One could say that a futures contract predicts the likelihood of a future event.
The price of a futures contract is created by traders who will be rewarded by
turning a profit if they are correct and will be punished with the loss of money
if they are wrong.
Therefore, we can say that the price of a contract, which represents the opinion
of the market, is more valuable than the opinion of any individual analyst or trader.
A good example of this is the Fed Funds Futures contract, which trades on the
CBOT (the Chicago Board of Trade, which merged with the Chicago Mercantile
Exchange last year).
This contract currently predicts that the U.S. Fed Funds rate, currently
standing at 2.25%, will fall to 2% after next week's FOMC
(Federal Open Market Committee) meeting.
The likelihood exists for further rate cuts beyond next week, but the contracts
seem to be saying that this cycle of rate cuts will end sooner rather than later.
Perhaps if these future traders believe that Bernanke and the Fed are nearly
finished cutting rates, the U.S. Dollar will finally find some support.
The greenback's dizzying decline has been a topic in this column since its
inception, but the damage to the U.S. currency has accelerated in recent
months.
The Euro has made an incredible run, racing from 1.45 to 1.59 vs. the U.S.
Dollar since early February, as seen here on the daily chart
(see Figure 1).
Figure 1: EUR/USD has rallied 1400 pips since early February. Source:
Saxo Bank
If you caught my appearance on the BBC last Friday, you heard my
prediction that after a period of consolidating its recent gains, the EUR/USD
currency pair will continue to rise, possibly to 1.70 by year's end.
If that sounds farfetched, consider this: while a rise to 1.70 from the
current 1.59 would require a gain of 1100 pips, or 11 cents, Euro has
already gained 1400 pips (14 cents) vs. the greenback in the past 2 ½ months,
and has climbed a whopping 2600 pips (26 cents) since August of 2007,
as seen here on the weekly chart
(see figure 2).
Figure 2: Weekly chart shows EUR/USD climbed from 1.33 in August 2007.
Source: Saxo Bank
Kudos to the BBC interviewer for remembering that on my previous visit
last fall, I predicted that EUR/USD would rise to 1.60. At the time this
sounded pretty outrageous,
since the pair was trading around 1.40 last fall, but it sure doesn't sound
far fetched now.
EUR/USD touched 1.5980 last week, a mere 20 pips from 1.60, before
pulling back slightly to its current level near 1.59.
Hunger Strike
Singapore is allowing its currency to strengthen gradually vs. the U.S.
Dollar, in a bid to stave off the inflation that is rampaging through
economies here, driving up food prices and creating a dangerous situation
for the many who live on the brink of starvation.
The greatest risk belongs to those countries who are dependent on
food imports.
Just yesterday in West Bengal, workers and students held a strike to
protest rising food prices; a similar strike occurred in India's fourth largest
city, Kolkata.
In Mexico there is a saying, "when the tortilla rises, the government
falls," and some analysts are predicting a crisis in that country.
In Thailand, nearly half of the respondents of a survey said they are
cutting back on rice, which is ironic because that country is the world's
largest producer of rice.
According to an official of the Asian Development Bank, "The era of
cheap food is over."
Who is to blame for this problem? The media seems focused on bio fuels
as a cause, because grain harvests are being diverted to gas tanks instead
of dinner plates.
But this is not the entire answer. Because some people are panicking and
hoarding food, supplies are scarcer than they should be. Speculators are
jumping on the bandwagon, driving prices higher.
High oil prices make it more expensive to harvest the crops and ship the
products, and these expenses are passed on to the consumer.
Unintended Consequences
One thing is for certain; the current low-interest rate environment is not
helping the situation.
Central banks fight inflation by raising interest rates. Meanwhile, the
Federal Reserve, the Bank of England, and other central banks have
been cutting rates and adding liquidity in a bid to prevent a recession and
the collapse of major financial institutions.
The Fed is particularly culpable, because Ben Bernanke and company
have cut rates by 300 basis points over a relatively short period of time.
This has caused tremendous inflation in the U.S., arguably much higher
than the reported inflation rate.
Now consider that many countries have tied their currency to the
greenback, meaning that they are also importing inflation along with
the U.S. This inflation is having a ripple effect throughout the world.
I would argue that over the past decade, every time the Fed either
pumps up liquidity or goes on a rate-cutting binge, they are
unintentionally creating a bubble.
Right now they are doing both. Remember Y2K? The Fed pumped the
system full of money in 1999 because they were afraid that a computer
design glitch would plunge the world into chaos when the new century
began.
So where did the money go? Much of it was funneled into the Nasdaq,
creating a spectacular tech stock bubble as the index eventually climbed
above 5000, more than twice its current value today, eight years later.
After the tech bubble crashed, the U.S. entered a recession. In order to
create growth for an economic recovery, the Fed under Alan Greenspan
cut interest rates to 1.00%.
The unintended consequence this time was the housing bubble, as real
estate prices in the U.S. and elsewhere skyrocketed to unbelievable
heights due to low mortgage costs, along with a hefty dose of
unscrupulous lending.
Now that the housing bubble has crashed, the Fed is once again
on a mission to provide money at low rates.
Simultaneously, we are seeing the creation of a third bubble, this
time in the prices of commodities like oil, gold, and most importantly
food.
Coincidence? I think not. Perhaps it is time for the Fed to realize
that we can't solve our problems by just throwing money at them.
Instead, we just end up with bigger problems. Cutting rates and
adding liquidity is fine, but doing it in drastic fashion creates
unintended consequences.
Aurthor
Edward Ponsi
