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It’s a big day for economy watchers with the US jobs report being the main centre of attention. Ironically, it is Labor Day on Monday, but I don’t think there is much to celebrate. In comparison to previous recessions since the 1970s, this is by far the worst recession in terms of job losses. Increasingly, previous economic recoveries have been described as ‘jobless’ recoveries. This time around you can export more of the same. A variety of auxiliary labour market indicators show that hiring is anaemic and the structural unemployment measures like the duration of unemployment or long-term rates of unemployment have risen sharply. The White House is looking at ways of trying to rectify this situation and press reports suggest that the President’s economics team is looking at ways to get the economy back on track as the mid-term Congressional elections in early November loom nearer. Should the unemployment rate move up, then Mr Bernanke will be looking to get the printing presses rolling again, not that previous efforts have done much to help the unemployed. As far as markets are concerned, a poor jobs report could stop this week’s equity market rally in its tracks. In the currency market, there is not a great deal to report and GBPUSD is hovering around the 1.54 level as it has been for most of this week.

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The latest economic data out this morning reported a dip in the construction PMI index to 52.1 in August from 54.1, while Nationwide house prices dropped 0.9% in August after a 0.5% decline in July. This is not particularly encouraging and suggests that the economy is still struggling and that the economic ‘recovery’ is fragile. The Bank of England doesn’t hold their monetary policy meeting until next week. I think that you will agree there is not much case for raising interest rates anytime soon. Indeed, even expanding quantitative easing carries no guarantee of success given that fiscal policy is pulling in the other direction.

Anyway, equity markets had a good start to the month after a poor August. I tend to focus on the S&P index as my guide to markets generally and I noticed that positioning and sentiment were at extremes (too many traders were short and bearish sentiment was close to previous highs). When everyone thinks the same thing and is positioned the same way then the ‘pain trade’ is a counter-trend rally which is what we got. Whether this rally has legs depends on tomorrow’s US jobs report, but my reading of auxiliary labour market indicators suggests that there won’t be much in the way of good news. There is no doubt that the US economy is slowing down and consumer spending is not much higher than it was last August. That is why the so-called ‘better-than-expected’ ISM data yesterday (a barometer of the manufacturing industry) needs to be treated with caution.

In the currency markets there is not a great deal to report. Both the yen and Swiss franc remain strong and there is no indication, as yet, of FX intervention to reverse those trends. Japan has a lot of political event risk in the next few weeks as regards a political leadership contest and the return of parliament. There has been a lot of talk of eroding the Bank of Japan’s independence, and the central bank being forced to do more QE. Sterling is a little softer against the US dollar this morning after the economic data at just under 1.54 but nothing too radical. The ECB holds its regular policy meeting today and is likely to keep rates on hold and extend emergency lending into next year. The ECB is also likely to raise its GDP forecast for this year after a Q2 out-turn of 1% in data reported this morning.

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The latest readings on the UK economy are not terribly optimistic. This morning’s PMI manufacturing index dropped to 54.3 in August from 56.9 and was the lowest level in the index in nine months. Likewise, yesterday’s money supply numbers show not much growth and without money supply growth you won’t get much growth in nominal GDP. In other words, the economy as a whole won’t enjoy any sort of sustained recovery. Likewise, data on the housing market pointed to a drop in house prices and low levels of mortgage approvals. At the risk of being boring, again there is nothing to suggest that higher interest rates are required. The Bank of England should stay their hand, given that fiscal policy is moving in the other direction.

Of course, the situation elsewhere is mixed and very reliant on China and Asia to keep on acting as the ‘locomotive’ for growth. Recent data shows that this is still the case so a global recession looks as though it can be averted. Germany is certainly doing OK, though that is not the case elsewhere in the eurozone as budget cuts start to bite.

In the currency market, the Swiss franc remains very strong and is making a record high against the euro. There is not a great deal that the Swiss National Bank can do about this as I think the currency strength is partly due to capital flight from some eurozone banks. Anyway, previous intervention earlier in the year did not work. Likewise, the yen on a trade-weighted basis has just exceeded its 1995 high and as yet (despite a lot of talk) there is no sign of actual intervention by the Japanese authorities. Sterling still remains soft and is making a low for the year against the Swiss franc, though not quite yet against the yen. Against the euro, sterling has partly given up the gains made since mid-July, though I think the euro still faces potential problems with some banks as well as government funding in the Club Med economies.

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The latest economic data out this morning is not exactly bullish with the Bank of England’s preferred money supply growth number still fairly soft. Mortgage approvals were still subdued but up a bit in July, though I guess that can probably be explained by the summer doldrums in the housing market. I think the real story though is that there are still a few people at the Bank of England who are not convinced that economic recovery is durable. You will have seen the comments from Charles Bean, the deputy governor at the Bank of England, who said at the weekend that there might have to be more stimulus to keep the ‘recovery’ going. Danny Alexander, at the Treasury, obviously isn’t listening, as he wants to rule out tax cuts for the next five years (and bad news for the folks at my old stamping ground many moons ago where Mr Osborne wants to take the chop to 25% of Treasury staff). Any notion that interest rates will go up anytime soon in this environment doesn’t make sense to me.

In the meantime, investors are nervous that the American economy is stalling and all eyes are on this Friday’s jobs report. I do not expect the report to contain any good news and the unemployment rate could well go up. That leaves the Fed with no other option but to switch the printing presses on again. The question being asked is will it work? Many are sceptical and think that you can’t cure a debt problem just by throwing more debt at it. However, what it does do is keep longer-term interest rates low, which is good news for company finance. It is unclear whether it does much to expand aggregate demand or prices. So this is a very difficult situation. Without wanting to be too gloomy, I recommend a very interesting research paper from Carmen Reinhart, After The Fall, that was presented to the Jackson Hole Economic Symposium last week which suggests that the next decade will be tough (click here).

In the currency market, the main theme is the strength in the yen and Swiss franc. There is plenty of talk about possible FX intervention from the Bank of Japan, but as yet no sign of action. Best to be careful, though. The Swiss franc is also strong as people take their money out of eurozone banks into Swiss banks…while the euro is treading water but might be riding for a fall if ‘round 2’ of the eurozone debt crisis kicks off. Sterling is still soft generally though there is the potential for some consolidation against the yen if the BoJ does act. All in all, plenty of volatility especially as equity markets look fragile.

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Today is set to be an interesting day. Ben Bernanke’s speech on the US economy is the centre-piece for financial markets as investors and traders look for fresh clues on US monetary policy as well as Mr Bernanke’s views on the state of the US economy. A month ago, he told Congress that the economic outlook was “unusually uncertain”. Since then, the economic numbers have got worse. The housing market is weakening with new home sales at a record low. The jobs market is soft and next Friday’s update on the unemployment rate is unlikely to contain good news. What is worrying is that despite zero interest rates combined with a large fiscal stimulus and quantitative easing (i.e., printing money), the ‘recovery’, which was sub-par over the last year anyway, is already petering out. A relapse into recession is a real possibility. Mr Bernanke is aware of the problems that afflicted Japan during the ‘lost decade’ of the 1990s, but he faces dissent within the Federal Reserve. My guess is that a return into recession and a potential slump in equity markets will concentrate the minds of the dissenters and allow Mr Bernanke to get to work on the printing presses again.

The big question is, though, will it work? The answer is that it is not clear. Liquidity is being hoarded by the banks and not being re-cycled into the real economy. Money supply growth is contractionary and monetarist commentators argue that without an expansion in money supply growth (and/or the velocity of circulation…MV in the famous MV=PT equation), then you will end up with deflation and economic slump. Maybe the ultimate end-game is simply debt restructuring, debt forgiveness and necessary liquidation and painful adjustment in balance sheets. If that is the case, then we are all in for a tough time. The same risks apply to the UK economy despite recent indicators like GDP in Q2 and yesterday’s upbeat CBI retail survey. Fiscal cuts have yet to be fully felt and so you cannot rule out bad economic news further down the road. In the meantime, sterling isn’t doing a great deal in the currency markets where there is greater attention at the moment on the possibility of intervention by the Bank of Japan to curb further appreciation in the yen. This morning’s CPI data out of Japan confirmed a slight deterioration in the DEFLATION backdrop. A lesson for us all.

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As the end of the month approaches, investors remain nervous about the prospects for the major economies as incoming news on economic developments provides little relief. Roiling the markets yesterday was the latest data on US existing home sales which turned out to be a shocker and just confirmed what some of us already thought, i.e., the US housing market is getting worse rather than better. More broadly, it is now looking like the US economy is moving dangerously closer to going back into recession, though many Americans on the long-term unemployment register won’t have been convinced by any evidence of a ‘recovery’ over the past year or so. Press reports of dissent within the Federal Reserve over the need for further monetary stimulus measures adds to the mood of uncertainty, especially in the equity markets where the near-term prognosis is not favourable.

Upcoming economic data from the other side of the pond, especially next week’s much-awaited jobs report, is unlikely to change the gloomy economic picture. However, an increase in the unemployment rate which sparks a stockmarket slump might persuade the doubters at the Fed to give Mr Bernanke free rein to print more money. The worry is that such policies (while averting a Depression and financial system collapse) have not delivered much in the way of a sustainable economic recovery. Maybe this is the ‘New Normal’ and that the reality is that the credit excesses of the recent past have to be resolved through further deleveraging and balance sheet adjustment. In this scenario, you can expect sub-par growth, high unemployment rates, low inflation and low interest rates for some time to come.

In the currency world, it is worth noting that the most traded currency pair, the EURUSD, has actually traded in a 1.18-1.33 trading range since the start of June. Now, the euro is in the middle of that range. Germany needs a weaker euro to keep its export engine alive. If the euro ever went back above 1.33, don’t be surprised to hear screams of pain from German industry. Exports are the only thing keeping the German economy going as consumer spending is pretty sluggish. Some commentators like Martin Wolf at the FT have (rightly) highlighted this consumption/savings imbalance in the eurozone, which is to the detriment of the trade deficit countries who are forced to become increasingly ‘competitive’, i.e., more pay cuts and unemployment, just to stay in the race with Germany. Ultimately, this will only cause deeper economic problems in the eurozone and a resurgence of the debt crisis.

Sterling has not completely recovered from the knock it took arising from Martin Weale’s warning of UK recession risks but neither has sterling collapsed either. For sure, there are plenty of stumbling blocks ahead, whether it be economic or political, but traders and investors are giving the currency the benefit of the doubt…at least for now.

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Martin Weale, the new member of the Bank of England’s Monetary Policy Committee, helped push sterling lower this morning with his comments that the UK economy faces the risk of a second recession. It looks as though he won’t be voting with his colleague Andrew Sentance for an increase in UK interest rates. For sure, the risk of a second recession (or, for many people, simply an ongoing recession) requires a long period of low interest rates for some time. Interest rates of 8% are crazy (as the economists at Policy Exchange are predicting), especially as we have yet to see the full impact of budget tightening come into play. My guess is that Mervyn King and the majority of MPC members understand and will turn a blind eye to any volatility in the inflation data (e.g. food prices).

In the meantime, it is also important to keep an eye on the global economy and there are increasing signs of a slowdown, especially the other side of the Atlantic. Economic growth in the current quarter is likely to be flat or negative and next week’s US jobs report could be a disappointment. Ben Bernanke, the Fed chairman, makes a key speech on Friday and I think he will pave the way for a second round of quantitative easing. This is good news for longer-term interest rates (bond yields) which can fall further generally (not just in the US) as the main economic drivers of deleveraging and balance sheet adjustment take a tighter grip. Japanese-style bond yields (i.e., 1%) are not impossible in the US, UK or eurozone.

In FX, this morning’s increase in German GDP numbers (which reported a 2.2% rise for the quarter) was all down to exports. Consumer spending rose by only 0.6%. German exporters would love a weaker euro and I would not be surprised to see further weakness here (even against the pound). The pullback in sterling I noted in yesterday’s blog might have just a little more to play out before traders find the currency attractive again.

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I’m back from my vacation but the financial world hasn’t changed much. Summer doldrums seem to have been the main theme with investors in an indecisive mood but concerned about a fresh downturn in the US economy. New data later in the weekly is expected to show a sharp downward revision to US GDP growth for the second quarter and the way the data-flow is stacking up, it looks like GDP growth could be flat or even negative I the current quarter. Although M&A activity is experiencing a sharp revival, it is all about the prospects for economic growth. America has thrown everything including the kitchen sink at the economy and the markets but the housing market remains moribund and the labour market has stalled. Next week’s US jobs report could be a defining moment for the markets going into the final quarter of the year especially as investment returns have generally been poor so far this year. I heard someone say that it is the return of money not the return ON money that matters. Yes, it is all about capital preservation and the fixed income markets are warning of a deflationary situation for some time to come in which the economy suffers anaemic growth and markets generate ‘half-sized’ returns. My guess is that the Fed has no choice but to implement even more quantitative easing but it is also important to get money supply growth rising again.

Money supply has been a neglected element in the economic debate but ‘old truths’ still apply and unless money supply growth expands (and it is flat in the US and eurozone at the moment) then you will not have the fuel to sustain growth in nominal income – which is why I nearly choked on my cornflakes yesterday when I read about a prediction that UK interest rates can go up to 8%! For what it’s worth I don’t see that, especially as the full impact of budget tightening has yet to be felt in the UK economy. In the interim, there is no doubt that retail sales and industrial production data is starting to improve but as yet one month’s numbers do not make a trend. The global economic environment looks less benign and much is dependent on China avoiding a ‘hard landing’. If they can’t, then we are all in trouble.

In the currency markets, I remain a euro bear. The eurozone debt crisis has yet to be fully resolved though there was a reprieve from the crisis during the summer. I think there is still more trouble ahead as countries like Ireland and Greece are enduring ‘economic torture’ as budget cuts are imposed and this will not be to the advantage of incumbent politicians. Sterling fell back from the 1.60 highs against the US dollar during my vacation to just above 1.55 currently. Better UK economic data hasn’t really had much of an impact as yet but maybe the prospect of worse news down the road is capping sentiment.

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Well, we are at the end of the summer holidays (for those that took them), and many of you will be coming back from the beach wanting to know what is going to happen next in your financial future. No one knows. But we need to try to take a best guess. After all, with interest rates at a virtual zero rate and equity markets and housing prices once again falling (the two major capital propellers of your wealth in the last 30 years), cash on deposit is only any good to you if deflation and capital destruction are occurring everywhere else. Otherwise, as you have become accustomed to, you want to put your money to work speculatively to pay for your historical lifestyle which is probably at a level unjustified by productive tax earning work and current returns on your cash. Let’s be honest, most of you made more money out of your home(s) and equities up to 2007 than out of your jobs or businesses. That pathway is at an end, and it is this truncation that explains the existence of so much angst amongst the public, in my opinion. No one can fathom how they are going to maintain their previous lifestyles merely through hard work and after tax income without asset price inflation to help them.

Nevertheless, there are some ways to exploit this widespread public angst, this removal of asset price inflation from the investment communities’ psyche and make some money in financial markets, because financial markets too need to adjust to the “new normal” economic environment, and they are taking a long time to do so. Most investors want the markets to return to the 'old normal', and continue to analyse valuations based on 'old normal' measurements. Those same institutional investors have a lot of cash to invest, can only buy, and see sell offs as opportunities. So it is dangerous to be too bearish. Bear markets, and we are in one, do witness strong rallies.

Here are my top tips for the next four months:

1) Gold – I expect gold to accelerate higher into yearend extending the steady climb that we have seen from $1160 to $1235 in the last few weeks.  There is no alternative for governments or central banks other than to continue to intervene by expanding the debt mountain and debasing currencies via further quantitative easing. My forecast for gold has long been that we will see $2000 at the beginning of 2011, and whilst this may appear aggressive at this time, I still wouldn’t rule it out. The bigger problem is where to buy it if you haven’t already. I still view the low $1200’s as possible, with risk established against $1188.

2) Follow the Euro Swiss exchange rate carefully. It looks to be headed lower to at least 1.25. if so, given its correlation with equities, the rate has grave implications for capital destruction in the equity market.

3) I believe that equities themselves are headed at least 10% lower from here. Many technicians (and I am not one) are making this call to be followed by a significant rally. Let’s deal with one move at a time. If I am right, the S+P 500 will trade below 1000.

4) The Yen – it has diverged from the Swiss Franc as talk from the Bank of Japan and the Japanese Government protest against a strong Yen. There is little they can do, as the Swiss themselves found out in 2010 to their cost. The Yen is going to go towards the Y80 level versus the dollar, with the risk of an overshoot, and GBPJPY is headed down to the Y120 level, I feel.

5) Long term interest rates are too extended in the view of many, but not when you compare them to Japan. Until trade protectionism breaks out in 2011 to defend domestic labour markets, bond yields should head lower, and the US 10 year yield, currently at 2.56 should reach 2.50 and then 2.30.

6) What of GBP? Well, I am forecasting it to fall to the Y120 level, and the Yen has parallels with the Swiss Franc. So to make money from buying GBP, either it will need to be against the dollar, the Canadian dollar, or the Euro, given that Australia is too expensive to sell and hold. My view on GBP is to be patient – let’s get through the October fiscal austerity announcements, see if the coalition can stick together, and then pick up some value versus the US dollar, and maybe the yen if we get to my levels above. GBP could be a very big beneficiary of the next equity market rally that will surely follow the current bout of pessimism and decline that lies dead ahead. I do not expect a crash in equities at any time, more a medium term grind to lower and lower levels of equity valuation over the course of the next couple of years, interspersed with strong rallies as investors cling to the illusion that the 'old normal' can return. It’s can’t and it won’t. You must get used to this change. The quicker you do, the more wealth you will be left with.

Good luck, I hope the last two weeks have been helpful – if you want to ask me questions, please feel free to email me directly at philip.manduca@ecugroup.com. Neil Mackinnon is returning from holiday and resumes his regular blog next week, which I look forward to reading as usual.

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A tough day for day traders in FX (and just about all other markets yesterday) as the ‘risk on’ and ‘risk off’ correlations moved the dollar up initially and then down hard, followed by it settling somewhere in between. Equities followed a similar path and curiously so did gold, although the latter’s movement was not supported by a similar movement in silver which is worth noting. The gold:silver ratio has been widening for some time which is bullish as gold really is a pure safe haven and alternative to money (forget those who are talking about the likes of Indian jewellery demand as a bullion fundamental in this environment; it is just not a factor), whilst silver – and to a greater extent platinum – have industrial and economic components to their valuations. Anyway, gold tested $1,220, before ratcheting higher to $1,230. The price action is very positive. Buyers just can’t buy gold cheaply at the moment.

Elsewhere, equities tried to push higher again yesterday and many savvy traders that I speak to feel that the pain trade – defined by a direction in price that suits the least amount of people with opposite positions – is higher. You may remember that I referred to this ‘pain trade’ in equities a lot last year, predicting that equities would rally until they forced investors to buy into the rally and suspend or cancel their scepticism, at which point the bear market rally would be complete. This duly happened, culminating in the bear market rally highs in the first part of 2010.

I do not get the same feeling now. I believe that higher equity prices in the next few weeks, which I do not forecast, would not drag in money from the sidelines, the owners of which continue to preen themselves in public, praising their wisdom in liquidating anything that was saleable in 2010. Liquidity, they state proudly, is key. I can’t tell you the number of people I meet, all of whom would be described as very high net worth, who wish to shed themselves of anything they can that requires regular cost maintenance. They are not receiving income on their cash and nor do they expect to do so in the next few years. They feel owned by their toys and there is a fire sale of toys throughout the western world at present (in the US, private jets are down 70% from their peak prices), which I feel will only worsen in 2011. Nothing, it seems, would get these people to re-invest in risky assets and they feel that equities, generally, are risky assets.

Yet the wealthy are bored in cash – they have nothing to publish their intellect and superiority with and this irks the very rich who are driven by the need for acclaim and recognition. They are all listening and talking to any intelligent opinion they can buy, but it has more to do with assessing the financial climate and how to preserve their wealth than figuring out how to do a fast deal for further gain. They are talking but they are not doing. There is real nervousness out there. Cash is being hoarded by banks, by corporations and by the wealthy. Those that need to borrow are either paying ruinous margins or just can’t access it. I suspect that there are queues of attractively priced deals lined up outside the door of every cash rich entrepreneur today from which he can choose. I repeat – this is not a bull market environment in the making. This has all the hallmarks of a long bear market in existence.

In the short term, I sold some equities yesterday with a tight stop loss, preferring the French market over the German and UK ones as we are already short UK Plc in cable (GBPUSD) and GBPJPY. I continue to believe that gold is pricing in QE2’s inevitability (by this I mean the second round of quantitative easing), which means new highs beckon above $1,265. We liquidated positions at $1,258 previously, but would not do so this time. I still feel the Canadian dollar is due for a major reversal sometime soon to reflect my economic outlook, once some of this current M&A noise dies down. True, there will be a lot of M&A noise for some time to come but not all as noisy as BHP’s recent bid. Have they got the cash to wage an aggressive buying spree on Potash? I don’t think so, but it does look like they need to do the deal. The debt to cash ratio will be key to monitor here.

Lastly, to update you on a favourite money market indicator of mine. One year money in one year’s time in the UK is priced at 44bps, less than half a percent. Given that the base rate is at 50bps, and three month money in four months time is priced at 75bps, what is this telling you? It is not good, is it?

I am writing my last blog tomorrow, before Neil returns from holiday, so I will try to leave you with some hard forecasts for the rest of the year.

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A strong rally in equities with the S&P500 and Stoxx600 +1.22% and +1.12% respectively yesterday gave the bulls some hope as they point to a renewed rally in copper, a significant M&A deal between Australia and Canada (see below) and the failure of the bears to gain any downside traction in the last week. Don’t be fooled – indeed, take advantage. This equity rally should see a lower high than the past (SPX below 1,130) and, just because equity markets are not cascading lower, this does not mean that they are not headed lower. They are, unfortunately, along with house prices (a lead indicator in the US yesterday – building permits – declined 3.1%). My central forecast has never been for another crash – there is simply too much liquidity and government support for the financial infrastructure. But there is not enough of anything else and that is the problem. I am seeking to sell rallies in equities, bond yields and commodity currencies, and to buy the currencies of trade surplus and safe haven countries such as the US, Switzerland and Japan. I am still looking for a renewed test of JPY80 versus the US dollar, which must mean I am targeting even lower relative levels in GBPJPY. I am. We are short from above JPY136, and have an intermediate target of JPY130-132 with an ultimate objective of below JPY120.

Elsewhere, the Canadian dollar rallied strongly yesterday on the announcement of BHP Billiton’s unsolicited offer for Potash Corp of Saskatchewan in a deal valued at $39bn. Yet in a sign that financial markets prefer to see cash not debt used for expansion, BHP's 5-year credit default swap is about 19bps wider on the day at 87/90bps as credit markets are concerned the company's credit profile may come under negative pressure if a successful deal is primarily funded by debt. Indeed Moody's overnight announced that BHP's A1 rating may be placed on review for possible downgrade "if a formal takeover is made, and predicated upon substantial debt raising". I am now short the Canadian dollar.

Today we get the UK MPC Minutes. The minutes in mid-quarter months are usually pretty uninformative, coming just a week after the much more exhaustive analysis in the Inflation Report. The August Report referred to “particularly large” degree of uncertainty about inflation and pointed to low to no wage growth, excess capacity and future budget cuts to exacerbate a deteriorating economic outlook. Rumours have begun to circulate, not without credence, that two members of the MPC actually wanted to resume quantitative easing. If this is reported within the minutes today, GBP will get damaged and accelerate a trend that has already seen it fall 3% against USD in the last ten days. I am targeting a return to $1.50.

Gold consolidated its rally on cue yesterday but did not correct, which again disappoints those – us included – who either wish to add or initiate positions. That’s a good sign.

The Daily Telegraph in the UK is publishing an interesting macro story this morning – labelled “Time is running out for the West”. They report that the Great Recession has dramatically shrunk the time left for the big AAA states to prevent a full-blown sovereign debt crisis as their demographic time-bomb threatens according to the US rating agency Moody's (click here for the article). Solid beach reading for the majority.

In the longer term, if I am not writing this blog at the time, remember to monitor the debate about Chinese monetary policy. Markets are somewhat buoyed, especially the commodity currencies and the base metals, by the prospect of a cessation to China’s recent monetary tightening and the commencement of a fiscal stimulus package. Keep an eye on the existence of floods and droughts in different parts of China which, in my opinion, suggests that food prices are not declining, contrary to a lot of talk in the street about the moderation of domestic inflation. The risk is thus for a higher CPI print from China in September. If inflation remains elevated, the likelihood of a China stimulus package becomes remote. The next CPI print is on 11 September. Otherwise, keep your eyes on GBP. A long-term buying opportunity is beginning to form in GBP but, like all such opportunities, there is more time and downside price action required first to get to the extreme levels that will make it one of the bigger risk reward opportunities prior to year end. I think the downside price action in GBP and equities has already commenced. The time cycle analysts believe that equities can sustain this rally for a week or so longer prior to falling. We will see.

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Well, the last of the summer holidays is approaching (they ended as far as the weather is concerned a few weeks ago in the UK!) and the financial markets are quiet. Quiet but not asleep. As usual, there is divergence building between valuation and price, and out of the current low price volatility we will get new trends over the next fortnight as prices play catch up. But in which direction?

My own analysis is that the numbers, whether they be fiscal or economic, do not point to optimism. Show me where I am wrong if you wish to disagree. Has all the hope been priced in? Where is the growth coming from without further public sector stimulus? The situation is quite the reverse in the UK and Europe, with corporates hoarding rather than re-investing their cash, and with the middle classes in dire need of extensive personal deleveraging to repay their debts amidst more neutral prosperity forecasts. Housing markets in the UK and the US are now pointing emphatically downwards again and consumer confidence is falling alongside real wages. Treasury bond yields, an area I started my career in, have historically always been the best predictor of future economic direction, and they are falling very hard now. Lower bond yields equate to lower interest rates, which generally do not accompany economic growth or reflation. The Federal Reserve clearly does not think that they have fallen far enough and are trying to push yields even lower by re-commencing their purchases of Treasury bonds. Why would you need a 2.6% yield on a 10-year Treasury with the Federal Reserve ready to be a buyer if yields tick back up (effectively providing you with a stop loss) when the 5-year future inflation rate in five years time is only expected to be 2%? For those that believe that a higher interest rate move is coming in the UK, 1-year money in one year’s time is now priced at below the base rate! What’s that telling you?

In the micro world yesterday the US released its TIC data, which details who is buying what in the US Treasury market to fund their trillion dollar deficits. China’s holdings of long-term Treasuries fell in June for the first time in 15 months, dropping by $21.2 billion to $839.7 billion. This is the largest ever monthly decline in China’s holdings and may be one reason why the Federal Reserve has focused solely on buying Treasuries in its attempts to debase the currency. I think that the Chinese, who have made a fortune out of the 2010 bond market rally, are taking some profits and diversifying into Europe and Japan to prop up their trading markets there.

In Australia, the Central Bank (RBA) believes that underlying inflation has only just retreated to within target for the first time in three years, economic capacity is constrained, above-trend growth is forecast and annual income growth is expected to surge into double digits. The RBA’s central view is that the muted household spending trends through the first half of 2010 will continue through the second half of the year and, although further rate hikes are currently on hold, the RBA is clearly biased to raise interest rates again, if global economic conditions do not deteriorate in the next month or two. I am not bullish of the commodity currencies at this time because I suspect that rates expectations are priced too highly and too many traders are long of them. The rates are wonderful whilst you can get them, but I suspect that they will be lowered not raised as the market expects over the balance of 2010 and into 2011. This makes currencies such as CAD and AUD and ZAR (The South African rand) overvalued.

In Europe, peripheral country credit weakness is gaining traction again as a concern. Indeed following a week-long build up of what were seen as negative stories, yesterday's data showed that Portuguese banks have increased their ECB borrowings by 21% in July which is not a good sign. However much of the peripheral weakness was likely due to investors and dealers making room in thin markets for today's two Irish bond auctions in which the government aims to raise up to EUR1.5bn in 2014 and 2020 maturity bonds. These auctions should go reasonably well now as bonds have cheapened up considerably as the 10-year yield has widened by 76bps against Bunds since their recent level in late July. Indeed Irish 5-year bonds and 5-year CDS are 99bps and 98bps wider respectively over this period, 7bps and 20bps of which occurred yesterday. Ireland 5-year CDS is now trading at its 2010 widest after its ninth consecutive business days of widening.

Gold pushed on further in a rally that I have been promoting for the last week whilst writing this blog, and yesterday touched $1,227. A correction is due and if it falls back towards the $1,210 level, I would buy gold again as I think that the acceleration and biggest degree of rally in this market is ahead of us. Yes, we have rallied from the $240 level over the last nine years, but it has not been a rally filled with $50 or $100 daily changes yet. You should see this occur before this bull market ends and I believe that gold will be in excess of $2,000 at that time.

Today, the economic releases are UK July CPI, where a small drop in petrol prices is likely to have depressed the headline inflation rate a little further to an expected rate of 3.1% year-on-year after 3.2% in June. US July housing starts are expected to bounce to +2% month-on-month after last month’s 5% decline. Consensus is at +2%. US July PPI is expected +0.1% month-on-month in the core rate and US July Industrial production is expected to be +0.5%. Watch the German ZEW confidence data – it will be strong as the Germans are buoyant with the success of their export drive. Germans have a history of being euphoric at other countries’ expense, and peripheral Europe is not unaware of their own miseries in comparison. The Germans have used Europe for its exports and appropriated its manufacturing base whilst Europe has used Germany to achieve lower interest rates in a world of deflation. Yet it is the Germans who are preening themselves whilst peripheral Europe faces austerity measures that they simply will not be able to swallow, after becoming used to years of public sector corruption and socialist benefits that have kept their lifestyles at levels not warranted by economic productivity. Become more German is the advice from Berlin. We have heard this before, haven’t we? This is another stress building in the eurozone for 2011.

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There was a mini trend reversal in many markets last week. As recently ago as last Monday's close, the S&P500 and the Euro Stoxx600 were trading at 17- and 21-week highs respectively. Since then they've fallen -4.3% and -2.6% respectively. Clearly the more pessimistic tone from the Federal Reserve and the admission that a cessation of the monetary exit strategy by the Federal Reserve was necessary were pivotal factors. In addition, US and China data showed further slowdown and with problems resurfacing in the European Sovereign space before and after the recent equity market peak, risk appetite deteriorated. Indeed credit markets started to turn nearly a week before.

Ireland was the catalyst as negative press stories started with fresh concerns surrounding its banking sector, specifically around Anglo Irish Bank's recapitalisation need and Bank of Ireland's weaker-than-expected results last week. Reports also suggested that loans transferred to NAMA were performing below expectations despite the massive haircuts already undertaken. Also, uncertainties around Anglo's restructuring proposal have weighed on Ireland's sovereign risk as media reports suggest that failure to approve may push Ireland's Debt/GDP ratio higher. Irish banks aside, we saw reports noting that Ireland's tax revenues in July were down 8.2% versus the same period last year. A 16-year high of 13.7% in the unemployment rate in July has been taking its toll on tax receipts. The portents for the success of proposed fiscal austerity in wider Europe is under examination. Away from Ireland, the past week also saw weaker GDP and unemployment data in Greece, and Friday's data showing that Spanish bank's ECB borrowings increased in July was accompanied by a weaker-than-expected Italian bond auction.

Even continued strength from Germany has failed to lift the mood. Indeed Friday saw a sparkling Q2 GDP number from Germany (+2.2% quarter on quarter versus the expected +1.3%). However, the fact that Germany is so buoyant while the peripheral remains weak (Greece and Spain GDP numbers disappointed slightly) perhaps highlights the difficulties in a ‘one size fits all’ monetary, fiscal and FX policy for the EU. It's hard to imagine these economic tensions alleviating anytime soon. They'll likely be with us for years. It's how the authorities respond that's the key.

Over the weekend, Yu Yongding, former adviser to the PBOC and member of the foreign policy advisory committee, has been on the wires indicating that Chinese reserve managers are becoming bullish on Europe and Japan while turning more negative on the US. China has been buying ‘quite a lot’ of European bonds, he said, while Japan Ministry of Finance figures also show China as a net buyer of Japanese debt (first half 2010 purchases have been at the fastest pace in at least five years). In keeping with recent comments, Yu has stressed the importance of reserve diversification. I view this statement as more political than financial – China is diversifying, but it is also focused on propping up the euro, as the eurozone is a key two-way trade partner.

Eisuke Sakakibara, formerly Japan’s top currency official was also on the wires over the weekend saying that what the markets are seeing “is not appreciation of the yen but weakness of the dollar, reflecting concerns that the US economy may falter.” He predicted a move to record highs in the yen versus the dollar. Sakakibara spoke after Finance Minister Yoshihiko Noda last week refrained from outlining steps to slow the yen’s rise and the Bank of Japan maintained its policy guidance. Note that a meeting between PM Kan and BoJ Governor Shirakawa is expected this week.

Meanwhile, gold continues its move higher, touching $1,220 as I write. I am still looking to buy gold on any setback and believe that further monetary debasement is inevitable.

Lastly, watch this week’s data in regard to purchases of US Treasury securities – if they confirm the Chinese statement above in regard to a significant reduction of Chinese buying, and as the US prepares for its mid-term congressional elections, I expect the anti-Chinese trade rhetoric to escalate in the US, creating further tensions in financial markets in the weeks ahead.

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Financial markets consolidated on Thursday except in a key focus area of mine – gold. A $17 rally saw gold break above the $1,210 level of technical resistance and, as I write, it is now trading at $1,217. It won’t be a straight line rally to new highs as the gap between now and when the Federal Reserve confirms its policy of accelerated currency debasement might be as long as several months. So gold will be vulnerable to profit taking bouts. However, a bull market can be defined in many ways. One is that it is hard for buyers to buy. For those seeking a correction to the $1,140 or even $1,060 levels, they have now been disappointed and are being forced to pay up to participate. If you can get a dip below $1,210, with a tight stop just above the $1,200 level, or circa $1,190 for those with bigger pockets, I think we have begun an acceleration here as gold anticipates the final solution from the world’s central banks.

Elsewhere, I was informed yesterday that fully 18.5% of Americans are underemployed. In addition street lights are being turned off in several US cities as police forces are also being reduced. Government at local and national levels are broke and not just in the US. It is only the largesse of yield-hungry investors and trade recycling emerging countries that continue to finance them. But for how much longer?

This morning already, one of those trade winners, the Germans, published their Q2 GDP at 2.2% which was a lot stronger than the 1.3% expected. It was the highest quarterly sequential increase since unification. All components of this release were strong. This is continued evidence of divergence between Germany and the European periphery where the GDP figures have not been so great. The Greek economy contracted sharply in the second quarter as government austerity measures bit deeper into incomes, according to government data released on Thursday. The national statics service Ellsta said on Thursday that Greek Q2 gross domestic product fell 1.5% on a quarterly basis, weaker than forecasts of a 1% drop and the 0.8% fall in Q1.

The Swiss National Bank reported this morning that it made a total loss of CHF2.8 billion in the first half of this year due to “exchange-rate-related losses on investments in euros”, one of the reasons why renewed interventions versus the euro are, barring any dramatic event, very unlikely. I expect the Swiss franc to strengthen further towards the 1.30 level against the euro.

In light of yesterday's focus on the Irish bond auctions, it is worth keeping an eye on today’s Italian auction of EUR3.5bn of 5-year and EUR2.5bn of 15-year.

Otherwise, have a good weekend.

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You see, if the economies of the US and wider Europe deteriorate by more than the optimists had expected, there are serious implications for the debt side of the debt to GDP ratios that investors have been pricing interest rates, domestic credit markets and the risk of default generally, and also how the rating agencies have graded credit risk levels for countries. As a consequence of the downgrading of the global economic growth story in the last few days, the next phase of market turbulence will come in three parts. First will be the worry that the recent projections of future economic growth will not be sufficient to reduce the need for higher government spending, for which read debt. Subsequently, if economic growth is not strong enough, then nor will tax revenues be as strong as anticipated, exacerbating the debt strangle and requiring less austerity or fiscal contraction. In which case, the third phase will be political capitulation and abandonment of any fiscal discipline as the populace (read: voters) demand more sugar.

This is the road we are headed down and there appears simply no way that the emerging or petrodollar countries can bail us out, having drained much of our money in the last ten plus years through subsidised trade practices or inflated oil prices all in the name of keeping world peace. We have been taken for mugs and the Middle East and Asia continue to laugh and prosper as they shop in Knightsbridge and 5th Avenue and buy prime properties in Mayfair and Manhattan. There will be a backlash by the US especially and Europe and it will be trade protectionism driven by the need to alleviate rising unemployment, but that will be next year’s story.

In the meantime, and consistent with the message above, watch the Greek unemployment news today. Ireland has begun a secondary spiral in its finances and is having to increase funds made available for another bank bailout. It has set alarm bells ringing everywhere as they were the first to impose strict fiscal austerity measures on themselves. Is this what happens? The UK is watching. So is socialist Europe, which has a low threshold of social pain.

In the markets, put simply, we had a meltdown yesterday. The euro lost over three big figures against the dollar (touching 1.28), the US equity market was down over 3% and commodities got hit hard. There are a lot of optimists out there and they won’t give up easily, so expect equity and FX markets to try to generate a countertrend rally imminently in continuing low volume conditions. This may get cable (GBPUSD) back up to 1.58, and the euro just above 1.30 again against the dollar, but I will be re-selling there. I note the Nikkei has now broken technical support, so watch out. In addition, platinum has also broken support, taking silver but not gold down with it. Gold remains a focal point for me.

When you take a step back on that beach that you are probably on and look at the bigger picture, you need to answer one big question: where is the new wealth in the West going to come from to reduce our indebtedness and allow prosperity to return? There is no new major technological invention occurring to generate mass purchasing; there is a surplus of labour in the world dampening income and wages; raising tax rates does not necessarily equate to higher tax revenues; consumers want to save and deleverage and not spend. So too do corporations, who are hoarding their cash. Put simply, the government finances in Europe, the UK and the US simply do not add up. There is going to be another problem, a bigger problem in 2011-2012. As we know, it has already all begun. It began in 2007. Sovereign bankruptcy has been alleviated but not been solved by issuing more debt and the debasement of local currency. More of the latter will be forthcoming over the next few months to fuel optimists and sustain hope. But it won’t solve the bigger problem. The maths just don’t add up.

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Last night the Federal Reserve did not renew a policy of quantitative easing, consistent with my expectation. What they did do was halt their exit from a super-loose monetary policy and become more downbeat about current and future economic growth prospects. I expect the Bank of England to mirror this prognosis in today’s inflation report which releases economic growth projections as well.

What is going on here is a gradual re-pricing of future growth and inflation projections by Western markets. Asia cannot decouple from this and its turn to re-price is next, as are the values of the commodity currencies of Australia, Canada, Brazil and South Africa. You cannot have a globalised economy on the one hand and, when it suits you, believe in a world capable of decoupling. Free trade and economic mobility remain powerful linkages until governments and laws break them.

The upshot in FX is to decide where you want to place your money. I am in no doubt. In a slow and slower economic growth world, which has only just begun to dawn on FX over the last day or so, I would bet on the US out performing Europe every day of the year going forward, and continue to believe that many of the fearful out there will trust the USD as a safe haven currency more than the fiscally segregated euro, or sterling which is yet to witness a severe bout of middle class deleveraging and fiscal contraction.

What about the high growth Asian currencies? There are enormous risks emerging in the emerging markets as they have increased their capacity over the last five to ten years to match the ‘old’ normal levels of demand and growth, and must now contract amidst high levels of domestic inflation and even higher social expectations. Life is going to become tricky for the likes of China. Overnight, Chinese growth softened, retail demand softened too, and inflation crept higher. No matter what, I expect Chinese growth to come in roughly between 8% to 10% for some time to come. But it is the nature of that demand that matters. The Chinese government would love to export their way to glory. The Chinese populace want to earn more money from that export growth to buy their own goods and generate domestic retail demand, which would suit the rest of the world. In the absence of growth in either, the government will continue to build roads to nowhere and infrastructure everywhere. It comes down to the quality of the Chinese growth story and I am certain that exports are going to come under increasing demand and protectionist pressure as we move into 2011. China is no guaranteed investment bet, regardless of what your friendly investment broker tries to tell or sell you.

Of course, I prefer gold to the dollar, and my recent nerves are somewhat pacified by the reluctance of gold to sell off, despite the lack of aggression from the Fed last night to debase its own currency – it will debase, and gold will explode higher. But not yet. So gold remains vulnerable to a move lower to offer better buying levels. As I will say every day, do not be short; for those that can afford to hold, stay long. For those of a shorter-term nature, keep your stops tight and hope for a move above $1,215 quickly.

Elsewhere, for those equity bulls out there (‘equities are cheap’ – they aren’t!), watch the Nikkei closely. Major technical support is upon us, a sustained break of the 9,200 level has major significance for other equity markets. The ‘new normal’ level of economic growth and standards of living is not going to be a pleasant experience for equity markets or their owners, who are still trying to price their investments and their lifestyles to the ‘old normal’ levels of economic growth and prosperity that they got so used to. Those days have gone. Gone for good. Falling bond yields are confirming this and those same bond yields will continue to decline over the next few months, barring a sovereign default crisis. Declining yields are not a harbinger of reflationary economic growth. The new world is going to feel very, very tough.

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The beginning of a dollar rally or the pause of the recent negative trend? As an investment manager, nothing happens in financial markets without creating a dynamic of many questions, several answers and one conclusion in the portfolio return. I have been looking for GBP to soften and last night further evidence of the need for middle class consumer deleveraging was delivered in the RICS UK housing price balance, which was -8% compared to the +5% expectation and the +9% previously. I had received advance information on trend from our private banking counterparties in the last few weeks who have been telling me that the housing market has been softening since June and that there is an increasing supply of properties and fewer overseas buyers emerging. This trend will continue for some time, in my opinion, and my forecast is that house prices in the UK will decline a further 10% de minimus over the next 12 months and by significantly more at the top end. There is so much development-owned residential property still hanging onto to historical price levels which were given to the banks upon purchase to secure the original financing and which no longer bear any resemblance to demand or current market levels. The banks know this too, but prefer to avoid revaluations at true and lower prices so that they can carry the properties on their books as though the loans remain healthy. They are not healthy. In my view, house prices will fall in the UK over the next 12 months, many developers are going to go bust, and banks are going to end up with distressed properties on their books as they failed to force the developers and weak loan holders to sell into a tradable market in the last 12 months. Minimal new wealth is being generated and those that have wealth have already got too many houses with too much servicing cost in an environment of no interest income on their capital. Everyone wants to deleverage.

In the US last night, McDonald’s Corp's better-than-expected comparable store sales growth for July was taken bullishly by some in the equity market. Really? When consumers move downstream to dine on hamburgers, I do not see this as a sign of prosperity. And why would consumers be prosperous with no wage growth, no employment growth, economic uncertainty, and the consumer and investment moods souring noticeably? Suddenly even Americans, the most commercially optimistic nation on earth, are no longer sure that tomorrow is going to be a better day.

Elsewhere, China continues to drain the world’s wealth as its trade balance came in higher than expected ($28.73bn v. $19.60bn). Such numbers will help continue the pressure on China to quicken the pace of revaluation and heighten Western trade protectionist pressures. How long before US politicians urge Americans to ‘buy America’ to give a fellow countryman a job? Worse, the Chinese data was exacerbated by a slowdown in imports, bringing no relief to the European (read: German) and US export machines.

Overnight, the Bank of Japan left policy unchanged. Today, will the Federal Reserve in the US do the same? The market desperately needs and expects another dose of monetary adrenaline as it continues to behave like a desperate junkie. I don’t think that the Fed will deliver although it is a close call. I noted Fed Chairman Bernanke’s comment in regard to unemployment last week when he stated that “it was unacceptably high”. The Fed’s mandate is to govern both inflation and employment. In addition, the potential for a complete washout in the US housing market, which is threatening another bailout of the Government mortgage agencies (FMAC and FNMA), is real, probable and expensive. The Fed will want to drive rates lower to assist mortgage levels. Yet I also feel that the Fed knows that it can’t keep bailing the market out each time it cries. I think the Fed waits to see how Q3 GDP turns out and saves its scarce powder until the start of Q4. This is going to disappoint equities and much of the FX market. I continue to believe that the yen outperforms (if equities start to fall hard, it will act as a safe haven currency, and if the Fed commences another round of quantitative easing, driving US yields lower towards Japanese levels, the yen strengthens too). I remain bearish of GBPJPY and cable (GBPUSD), and have managed to reduce the risk on our Dollar debt book, FX managed accounts and Global Macro hedge fund by tightening up our stop loss levels behind the overnight drop in these cross rates. Gold is just about holding onto the USD1,200 level and my general nervousness about the sustainability of this rally remains valid. If the pessimism (above) is right, look for the biggest losers to be the commodity currencies. More on that later this week. Enjoy the day, whatever beach you are on, from a rainy London this morning.

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Well, the unemployment news in the US came and went on Friday, and has been superseded in importance by the market’s expectation (read: “need”) for more monetary loosening, or quantitative easing, from the US central bank. My own bet is that the Federal Reserve continues to wait prior to debasing its currency and bailing out the US housing market, which it will have to do, especially whilst equities refuse to sell off despite sustained evidence that low growth is here to stay. I feel that the equity market is running on fumes at present with continued withdrawals from US mutual funds and increased inflows into safe haven investments such as government bonds. The evidence is that equity markets have not yet priced in the ‘new normal’ of flattish growth and low inflation for the foreseeable future, requiring mass middle class consumer deleveraging despite further evidence within the US employment report of negligible income growth.

My own conviction trade at present is that the yen continues to strengthen by more than most expect, targeting JPY130 versus GBP and JPY80 versus the USD. Indeed, I feel that the UK faces the headwind of a downbeat Bank Of England growth report this week followed by political risk next month in the run up to fiscal austerity. Note that the 5-year Gilt now yields below 2%. Is this due to inflation worries? I don’t think so.

Elsewhere this week there is a Federal Reserve monthly meeting, a lot of US treasury bond issuance (which may give better yen buying levels as US yields try to attract buyers of over $75bn of treasury bonds), and a lack of willingness amongst investors to assume risk. I do feel that there are many watching their Blackberries on the beaches waiting to buy into the present USD weakness and are waiting for a price action trigger to do so. When it happens, look for a severe reversal in USD weakness. But at the moment, the dollar remains weak each and every day.

In regard to gold, the support at USD1,160 continues to hold, and whilst it does, stay long. Do not be brave if it weakens. If QE is not forthcoming from the Fed and the USD starts to rally, gold may come under renewed pressure. I would not be short, ever, of gold, but would keep stop loss orders tighter than normal on this latest rally. Until gold breaks back above USD1,260, I remain a more cautious bull than my normal natural exuberance with the yellow metal, still targeting USD2,000 within the next six months.

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Today sees the key US employment data released. Frankly, my view has been that we are in a secular phase of minimal to zero employment growth with minimal to zero real wage growth, as the global labour arbitrage story sustains – this means that cheap labour in Asia is exactly that: cheap. While it remains cheap, industrial production will continue to relocate there, leaving us with surplus overpriced labour in labour intensive sectors in a global economy. This has obvious implications for consumer spending in Europe and the US. Hence the viewpoint that we are in for sustained low growth for some time to come. Debt deleveraging is required, because leverage was assumed on the basis of higher growth and higher inflation. Deleveraging has barely commenced, although savings have increased. Not good news.

What this means is that interest rates are likely to go lower. I was on Bloomberg TV yesterday (click here) saying exactly this, and I can see another 50bp off the US 10-year Treasury yield at a minimum. For those in the UK, note that the 5-year Gilt is yielding 2% again, the same level as in the depths of the financial crash of 2008. The yen is likely to flourish as European and US yields continue to compress on Japanese rock bottom yields (their 10-year yield is at or below 1%). I am targeting JPY80 versus USD, JPY120 versus GBP, and JPY105 versus EUR sooner rather than later. Elsewhere, gold continues to remain above USD1,160 which is a key support for me. Whilst above this level all looks good, but I wouldn’t be brave if we break this level. The market is expecting the Federal Reserve to commence another round of quantitative easing sooner rather than later and I feel that there may be some disappointment here, certainly until equities weaken by about another 10%. This disappointment should benefit USD in the short term. 

Lastly, I really do feel that GBP has a little of the feel of the Titanic about it – a political battle looms between the coalition over the spending cuts yet to be determined and then implemented in October. No, they haven’t even been detailed yet, which explains why you don’t’ feel any worse off – yet. The implementation will be the really hard part of the process, and the risk is that we get some fudge. The Lib Dems are being squeezed both in profile (when did you last see Nick Clegg?) and in the polls, and will need to stand up and be seen to protest about some of the welfare cuts and redundancies to satisfy their grass roots support. Political risk will re-enter the UK landscape in September and cause weakness in GBP. It will, of course, set up a significant buying opportunity in GBP for our debt book to benefit prior to year end, versus a too strong yen, a Swiss franc (which may generate negative interest rates), and of course versus a deflating ‘negative growth’ Europe. More on that next week. Enjoy your weekend, whichever country you are holidaying in.

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Charles Goodhart, a former member of the Monetary Policy Committee, warns that when UK interest rates go up they will go up more quickly than the market thinks. However, he doesn’t see any need for interest rates to go up right now and I certainly agree with him on that. A ‘double-whammy’ of higher rates and very tight fiscal policy could easily capsize the economic recovery and even if inflation doesn’t fall because of the VAT increase and higher food prices (e.g., bread due to the impact of drought in some wheat-producing countries like Russia), it is more important to secure a sustainable economic recovery. In that regard, the global outlook is less certain with America showing some signs of slowdown and China, which has been the ‘locomotive’ of the economic recovery so far, also showing some signs of cooling down.

Otherwise, sterling is steady on the foreign exchanges at around 1.59 again though the market focus is more on the US dollar ahead of tomorrow’s important US jobs report. If the unemployment rate surprises by moving up sharply then recent speculation that the Fed might adopt a fresh round of quantitative easing would weigh on the currency.

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Ahead of tomorrow’s decision by the Bank of England’s Monetary Policy Committee, markets seem a little rattled after a good start to the week. US economic data yesterday confirmed the story of an ongoing slowdown in the economy, though probably not by enough to persuade the Fed to announce an imminent round of fresh quantitative easing. However, the fact is that a slowdown is taking place and the recovery in the US economy from last July proved short-lived despite massive monetary and fiscal stimulus…a somewhat depressing and ‘depressionary’ thought.

The Japanese too have got their problems on this score with the yen continuing to head higher and now (on a trade-weighted basis) at its highest level since 1996. With the 10-year Japanese bond yield now probing below the 1.00% level, the signals from the currency and bond markets point to deflation continuing. It is also at variance from the message being sent by the equity market following the rally in July and into the first week of August. Somebody is wrong.

Here in the UK, the latest data on the PMI services index for July registered a slight decline to 53.1 from 54.4, above the recession/recovery line of 50 but suggesting that there is no need for UK interest rates to go up. There is simply too much uncertainty in the global economy and financial markets at the moment to justify a move like that. Sterling continues to hold up well at 1.59 against the US dollar but has not really done a great deal over the last 24 hours and, on a trade-weighted basis, the pound has actually edged a little lower. Let’s see what the BoE brings tomorrow.

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Stockmarkets performed well yesterday extending the rally seen during July. Some of the impetus (apart from good earnings results at the banks) comes from market hopes that the Fed might consider a fresh round of quantitative easing (QE) and this morning’s Wall Street Journal claims that the Fed is mulling using the $200 billion income from its existing portfolio of mortgage-backed securities to buy US Treasuries (click here). Mr Bernanke’s speech on the US economy yesterday was not, in my opinion, bearish enough to suggest that fresh QE is just around the corner, though if Friday’s jobs report is a ‘shocker’ then the printing presses will be readied for action. In the meantime, speculation that the Fed could go down this route again is weighing on the dollar and the sterling/dollar exchange rate is at 1.59.

The Bank of England (BoE) announces its monetary policy decision tomorrow and the markets are not expecting any surprises. The latest data on UK construction showed a drop in the CIPS index to 54.1 from 58.4 but the construction industry is doing well with six towers being constructed in the City and the Olympic stadia at Stratford still to be completed. For the rest of the economy, the picture is still unclear and there are plenty of gloomy forecasts on the housing market. For what it’s worth I was quoted in the Daily Mail on Saturday, giving a much more bullish view about prospects for the housing market (click here). However, my advice to the BoE remains the same: keep your options open. An aggressive tightening of fiscal policy is taking place and the full effect of this on the economy has yet to be seen – so no need for monetary policy to be tightened and thereby adding to the pain.

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It is interesting that there are increasingly disparate views of where the UK economy is going. Last week, the NIESR forecasting institute said that the 1.1% GDP growth in Q2 was just a ‘blip’ and they forecast growth rates of below 0.5% for the rest of this year. Mervyn King, in his testimony to the Treasury Committee last Wednesday, warned of stagflation risks and is clearly in the camp that sees no reason to put interest rates up. In contrast, the weekend press reported a bullish forecast from the Goldman Sachs economics team that sees the UK economy outperforming its peers next year. However, I also noted plenty of forecasts from a variety of professionals in the housing market predicting falling prices over the next 12 months. All of this makes this week’s Monetary Policy Committee meeting more interesting than usual. Will Andrew Sentance be joined by an additional dissenter in calling for higher rates, or will Mervyn King be able to maintain a consensus for no change in policy. My guess is that Mervyn King’s view will prevail as I think it right it should.

The global backdrop is still uncertain. Last Friday’s GDP data out of the US highlighted a slowdown in the pace of recovery while the latest data out of China at the weekend showed a cooling in manufacturing activity. Indeed, the Federal Reserve is perhaps more alert to the dangers of Japan-style deflation and some commentators are starting to think that the Fed could re-instate quantitative easing at its next meeting on 10 August. In the meantime, the stock-markets are starting the new month by extending July’s rally. July was a good month for equities as it turned out. Sterling has also done well and this morning stood at 1.58 against the dollar. The US dollar is being dented by soft economic data and in this regard, Friday’s US jobs report will be crucial. A bad report keeps the dollar on the back foot and only encourages the Fed to keep interest rates lower for longer as well as resorting to the printing presses again.

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