Thursday, December 28, 2006

2007 Predictions (part 1)

With 2006 winding down, everybody's out with predictions for 2007, so I thought I would follow the crowd for a change and throw down a few of my own observations before the clock runs out.

Since there are two trading days remaining, I'm going to cut my predictions into two parts, covering currency, interest rates and commodities today and the stock markets, economic trends and some political observations tomorrow.

Taking a somewhat more cynical view of markets as opposed to some of the more supply/demand theorists, I'm presaging my prophecies with a couple of caveats: 1. The Democratically-controlled Congress will restore a sense of fairness and balance to the country as a whole while putting some pressure on the administration for fiscal restraint; 2. Our lame duck president will remain stubbornly in opposition to public opinion on Iraq and the faux war on terror and face calls for resignation or face impeachment as early as Spring. (For more on my views on impeachment, see my political blog.)

Currencies: Stabilizing dollar

After years and years of dollar depreciation, the tide may finally begin to roll out. The demise of the Dollar vs. the Euro is vividly revealed in this Euro to US$ chart.

Since reaching parity (1$ = 1EUR) late in 2002, it's been a pretty steady path of appreciation for the Euro at the Dollar's expense though the trend has definitely slowed since the peak in December 2004. It was at that point that the Fed hiked rates 25 basis points to 2.25% and the fifth consecutive rate increase, with the first in June, 2004, when the rate was finally moved off the 1% "emergency" rate to 1.25.

Since then, the Fed raised rates for a total of 17 consecutive meetings, the last of which was June 2006, when the FOMC finished their upwards adjustment at 5.25%, where it stands today.

So, there is no correlation between US interest rates and the value of the dollar versus foreign currencies.

Talk of the death of the dollar has been strong lately, however, but wildly overstated. The abrupt change by Iran - to price their oil in Euros rather than dollars - and the flight of some Gulf nations to ease their foreign reserves and investment funds partially out of US Dollars likely has more to do with politics than money, though the two are closely affiliated.

If the US isn't getting the message that meddling in the Middle east has reached its limit, maybe moving some money away from US investments may get our attention... at least that's what it looks like from afar.

Since we're reaching a double bottom in the Euro-Dollar trade, I expect the dollar to bounce between 1.33 and 1.18 in 2007, with the main triggers being our international relations and how well the Congress reigns in spending.

Interest Rates: Little change

The Fed is now 4 meetings into stand pat mode, fixing the Fed funds rate at a very fair 5.25% and that's not likely to change dramatically. The first half of 2007 may see some slowing of the economy and calls to ease rates, but the Fed will not see a recession looming and will choose to err on the side of prudence, keeping rates the same at least through June.

The June meeting may be the most propitious time for the Fed to make a move as the economy will look like it's stalling out, but with inflation not likely to be much of a concern in a slowing environment, raising rates will be pretty much out of the equation as well.

It's going to be a boring year to be an economist as we move politically and economically back to the center and further away from the radicalism of the previous six years.

Commodities: Lower prices good for all

In the commodities field, lower oil prices are going to keep the economy on an even keel. Oil prices have been going south generally for the past six months and the new political climate is likely to foment more declines in crude and gasoline.

There's a glut of goods and raw materials in the US and to a lesser extent worldwide and distribution will be a key. China will not be able to continue expanding at their breakneck pace as the developed nations will experience slow growth. The overriding factors of globalization and reduced demand for imports to the US should keep prices for functional commodities - copper, silver, zinc, oil, natural gas, coal and timber - somewhat in check.

There will be opportunities for reasonable gains both on the short and long sides, but these occasions will be short-lived. The overall trend will be lower with gold bottoming out in the $550-575 range, silver backing up to $10.75/oz. and copper easing to a more reasonable 2.15 per pound.

Another warm winter, courtesy of global warming, will contribute to keep oil below $60/bbl. for much of the year. A fall below $50 is not out of the question and stabilization in the $44-47 range is a distinct possibility by Fall.

The continued slowdown in the US housing market will be the main factor driving all commodity prices lower.

Tomorrow: Stocks, trends and politics.

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