability needs; a larger pool of government dependents being one of them. Policymakers need to remember that most Spanish households actually rely on the retirement payments from the elderly family member to stay afloat.

Soft Landing Ahead for Housing Markets in Canada and Australia

Global housing prices rose steadily from 2001 to about 2008 when the bubble eventually burst in the US. The problems in the US were a special case as a growing system of over-leveraged banks fueled by government subsidized guarantees led to a hard landing. During this time, resource driven economies such as Australia and Canada experienced a minor correction. With prices continuing to rally despite global deleveraging, China's major trading partners will bear the brunt of a soft landing. However, China's desperate need for resources will stabilize the imbalance.

The chart above clearly shows Australia, Canada, and Hong Kong being stubborn to the US correction post-08. Hong Kong's prices have risen sharply due to artificial demand as part of China's economic plans. Expect a major correction soon; stabilized afterward as China undergoes more "laissez-faire" economic reform.
** Click here for full interactive chart. Look at Sweden and South Africa! Poised to pop soon. **

Canada's Banks are Well Positioned, But Worries Remain

Keystone Pipeline Delayed Until After Election Year

The Obama Administration delayed approval for the Keystone XL pipeline extension from Canada to the US Gulf Coast. Yet another move to play it safe and place political strategy ahead of real economic due diligence. The administration decided to play it safe and dismiss any decisions on moving forward until 2013, one year beyond the 2012 presidential elections.

The current Keystone pipeline starts in Hardisty Canada and extends down the US mid-west belt to St.Louis. The proposed Keystone XL pipeline project will push westward, passing through the borders of Nebraska's Ogallala aquifer to reach the southern tip of Houston Texas and Port Arthur Louisiana. The estimated $7 billion project has been in talks for decades, and the US government was supposed to follow a schedule of 12-18 months of logistic, economic, and environmental studies.

Instead, the delay will decrease optimism among US shippers and refiners, Canadian oil sands producers, and job hunters from both sides of the border. Gulf Coast refineries need certainty about their supplies; delaying their scheduled deliveries one year out (along with the time needed to build), is enough reason to forget the idea of getting oil sand crude altogether.

Aside from the fact that the US clearly does not have an energy plan, it's also puzzling as to why the government allocates so much time for review and political strategy, but does nothing in preparation for new projects. It would be logical for the US to beef up safety precautions such as engineering barriers and enhanced filtration to make way for a project that is sure to develop some ROI for the neighboring states. Issuing a municipal bond to bring the infrastructure project into fruition, while paying back those bondholders with revenue generated by industry productivity is a solution that makes sense. We need a collaborative approach to work around constraints to maximize capital, labor, and productivity resulting from the pipeline project. Canada deals with the production, the neighboring states deal with optimizing economic gain from the pathway, and Houston and Port Arthur deals with the inflow of oil sand crude and delivery to the nation.

Another year of bickering does nothing when no one is willing to get serious. Canada must be laughing in a field of oil sands right about now. We can't blame them.

What Should the US Do About Rising Oil Prices?

Unfortunately, this question seems of high importance when energy prices rise. However, people tend to forget about the problem when prices decline to normal levels. The fact of the matter is that high energy prices are a good signal to whip us into shape. The longer we wait to correct the problem, the more susceptible we are to volatility.

The truth is that oil is in low supply, and in high demand; thus reflected in its price. If the supply was of comforting amounts, 8% threats would be of little concern. Too much of the world is dependent on the Middle East for its oil imports, and too many in the west fail to realize the impacts of continued demand for the stuff. Does it not seem odd that most of our foreign relations and wars are focused in the very region that fuels our economy? We need a comprehensive energy plan - an all of the above approach. This is one sector of trade in which some degree  protectionism works. Energy production for domestic consumption trumps the status quo. America is abundant in natural gas, solar and wind corridors, and more.

We can leverage this opportunity even more by utilizing NAFTA to operate what I call a strategic North American Energy Alliance  (NAEA): tapping into onshore and offshore drilling areas, contributing to our strategic oil reserves, natural gas exploration and development, incentives for cleaner and sustainable drilling innovation, expanding the wind and solar corridors to power grids that connect the North American continent. Canada is already skilled in extracting oil from tar sands, most of which exported to the US. Mexico's control of most of the Gulf region contributes to their comparative advantage in oil, exporting to the US. Our contribution needs to be significant. We need to produce enough for domestic use, and then some for the export advantage to China and India. If anything, we need to act fast on a plan like 'NAEA' before China does. 

There are many ideas on the table. Bowing down to the Saudis should not be one of them. James Cramer, the energetic host of Mad Money on CNBC made this statement: 

First, Cramer said the government needs to sell oil futures contracts against our strategic reserves to stop the jump in oil prices. Second, the U.S. government must be vocal about its support for Bahrain and Saudi Arabia, which will help prevent unrest from spilling over into these regions. Finally, Cramer said Congress must pass the natural gas act to subsidize 18-wheelers converting from oil to natural gas.

The government and US based oil companies already sell oil futures. But, apparently its not a fix all solution. The price we pay at the pump could be so much more if it were not for the futures market. The fact that there is so much panic over near $4 at the pump means we are in serious trouble if the 'real' price comes to light. I'm in support of the Natural Gas Act, and of course for the US having its two cents about peace in the Middle East. However, the massive amounts of aid and imperialist like influence in the region is disturbing. We are disliked because of our influence, no matter how much we try to mask this with a message of peace. The aid flows stir violence to create an unstable society for the US to offer a promise of modernization ("a human right?"), all for the control of what lies beneath the sands of Arabia - that is oil. It's a long term agenda that will leave us in a world of hurt. It's better to hone in some domestic strategy opposed to meddling with so called buddies who play us blindly.

Here's a video of former Vice Presidential candidate Sarah Palin. Her remarks on the need for energy independence are spot on. Our abundance in resources are clear, and its about time we use this.



I'm also a strong supporter in an all of the above approach. T Boone Pickens also has a plan that will reduce our reliance on foreign oil.

Hushed Data Shows China's Rapid Demand for Agriculture

DATA WATCH: Reputable organizations in the US and China provided expectations backed by secretive data that suggest China's shift in trade strategy. During the country's expansion, much focus is placed on industrial demand. Although this sector of trade remains strong, much of China's demand will consist of agriculture.

China's January PMI readings dropped to 52.9, below forecasts of a moderate decline of 53.9, signaling a slight drawback in manufacturing. However, PMI numbers were kept within a tight 51-55 range throughout 2010. Industrial orders are expected to remain in this range because of a domestic pullback as the Chinese government controls industrial expansion. Meanwhile, the strategy is to leverage inflation and fuel the agriculture markets even more.

Fifty years of history show sufficient supply  of corn to meet domestic demand in China. As time passes, imports tend to increase. According to the Financial Times, from 1978-79, China imported 3m tonnes of corn. From 1994-95, imports increased to 4.3m tonnes. The US Grain Council released data from unnamed sources that show China's shortage of 10m-15m tonnes of corn. Usually, the Chinese government keeps 30% of corn in stock, but sources say that that the government will only demand 5% in corn holdings. This means that China will need to tap the trade market for 9m tonnes of corn.

The strategy will surely increase the world's dependency on Chinese demand. As inflation increases their purchasing power, which will then fuel domestic demand, China will continue to be a strong trade participant. The game shift to agriculture is expected to prevent future economic shocks of inflation, which many investors worry about. Increasing imports of agriculture will increase supply, and thus decrease food prices in China. The current large demand for food in all developing countries places heavy pressure on production - but supply constraints brought on by weather, raise prices. China realizes this, but has a plan to make it work.

Remember, the 5% corn stock is just an estimate. There is probably a bigger story behind the statistics. China is known for keeping extra supplies by offering subsidies to hoarders. This extra stock kept within China will offer more opportunity for price control as food imports add to the increased supply of agriculture.

China's demand for corn is a great opportunity for the US. Corn is to America what oil to is to Saudi Arabia. The US will need to ramp up production to fulfill both domestic and Chinese demand. The US is a major consumer of corn, being a prime ingredient in almost all foods. An increase in production will be a strain, but subsidies will most likely help.

Some analysts worry that the currency appreciation of the US Dollar and Aussie will affect trade with China. But, the Yuan is also rising, increasing China's purchasing power. Australia and the US have farm subsidies to help offset this risk.

Expectations of wheat imports are up because of the worst drought in 60 years in the Shandong region of China. According to China National Radio, unnamed sources provided data that suggest China's imports of wheat to exceed 114.5m tonnes. Dantes Outlook reported our findings of a recent order from China to the tune of 150kt in feed wheat from Australia - 3 cargos of shipment from March-April. The demand is intense, and the opportunities for investors are clear.

All eyes are on Australia, with stronger growth forecasts. The RBA stated that economic activity is expected to expand at an annual pace of 4.25%. The increase in industrial and agricultural production will fuel employment, which will then equate to stronger household spending. Traders are busy factoring in their expectations for an RBA rate hike sometime this year - chances are after the natural disaster damages ease.

AUD/USD Daily Chart. Clear point of entry for a long term trade considering the due diligence of this post.

Global Manufacturing Leads the Recovery

The manufacturing sector suffered the worst decline throughout the global economic slowdown. However, recent economic data points to a pick up in activity - but areas of caution remain.

Let's start with Australia. The country's prime location and export dependency make it a key indicator for the projected trade activities of Asian giants. Australia's manufacturing sector is off to a slow start in 2011 with PMI largely unchanged and below 50 - indicating a contraction in activity. Firms remain cautious, resulting in inventory declines and lower ordering numbers mainly in construction. The cautious attitude comes amidst a 'fading' resource boom. China's demand for Australian resources is falling off a bit, below expectations of its assumed positive sloping demand curve. We'll get back to China later in this post. 

Here in the US, the manufacturing sector is rising at its fastest pace in seven years. The ISM report shows employers' positive outlook on future hiring. ISM numbers are currently at 60.8, well above the critical 50 mark, indicating strong growth. The Fed will continue its $600 billion in asset purchasing (QE II), but ease down in the long run, so long as employment and manufacturing follow an upwards path.  

Another important indicator is the housing market, which is still on the decline. The US Commerce Department reports that construction spending fell 2.5% in December 2010 - its lowest level in this decade of convex activity.

There is good news on the corporate front. US companies are reporting stronger financial standings, with positive earnings forecasts for the early quarters of 2011. The picture looks even better in the small business sector. According to Thompson Reuters/Pay Net Small Business Lending Index, borrowing by small businesses is up for five months straight. The auto industry is led by General Motors (GM) and Ford, reporting an increase in sales by 22% and 13% respectively. A remarkable comeback for GM after its tumultuous financial standing. The US auto companies are expected to pick up hiring (especially in the Detroit area; currently facing near 12% unemployment). GM and Ford have since re-focused strategy towards lower costs and more fuel efficient innovation, equating to a demand for talent. 

The US economy is up 3.2% on an annual basis - from the last quarter in 2010.  

Europe manufacturing is also booming, mainly led by Germany. For a candid visual analysis of January PMI graphs in the Euro-zone refer to my colleague Edward Hugh's Facebook blog. 

Despite strong ISM numbers in the US and Europe, there are still slight problems ahead. For one, Australia remains sluggish, which is not a good sign about direct demand from emerging markets. It's clear that something is up in the East. 

Here's the problem. The global wave of inflation = higher input costs = pressure on profit margins. Businesses will need to find ways to absorb this before domestic consumers start to heavily economize. The high input costs begin in Asia. China has some structural problems - domestic inflation and a shortage in young factory workers. The Asian giants that specialize in the physical manufacturing of export goods to the west (such as Thailand and Vietnam) meet a block in the supply chain when the first batch of goods arrive in China. The lack of factory workers who are demanding higher wages to fend off inflation, create this inevitable input cost on the finished product. This in turn creates higher priced goods in the US and Europe. 

On the other side of the trade equation, the Chinese government plays the game well. Domestic inflation is sending the Yuan higher, which means greater purchasing power for more imports. However, the rising value of the Australian Dollar makes resources goods down under less attractive. So, we can give Australia some slack in our model that measures the direct conditions of Asian demand. 

I say this is a short term problem that has a lot of room for correction. Latin America also has a problem of rising currency values, but governments have worked to push the value lower to make export goods attractive for Chinese demand (hence the currency war). And to fix China's input cost problem with its shortage of young factory workers - look towards India. A nation with a large population of young workers, mainly working in outsourced industries from the West, but also capable of picking up factory work to keep the Asian supply chain network in tact. 

Chart of Note: Aussie Lower on Weak Trade Data, but Hope Lies in Agriculture

Just now, the Australian import and export prices were released: export prices fell 8.1% from a quarter ago, while import prices fell 3.8% from a quarter ago. This illustrates lower yield from trade for Australia.

A month ago, I raised great concern about Australia's trade sustainability with China. This mainly because of China's rapid expansion that is set to cool down a bit as the country tackles domestic problems such as inflation.The demand for goods abroad will remain high, but sluggish based on its known buying frenzy trend. Weak reports like this don't mean well for Australian investors; most notably the Aussie.

I also suggested that Australia make stronger ties with India. However, the Indian government expressed concern over its widening trade gap with Australia:

In 2009-10, India's exports to Australia stood at just USD 1.38 billion, while imports amounted to a whopping USD 12.4 billion, translating into a trade deficit of about USD 11 billion for New Delhi. 

Krishna "urged greater flexibility and requested for early action on issues that impacted India's exports to Australia, especially in service exports (IT) and products such as pharmaceuticals, mangoes and table grapes," it said. 

However, Australian Foreign Affairs Minister Kevin Rudd said Australia has an open market and welcomed Indian trade and investment, it said. - The Economic Times

However, there is hope - a great opportunity actually. The demand for agriculture is sure to grow as China's domestic inflation needs to be tamed - most importantly, food prices. Reuters reported yesterday that China purchased 150kt of Australian feed wheat (3 cargos of wheat shipment for March/April).

In 2010, China imported 1.23 million tonnes of wheat, 36 percent more than in 2009, which saw a big shift from net exports the previous year. China normally imports to meet demand for high quality bread and cakes at the top end of the market, but it is under no pressure to import because it holds large reserves. - Reuters

Food prices in China have shot up by about 11%. Raising the supply of agricultural products will work to decrease the price burden on Chinese consumers so that they can continue to demand other goods to keep China's economy kicking. I hope traders realize this opportunity for Australia.

China's Upcoming Rate Hike and its Ripple Effects

The official numbers coming out of China show that the economy is rapidly expanding.  Consumer prices are up 5.1% for the year.  CPI excluding food is up by only 1.9%.  Higher food prices are fueling China's inflation.  For the period, food prices have shot up by 11.7%.  The Chinese government is attempting to implement price controls on grains, edible oil, and sugar.  Analysts are expecting the Chinese Central Bank to hike interest rates sometime this week.  This has created a ripple effect of economic balance in commodities, Chinese trading partners, and the US.

China's growth did not derive directly from trade; the problem is domestic.  The country's lax monetary policy, tax code, and currency manipulation have contributed to the current property boom.

Rapid construction fuels Chinese demand for commodities, boosting imports, and adding to export productivity in Australia and Brazil.  China's trade surplus narrowed by $22.9 billion in November. A drop from 16% in October, then facing a $27.2 billion surplus. Since then, exports are up by 34.9%, while imports remain higher at 37.7%.

China's trade deals with its South Pacific friends have contributed greatly to the regions trade productivity.  So much so, that the Australian dollar basically mimics China's economy; the value of the Aussie essentially being dependent on China's demand for natural resources.  Brazil is also a hot bed of commodities, and recent deals with China have accelerated South America's export growth. However, China's domestic problems have spread to its trading partners.

Australia and Brazil have property booms of its own. On a much smaller scale, Australia's expansion is almost a mirror image of China's.  Much of Australia's property boom is located in urban areas like Melbourne and Sydney.  However, the inverse with China is that much of Australia's property boom is in developing cities like Perth.  Western Australia holds a large sum of the country's mineral deposits, and the mining industry contributes to job growth, heavy construction which adds value to land, new homes to house the influx of workers, and now a population glut with immigrants flocking to Australia to capitalize on its growth.  Because of this, Australia was among the first to raise rates, and continuing to do so.

In China, much of the growth is in-equal.  The housing boom is on the eastern shore in the tightly enclosed urban areas.  The western part of China remains sluggish, with a large elderly population.

The US almost seems isolated from this. Not so much.  Our trade gap has narrowed with China, with exports up around 8%.

With expectations of a Chinese rate hike, Gold prices are down 2% on the week. US Crude Oil Futures are down 1.57%.  The Australian dollar, despite having a nice rally, is set to decline - rate hike lowering the value of the Yuan, thus decreasing China's  purchasing power for commodities.  If the Chinese government shifts focus to domestic issues, they will need to demand less and tighten monetary policy to cool the housing market.  This will also ease trade productivity.  In sum, expect the Aussie to decline when markets open.

Carry Trading the Falling Dollar

FUND STRATEGY: The latest FOMC statement contained specific language signaling prospects for more quantitative easing in the coming months. As always, Fed talk says if only necessary, but the report shows lagging data leading up to that moment of, well, necessity in their minds. The markets pretty much believe that there will more treasury purchases to keep borrowing rates low - as a monetary stall of stimulus. We see the Fed desperately trying their powers amidst midterm elections, where true fiscal policy is needed, but will have to wait, probably until early next year.

So, here's the opportunity. The dollar is decreasing against a basket of competing currencies, so a short dollar position in the FOREX market is the prime choice for traders. Ben Slotnick, one of our readers, messaged me about the advantage of using arbitrage through carry trades. This works by taking advantage of the interest rate spread between the US and emerging countries. Since borrowing costs are very low in the US, investors will naturally borrow but with the purpose to sell dollars in exchange for another currency with high deposit rates; thus pocketing the spread of cash exchange. The country that has high deposit rates is in the process of withdrawing monetary stimulus; countries like Australia and India. The risk is that exchange rates fluctuate, causing the value of the currency exchanged to possibly cancel out the purpose of profiting on a spread.

The current conditions show a trend that will likely continue throughout the rest of this year. The screen-shot from CNN Money shows the overall picture of bonds and rates. The recent uptick in yields is from better economic data (durable goods), but analysts say that yields are still in a zone of resistance.

Banks, who are adjusting investments during these times of government desperation, are profiting. As the Fed tries to crowd out the treasury market to encourage banks to transport cash away from government debt to borrowers, the banks will result to carry trades. This will place more downward pressure on the dollar, benefiting short dollar traders in the FOREX markets, and hopefully benefiting policy makers who are apparently wise enough to realize the externalities of their actions. On a quest to lower the dollar's value, policy makers are probably planning to export our way to recovery. Again, this doesn't work well for a reserve currency that's subject to high fluctuation. Germany may have benefited from a weak Euro, but it's not enough to help the entire Euro-zone escape its troubles.

But, think about it. Banks are sitting on a good amount of cash while the government tries to stimulate. Once we have better fiscal policies that effectively stimulates growth, and the Fed calms down, banks will feel comfortable to lend their excess cash. Also, if exports do pick up manufacturing will become more productive which will create jobs. Banks will lend, until Bassel III rules and financial regulation standards kick in. At this point, counter party risk will be an issue, so long as we sustain a recovery.

Gillard snags Prime Minister seat from Rudd. What's next for Australia?

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Australia's political shake up made global headlines as Prime Minister Rudd was ousted by his Deputy Prime Minister Julia Gillard. She had enough with Rudd's handling of the Australian government, which she realized was going off track. Gillard decided to exercise her right to step up and contest Prime Minister Rudd who respectfully backed down, thus declaring Julia Gillard the first female prime minster of Australia.

Gillard's forceful political action comes just before national elections. She realized an opportunity to gain the high seat of Australian politics by highlighting Rudd's weak points which now gives her an advantage in the upcoming elections. It's embarrassing to have a member of your cabinet speak out against your governing and then request a leadership change. Gillard is now in the spotlight, and she has time to reverse Rudd's unpopular policies to gain favor amongst Australian voters.

Former Prime Minister Rudd gave a very emotional speech that was tear jerking for many viewers, including myself. He started each sentence with "I'm proud of the fact of" and everyone was able to understand the economic and social accomplishments of Kevin Rudd. For one, along with his Finance Minister, Rudd helped Australia weather the global recession, a move that is highly praised on Dantes Outlook. I'm a fan of the new Australia, and the country is certainly in a better financial position despite the global economic downturn. Rudd continued to state that he is proud of establishing Australia's first education curriculum and national standards. Setting up a national organ donors market was an accomplishment that hit close to home for Rudd. He received a heart valve transplant many years ago, and memories of that caused Rudd to shed a tear during his farewell speech.

Seven years ago, Rudd won Australia's Prime Minister elections by a landslide, but then his approval ratings recently declined significantly. He flip flopped on climate change policies, and is not liked by Australian miners who face a 40% tax on the nation's most successful industry. Gillard is set to make a final decision about the tax by Friday. Mining sector stocks such as Peabody, BHP Billiton, and Rio Tinto are set to rise ahead of anticipation that Gillard will take the popular course of action in support of the mining sector and reverse Rudd's tax.

The Australian dollar rose as the leadership shift took place, proving even the market's dislike of Kevin Rudd.

Despite some unpopular policies, Rudd had a good outlook for Australia. He strengthened Australia's ties with Asia to boost the country's export economy. Australia was always an isolated country, but for the first time they have a say the world economy, gaining a seat at the G-20 meetings. Julia Gillard thinks Australia is expanding too fast and population growth is unsustainable. Real estate developers who are participating in the country's booming housing market dislike Gillard's goals of closing up Australia.

One of the biggest take-away from Rudd's speech was the commitment to lead. Rudd was defeated and he backed down, but his interest in moving Australia forward remains as he vowed to help the government in any way he can. Prime Minister Gillard stated that she will re-appoint Rudd to perhaps a cabinet if she wins the upcoming elections. I'm not sure how likely that will be; I wouldn't trust her.

Either way, I admire Rudd's dedication to his job. He did encourage social change, and accomplishing government assistance programs to the people of Australia were positive moves. That's the reason why I take a conservative approach to governments in trouble - to support a more liberal government during good times. Australia is in a better position to provide good services to the people, and that's a remarkable accomplishment for any leader. When a country prospers, so do the people who are invested in its longevity. I'm proud of the fact that Australia has gained the global recognition that it deserves.

The Effects of China's Yuan Revaluation

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China's official announcement of their plan to reevaluate their yuan to eventually break its peg to the US Dollar has caused a ripple effect in global markets. US treasuries declined, and other major currencies rose against the US dollar. The chart above displays today's market decline in the S&P 500, as US companies react negatively to higher cost of Chinese goods.

The decision comes just after US Treasury Secretary Tim Geithner pressed China to allow their currency to naturally appreciate, thus allowing the US dollar to appear more attractive. The yuan revaluation benefits China as it gives them more purchasing power. China leads the export recovery, which provided enough reason for the Australian and New Zealand dollars to rally in response.

The US will benefit in one way from the yuan revaluation in trade. A weaker US dollar in the long run is likely to boost our exports. However, the dollar's demise has returned as major currencies rallied against the greenback. US consumers will eventually end up paying more for Chinese made goods, but don't mistake this for inflation - it's simply a trade balance.

Gold will rally as China shifts their holdings of US dollars. Most importantly, this shift has cause a decline in US Treasuries. China will not buy as much Treasuries as it did before to maintain the yuan's peg to the dollar.

Keep in mind that the yuan revaluation will be gradual, so there is still possibility that this news will subside and European debt concern will come back into play. Many economists say this is a risky move for the US as the cost of Chinese imports will rise. The Chinese realize the benefits for them, they are not so much concerned for the US. The announcement was bound to happen as the Chinese have long voiced concerns for the crumbling US economy.

Chinese industrial companies and commodities will benefit from this gradual revaluation, and demand will pick up from China. This should come as no surprise to those who are already invested in the China demand craze. Dantes Outlook was already prepared; the yuan appreciation just fuels the return on investment.

The big drag in the DOW today were those companies that rely on cheap imports from China.

G-20 Wants less Export Dependency, more Domestic Demand

With the global financial mess escalating and volatile markets speculating currency and bond values, it’s convenient for global financial leaders to convene and discuss solutions. I’ve been listening closely to these G-20 discussions, and some good points are finally being brought up. The issue of deficit reduction is a first step. Everyone knows that this is a major problem; certainly as the sovereign debt crisis spreads across the Euro zone. More countries, such as Hungary, are now stepping up to alert the world of their financial concerns of unsustainable debt. Central banks and bondholders are working to relieve these issues, and the G-20 is proposing ideas on how to calm financial markets. The idea of a universal bank tax was shut down. The new idea that has some potential is for larger capital holdings so that taxpayers will be protected in the event of another bailout. Canada is weary of this new proposal because their banks are already subject to strict regulation. Universal regulation does not work well with certain countries that have specific economic conditions.

Most of the financial ministers warned about the unsustainable approach for recovery by relying on exports. This explains the risk factor in export based economies. These remarks are a direct blow to countries like Australia and Canada. Despite rising interest rates, and stronger export numbers, the Australian dollar took a major nose dive recently because of worry about risk. Not only the risk of the global financial crisis, but their export dependence and the need for domestic growth. Perhaps exports are fueling a domestic recovery, but how long will that last? China will not always demand commodities at such a fast pace. The Chinese realize that they are importing too much, and must balance a trade deficit by exporting more. Bad news from China directly affects the Australian economy.

But it’s hypocritical for the US to call out other countries for relying too much on exports. Obama vowed to double exports in his State of the Union address, and we have continuously placed pressure on China to allow their yuan to appreciate so that the dollar will be more attractive to the international trade market. A stronger dollar in response to the Euro crisis did not help with this goal of increasing exports. However, the appreciation of the yuan might help. The Chinese yuan is pegged to the dollar (buying US dollars to regulate their currency value), so the free markets don’t have much say in the true value of the Chinese currency. The US has even accused China of manipulating the value of their yuan.

Trade will definitely help with boosting the economy, but the G-20 members are correct that domestic demand must pick up to sustain a recovery. Meanwhile, Fed Chairman Ben Bernanke is speaking out about the domestic economy. In a speech this week he warned that unemployment numbers may remain high, but the Fed will raise interest rates ahead of a recovery. The markets anticipate a rate increase during the first quarter of 2011. Following the G-20 advice; a stronger domestic economy should be our main goal. --below is a chart of China's Balance of Trade:

The Export Driven Recovery

The race to positive GDP is in full swing. While the Euro zone gets all of the negative attention, and the US shines in response, the recoveries elsewhere are casted into the shadows. In the FOREX marketplace, no country is left unnoticed, so I decided to zero-in on three export driven commodity based currencies: New Zealand, Australia and Canada. These countries have a strong portfolio of natural resources that are in high demand, and make up a significant portion of GDP. This causes high volatility in their currency performance because they move according to commodity prices. However, the global recession provided a much needed boost for these countries.

New Zealand

Always used as a great case study, New Zealand had its ups and downs as their Central Bank scrambled to tame a growing economy. Following in Australia's footsteps, New Zealand issued a major stimulus plan that was focused mainly on investments with an eye on return. Because their economy is not as exposed to the global financial markets, the effects of the recession was not as severe compared to the US and Europe. New Zealanders suffered high unemployment as businesses faced pressure from lack of confidence and funding from banks. The stimulus provided an extra boost and sent housing prices back to comfortable levels. The Central Bank raised rates to tighten the recovery, and its currency rallied in response.

Despite the current positive news, New Zealand faces a tough year ahead. They must find a way to pick up the missed pieces of their second major recession in almost 50 years. The massive stimulus may have been too much, and government debt is projected to increase to nearly 35% of GDP by 2015. This could call for spending cuts and higher taxes; both may accompany higher interest rates and other monetary stimulus withdrawals.

The full response to handling stimulus pull back will be gradual, but the New Zealand government is taking some major steps forward. Once again, returning to exports, New Zealand recently began talks with India to end trade barriers. India will be a major player in the global marketplace as their economy shifts from agriculture to manufacturing. Demand for natural resources will be high, and New Zealand has found a specific trading partner.

Australia

Similar to New Zealand, Australia was not as exposed to this financial crisis. However, the banking industry is big enough cause economic suffering. A stimulus was implemented, and the nation quickly rebounded. Australia was one of the first countries to come back with an interest rate hike. New monetary tightening measures are always coming out of their Central Bank, and investors have scrambled to profit from the recovery down under. Again, the government must pay attention to debt and cost cutting measures.

Exports have long been Australia's strong focus. One of the major players in the Asia-Pacific Economic Cooperation (APEC), Australia has responded to China's increasing demand of natural resources. The country boosted exports in coal, iron ore and steal to benefit from China's industrial boom. They realized that China and other emerging powers will dominate the global landscape as rich countries stumble. Prime Minister Rudd made strengthening ties with China his main agenda during his election. He speaks Mandarin, and is often seen shaking hands with Chinese trading partners. Exploration, development, and exporting is at the heart of the Australian economy. The country must diversify their scope of investments and try to even out their focus on domestic demand.

Canada

Canada is a major exporter of Natural Gas and investments in offshore drilling and mainland exploration up north ensures confidence in their export driven economy. The country's proximity to the US hurt its economy after the effects of our recession spread north. However, using natural resources as a hedge came in handy. Canada is involved with more projects extending northward into the untaped arctic regions, neighboring Alaska, and new pipeline deals linking the far west to the US mainland.

The country isn't just built on oil and gas, but the diversity of their economy is well evident after the stimulus concentrated investments in various sectors. The recovery is slow but better compared to their major counterparts like the US and Europe. Industries such as real estate have experienced a strong reversal. Home prices have nearly risen 0.5%, and there are even talks of another housing bubble.

Last year, the Central Bank stated that Canada's recovery will be shaped like a hockey stick. A V shaped recovery is likely, but should be handled with caution. Expect some interest rate hikes (perhaps this year), and a booming housing sector. The Vancouver Winter Olympics provides a boost to the western economy.

Employment is still a problem, but the deficit is slowing down.

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Commodity currencies should be short term investments. Ride the volatility wave while the Central Banks release their stimulus withdraw plans. Short when commodity prices decline, or if the US and Europe rebound. Over the long term, the fundamentals explained in this article ensures positivity for New Zealand, Australia and Canada.

WalMart Canada Saves Energy By Dimming Lights!

Following the previous gender discrimination law suit, WalMart attempts to stay positive with another PR push. The company's latest move is to become "green"! The new "environmentally friendly" WalMart demands smaller packaging containers and now energy efficient store lighting. The move will be better for the company's Canada stores because it will save them money and take away the negative publicity. Currently, WalMart has 240 stores in Canada and the new method of dimming lights is expected to save about 4,500 tons of carbon emissions during the summer season. I think that this is a great move for WalMart to become liked by the public. I still think that the company needs some one in charge of ethics but I'm all for the environment and agree with the project. Word on the street is that WalMart will use LED lighting in refrigerators supplied by CREE Inc. which will lower the company's energy use. WalMart states that their mission is not to save money but instead save the environment. Go WalMart!

**********STREETBLABBER APOLOGIZES FOR THE UPCOMMING LAPSE AT WHAT IS DEEMED TO BE AN EXCITING ACCOUNTING PROGRAM HELD AT PACE UNIVERSITY!!!! I WILL BE GONE FROM SUNDAY, JUNE 24TH TO THURSDAY, JUNE 28TH***************