THIS WEEK: THE FED-ECB CHESS MATCH
The Well-Timed Strategy for Week Ending June 6, 2008
by Peter Navarro, Ph.D.
June 2, 2008

The Markets

Last week, treasury yields hit their highest levels of the year. This can mean one of two things. Either the economy is recovering, and the bond market is predicting an up-tick in demand-pull inflation. That�s bullish. Alternatively, the economy is not recovering and the bond market is predicting an up-tick in cost-push inflation � the bearish stagflation scenario.

Watch this carefully � along with the chess match currently underway between the U.S. Federal Reserve and the European Central Bank. At stake is the relative value of the dollar to the euro together with the fate of oil and commodity prices, which are tied to the dollar.

At this point, the Federal Reserve is likely done with cutting rates and the only question is when (and if) it will raise them. The currency markets understand this and have been bidding up the dollar relatively to the euro. As for the Fed, perhaps it has finally figured out that cutting rates is merely debasing the dollar, driving up the �oil tax� on American consumers and businesses, and having a net contractionary rather than expansionary effect.

Across the pond, the ECB goes back and forth between wanting to cut rates (to rescue Italy and Spain) or to raise rates (to cater to the German obsession with inflation). However, with the dollar firming because the U.S. Fed is done cutting, a falling euro puts into play an ECB rate hike. This is because a falling euro will contribute to inflation concerns and raising rates will prevent the euro from falling.

Of course, this all seems like a �damned if you cut, damned if you don�t cut� for both the Fed and the ECB,. This is why I think we are closer to a world of stagflation in which interest rate policy is ineffective than a Keynesian world where central bankers can solve one problem such as recession without exacerbating the other problem of inflation.

And by the way, the relevance of this seemingly arcane discussion to your trading should be obvious. The trends for the bond, currency, and stock markets will all ultimately be determined by monetary policy and its effect on interest rates and the dollar and euro and oil prices.

Presidential Politics

Click here for an interesting analysis in U.S. News and World Report of the presidential race. It shows McCain leading Obama by 281 to 257 electoral votes and McCain leading Clinton by 277 to 261 electoral votes. What�s most interesting is that the swing states are very different depending on which candidate � Obama or Clinton � is the nominee.

In the McCain-Obama race, target states and their electoral votes include Connecticut (7), Delaware (3), Hawaii (4), Kentucky (8), Missouri (11), New Jersey (15), Oregon (7), South Carolina (8), Virginia (13), Washington (11), and West Virginia (5).

In the McCain-Clinton race, you have Alaska (3), Colorado (9), Indiana (11), Massachusetts (12), Missouri (11), Montana (3), New Jersey (15), North Carolina (15), North Dakota (3), South Carolina (8), and Virginia (13).

Note that only a few states are on both lists: Missouri, New Jersey, South Carolina, and Virginia

This seems to be an argument on the Democratic side for the �unity ticket�

© 2008 Peter Navarro

“Any trader or investor who ignores the power of macroeconomics over the world’s financial markets will, sooner or later, lose more than they should and if they are trading on margin, perhaps more than they have.”-- If It’s Raining in Brazil, Buy Starbucks

Peter Navarro is a business professor at the University of California and the author of the best-selling investment book If It's Raining in Brazil, Buy Starbucks and The Well-Timed Strategy. His latest book is The Coming China Wars: Where They Will Be Fought, How They Can Be Won.

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