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US bonds clip euro's high

By Neville Bennett

Friday 8th August 2003

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There are tremendous convulsions in world markets. It's hard to pin down their origins but, for the purposes of an argument, let's say it starts with interest rates.

A negative charge in interest rates affects a stock market, breathes life into bond markets and has a tremendous impact on exchange rates.

New Zealanders are perhaps one of the groups most conscious of exchange rates. Trade plays a huge part in our exports and imports. Exchange rates influence large industries such as tourism and education. It also affects debt, which is high.

The greatest change is in debt markets. US 10-year treasuries have increased yields about 150 points since June 16. It is the fastest increase in yields in a generation, and it is hard to exaggerate its significance.

This article will concentrate its impact on the euro. For investors, it is suggested this could be an opportune time to consider euro assets, by way of diversification.

Obviously, the rapid appreciation of bond returns makes the US more attractive to foreign investors. The spread, or difference, between domestic rates and the US will be attractive to savers such as the Japanese or Germans, whose central banks have driven rates to unattractive levels. These countries are in the grip of deflation and their authorities are pulling out all the stops to increase employment and economic growth.

US authorities have a similar mind-set but their debt markets have acted differently. Investors in the US have demanded a larger risk premium against a worthless dollar. The gold market has buzzed, bond yields have surged and the stock market has faltered.

A glance at the graph shows the euro bumped at lows of 84-86USc through 2000-02. Perhaps it suffered differential interest rates; it also suffered the drain of relatively better stock market prospects. But once the bubble burst, the US dollar depreciated against the euro.

The trend was the kind hedge funds dream of. The graph shows incredible persistence. As the hedge funds have to front up with a small margin on their contracts, they made a killing on their leveraged accounts. Good money was made by following the Dow and Nasdaq down, and gold, oil and the euro up.

Ostensibly, the hedge funds made about a third on the shift of the euro from 84USc to $US1.20. But, through leverage, they made several hundred per cent.

But the ascent of the euro has ceased. More detailed charts indicate the euro has lost ground as US long-term rates have hardened. The trend may now have gone into reverse.

How does an investor get further clues? There are a thousand answers but my practice is always to look at interest rates and the futures markets. In futures, prices have been headed lower and volatility has diminished. Contracts for September are heading south, with the current $US1.15 seeming high. Recent contracts have fallen to $US1.12c.

These movements can be followed in incredible detail in the charts and contracts on Barchart.com (www2.barchart. com). The investor can examine, for example, short-term indicators. The chart for seven-day indicators spell out "sell;" so does the eight-10-day moving average and the 20-day moving average. The 20-50-day oscillations are also a "sell" but the 20-day Bollinger band suggests a cautious "hold." Each of these indicators is available in chart form.

In the medium long-term, the indicators are now divided but the commodity channel indices indicate a sell. These tend to be useful means of analysis, as commodities tend to correlate closely with the US dollar. On balance, the verdict from Barchart is that the euro will depreciate.

Thus, my guess is that the euro's bull run has been checked by the rising US bond returns. The pendulum has swung. The euro made 12.7% against the dollar in a year but is almost certain to lose ground.

The New Zealand dollar gained 21.0% in the same 12-month period. Will it therefore appreciate against the euro? Unfortunately, the kiwi-euro cross-rate is not well researched. The National Bank does, however, have useful graphs (www.nationalbank. co.nz/economics/exchange).

The kiwi has ranged in value from 50.50-52.40USc in the last three weeks, and over the year has appreciated from 47USc to 52USc. Looking at the trends, my guess is the kiwi will get stronger ­ to perhaps 55USc.

The weakening of the euro, if that is what's happening, will be regarded as a blessing in Euroland. French, German and Italian growth has been held back by overpriced exports. If Euroland growth rates increase and the currency devalues, there will be opportunities to buy good European shares.

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