by Kevin Klombies, Senior Analyst

Monday, July 30, 2007

Chart Presentation: The Euro/Yen

Aside from the fact that the equity markets performed dismally last week as bond prices jumped higher there were a few details within the markets that bear noting. The strength in the yen and weakness in the euro, for example is something new while the upward turn in the price of 3-month eurodollar futures also warrants some attention.

Our intention is to try to make the case that the yen’s strength against the euro today is a mirror image of the yen’s weakness against the euro back in late 2000.

The chart at compares 3-month eurodollar futures, the cross rate between the euro and the yen (euro/JPY), and the Nasdaq Composite Index from 1999 through 2001. Below right we show 3-month eurodollar futures, the euro/JPY cross rate, and the sum of the share prices of Bear Stearns (BSC) and Nucor (NUE) from the current time frame.

The argument begins with the observation that the yen tends to go with ‘tech’ while the euro is better in a strong commodity price trend. At the peak for the yen against the euro one would expect to see the top for a tech-related cycle while at the peak for the euro against the yen one might expect to see the top for a commodity-related cycle.

In late November of 2000 after the Nasdaq Composite Index had begun to dive down below its moving average lines two things happened. The euro began to strengthen against the yen and short-term debt prices (3-month eurodollar futures) began to rise. Consider that on November 15, 2000 the Federal Open Market Committee voted to hold the funds rate flat at 6.50% and stated that, “…the risks continue to be weighted mainly toward conditions that may generate heightened inflation pressures in the foreseeable future.”

The point is that the markets began to react to the approaching cyclical slow down well before the Fed understood that there actually was a problem. The ‘tech and telecom’ trend had been dominated by yen strength against the euro and had led to ever higher interest rates. In November of 2000 the euro/yen reversed trend at the same time that the markets began to pull interest rates lower. In the current situation the weakness in financials levered to the mortgage market (Bear Stearns) and cyclicals like steel maker Nucor created a similar albeit opposite reaction as the yen finally began to show strength against the euro in the face of falling interest rates.


Equity/Bond Markets

A number of commodities made price peaks in 2006 including copper, platinum, and gasoline. Concurrent with this 10-year U.S. Treasury yields reached 5.25%.

We will argue that the market’s current problem is the strength in crude oil futures prices but that since platinum, copper, gasoline, and yields have failed to break to new highs this year it makes some sense to argue that crude oil prices are not on the verge of breaking up towards triple-digits.

On this page we have included three comparative charts of crude oil futures and the Amex Oil Index (XOI). The chart is from 1990, the chart at bottom right shows 2003, and the chart below is from the present time period. We could also have used last summer as a comparison but we trust that these examples will suffice.

The fairly simple point is that in all three cases shown there was a disconnect between the equity market and the price of crude oil at the very end of the cycle. In other words even though the oils (XOI) tend to trend with oil prices… there comes a time when the equity markets react so negatively to oil price strength that even the oils turn lower.

In September of 1990 the XOI turned lower as oil prices moved upwards and we can see the same reaction in January of 2003. In both instances the broad U.S. equity market (S&P 500 Index) did not bottom until oil prices finally reached a peak and began to decline.

The chart below shows that the markets are mired in a similar trend with the XOI already down 10% from the peak set earlier this month even as crude oil futures press upwards. The longer and further oil prices rise the more negative the equity markets but, on the other hand, as soon as oil prices pivot lower the equity markets should respond in kind by pivoting back to the upside.