What if we had a time machine that could tell you how the world markets and economies are going to behave? We do – it’s called demographics. While this time machine won’t tell you the winner of the Super Bowl in 2015, it will tell us a lot about the probable behavior of world economies, consumer behavior and investment and saving preferences.

We all know about the Baby Boomers in America. The appearance of this cohort has dramatically affected American consumer and investment behavior for the last half of the 20th Century and will do so into the 21st Century.

The last six months was not one of the best periods for the United States Dollar. The value of the dollar declined by about 7.5% against the Euro, 1.3% against the British Pound, and around 3.5% against an index published by the Federal Reserve System (an index relative to currencies in a broad group of major U. S. trading partners). During this period, United States policymakers were focused primarily upon a liquidity crisis that hit full force in March and resulted in an assisted merger transaction and weakness in the domestic economy. The Federal Reserve and the U. S. Treasury Department were continually putting out fires here and there and providing liquidity to securities dealers and investment bankers. The first half of 2008 was not a time these policy makers could pay much attention to the decline in the value of the dollar.

What is the outlook for the next six months?

The jobs number for the month of June was bad but not bad enough to stifle the gains in the US dollar. Non-farm payrolls fell by 62k, the sixth consecutive decline in a row. The April number also was revised down from -49k to -62k while the unemployment rate remained at 5.5%, matching the highest level since October 2004.

Anything short of 100k would have been dollar positive and that is exactly how the market reacted today. The biggest contributors were healthcare, education, leisure and government. The biggest losers were in goods producing and business services.

This market just doesn't get any easier, does it? Consider that in the last day and a half, we've observed the following:

a) A stunning intraday rally on Tuesday off the S&P 500 Maginot line, apparently based on GM (GM) sales figures, the flimsiest of possible justifications.

The dollar dropped to new session lows as the June ADP survey on private payrolls dropped 79K, versus expectations of an increase of 20K decline following a 40K increase in May.

Notably, the track record of the ADP survey in predicting the Department of Labor's private payrolls has faltered significantly over the last 4 months. DoL's initial readings on private payrolls showed -101K, -98K, -29K and -66K in Feb, Mar, Apr and May respectively, while the ADP private payrolls showed -18K, +3K, +13K and +40K. The considerable divergence of the last 3 releases means that a stronger than expected release yesterday morning may not be positively received by the dollar.

There’s no stopping the oil-buying frenzy, and no stopping the Euro upward momentum. Crude oil for August delivery rose to a record $144.32 a barrel in after-hours electronic trading on Wednesday; many shorts may have been squeezed on news that Israel may attack Iran, the second largest oil producer in OPEC, on the basis of the latter’s nuclear program (although the US government has said that scenario is unlikely). The uptrend in oil prices is suppressing dollar recovery, particularly against the Euro.

Further Euro Gains?

Like a bridge over troubled water, the U.S. job market could be finally caving in. At least that is what a raft of recently released employment indicators may be suggesting.

- the Rasmussen employment index, a measure of workers’ views on job security, fell in June to a record low of 78.6
- TrimTabs, which extrapolates U.S. Treasury tax collections, estimates a drop of 133,000 jobs occurred in June (and adds that the acceleration in losses in the last two weeks of the month suggests a plunge of 300,000 jobs in July).
- Automatic Data Processing (ADP), a major payroll processing company, reported a loss of 79,000 private-sector jobs in June (having reported a 142,000 net increase in jobs up to May).

The Euro is rallying ahead of Thursday’s ECB monetary policy meeting telling us that the market expects ECB President Trichet to say something hawkish. A 25bp rate hike has already been discounted by currency traders, but with the annualized pace of Eurozone producer prices growing by the fastest pace on record, consumer spending in Germany doubling expectations and the German unemployment rate falling to a 14 year low, the ECB may have to reconsider their plans to raise interest rates by only 25bp this year.

The ECB is a central bank that hates surprises and because of that, they always like to prepare the markets weeks if not months in advance of any pending move. That is why they have been telling us that a 25bp rate hike, which would be their first since 2007 is the appropriate expectation for the upcoming monetary policy meeting. They have also been warning that they are not planning a series of rate hikes. However the ECB may have to backtrack on these words given the recent economic reports.

Non-farm payrolls for the month of June are due for release this morning, but with the Federal Reserve no longer looking to cut interest rates, will the degree of payroll growth actually have meaningful impact on the U.S. dollar?

The NFP number is being released at the exact same time that ECB President Trichet begins his press conference (3 Potential Outcomes to the ECB Meeting), which means that we could see unusual volatility tomorrow morning. The ECB press conference and the NFP report will either neutralize each other or be a toxic combination for the US dollar.

Well, we're 24 hours before the most important market day of the year (tm), and stuff frankly feels a bit nervous. Liquidity seems to resemble most of the participants in financial markets these days: poorer than it used to be. Another chapter was written in the story that Macro Man began yesterday, as the Bank of Korea responded to the economy's inflationary impulses by intervening heavily to strengthen the won near the close of the domestic FX session.

Macro Man's heard varying reports, but consensus seems to be that BOK sold $3B or so against the KRW, which helped to push USD/KRW nearly 2% lower. BOK has plenty of ammunition - $258B in FX reserves as of the end of May- and it's frankly refreshing to see them being deployed in such a manner. (Macro Man has no exposure in KRW, and hence no axe to grind here.) Quite a contrast to our friends round Moscow way!

Oil continues to trade near elevated levels (above $143 as at the time of writing) on Iranian verbal threats, and the Dow Jones Industrial Average is down more than 130 points. Iranian Deputy Oil Minister was reported as saying Iran is ready to repel any attack, and said that an attack would disrupt oil exports and disrupt the entire oil industry in the Middle East. Middle East tensions are at the forefront again. Meanwhile, OPEC president said that oil prices reflect war risk, and to keep oil prices down, the US needs to stabilise the US dollar.

For the dollar to be stabilized, that’s not an impossible task. Further dollar decline could be prevented if traders can see a commitment by the Fed to fight rising inflation, but alas, the Fed thinks that inflation is likely to moderate later this year.

US-based investors are faced with a falling dollar. Any US-based investment is decaying due to an inflationary monetary policy and debasing of the currency. That translates into less purchasing power at the store and at the pump.

Many have recently been flocking to the Euro and while this strategy has been successful, Elite E Services feels this will be short lived as Europe has its own problems. It is a difficult environment to make any forecasts in FX or any other market, however we believe there are several safe plays that should be added to any portfolio: Gold and the Swiss Franc.

Barry Eichengreen, via Brad DeLong:

There are now fifty countries in the world with inflation rates over 10%. It's like the early 1930s, but just reverse the sign: back then everybody with their currency linked to the dollar imported deflation; now everybody is importing inflation.

We are back to the drawing board with the US dollar. Strong consumer spending and the lowest unemployment rate in 14 years could force the ECB to backtrack on their words and actually prepare the market up for more than one rate hike in the third quarter. The June consumer price index is expected to be at 4% double the ECB’s 2% inflation forecast.

Up until now the ECB has openly hinted that a rate hike in July will be one-off, but with inflation pressures continuing to increase and growth resilient, 2 rate hikes from the ECB this year is more than realistic.

It is a wondrous thing to be the global reserve currency.  We can run government deficits of any size that we want, and the rest of the world gets to fund us by buying our debt.  Thus, when I look at calls for still greater stimulus (through Government spending and borrowing) from men like Bill Gross, Larry Summers, and Bob Shiller, I just groan.  When does the rest of the world say “Enough!”, particularly the Persian Gulf States and other oil exporters who don’t have as much of an economic reason to support the US Dollar, because they don’t have to promote exports to the rest of the world?  But, perhaps for political reasons, they keep buying US debts.

This will not end well; the only questions are when, and how severe?  On this issue, I’m not sure it matters who the next president is, because the US no longer independently controls its own destiny.  (Great question for the debates: “Sir, what will you do as President to strengthen the Dolllar’s position as the global reserve currency?”  I would expect the intelligent equivalent of a stutter.)  The main barrier is that there is no good replacement for the Dollar as the global reserve currency.  The Euro could still fail; large-scale monetary unions need to be political unions for them to succeed in the long run.  The rest of the currencies are too small, or their banking systems insufficiently liberalized.

I think the ECB and in particular, Jean Claude Trichet, does not get it. The ECB raised its base interest rate by 25 basis point citing inflationary pressures. Guess what, the ECB is causing inflation. No sooner than they raise interest rates do commodity prices rise and voila (that is a word with French etymology), we get more inflation.

Of course, the ECB has a bigger nut to crack – the unions. The ECB faces labor cost push inflation which was to a great extent ameliorated in the US thanks to Ronald Reagan’s firing of the air traffic controllers and the erosion of the US car manufacturing industry. At this point in time the UAW is nothing more than a retirement management organization. What is the UAW going to do – strike? Sure, then we make less Tahoes and Expeditions. Big deal. Then the public buys more Corollas and Maximas.

There is talk of government intervention, banning of institutional investors from commodities, and recently on the CFTC website they released “emergency authority” which has been only used four times in history and not since 1980. The Commission has exercised its emergency powers in response to extreme events, such as manipulation or a specific disturbance that caused a sudden shock to the markets. The CFTC has never exercised emergency powers based on price trends that have developed over months or years. As opposed to speculators causing the dramatic increases in commodities prices, is it not possible that demand from emerging markets and the lack of investment by suppliers has created a structural change in commodity markets fueling higher prices? For the government to get involved at this point they would essentially be manipulating prices, or doing the same thing that they blame speculators are doing, Isn’t that ironic? They should not interfere and let supply and demand determine price. If this media attention does anything, we hope it informs investors on how serious of an issue we have at hand and the fact that prices of commodities may be rising for years to come.

Energies

Late in the week, crude oil broke out of the sideways consolidation we have been in for the last 15 days. On the week, August gained $4.36 and intra-day Friday we traded just below $143/ barrel. With continued weakness in the dollar, increased investor participation, and the lack of some type of intervention, $150 appears to be a self fulfilling prophecy. After 5 weeks of seeing draws in inventory we finally got a surprise build in oil inventories and even with that, prices were able to move higher. Generally when bearish news is ignored and prices trade higher it should tell you that prices are moving north. At this juncture we’re still content on the sidelines, but we do have a friendly bias being that prices have now broken out of the sideways consolidation. The 20 day moving average just above $134 should serve as support in August with the market now having its eyes on $150.

Will US Treasury secretary Hank Paulson beg for a delay in the inevitable series of rate hikes the Euro will see in the next two years?

Paulson has started out on a trip to Frankfurt in order to have a cup of tea with ECB president Jean-Claude Trichet and declared ueberhawk German Bundesbank president Axel Weber. He will see them at separate meetings before the ECB will decide on a possible rate hike in its governing council on Thursday.

In early Monday trading, the Euro continued to bob along the bullish wave that brought it to a three-week high of 1.5840 against the US dollar, before retreating back below 1.5780. Oil again rallied to another record high of $143.67 per barrel, so where else could the dollar go?

Today’s Chicago PMI manufacturing showed some improvement in the Chicago area, posting a reading of 49.6, still in contraction territory but at least not as bad as the previous month. This may stem the fall of the dollar as we enter the New York trading session. The US dollar’s fate this week will be determined by the US ISM manufacturing data to be released on Tuesday and the all-important non-farm payrolls reports for June on Thursday. A peek at the health of the labor market can be gleaned from Wednesday’s ADP private-sector report.