Marco Picture

China appear poised to slow their economy. Whether or not there is an agreement or deal with the U.S. to coordinate global economic activity is debatable, but it appears there is some plan to slow Asian economic growth and inflationary pressures. The set up of the Chinese raising interest rates, the Indian’s tightening capital standards, Chairman Bernanke sounding dovish, and dollar supportive talk by the Japanese suggests something meaningful is brewing. These events don’t come out of the blue. Recent actions are in line with the G7 statement which argued for Asian currency adjustment to help remove global imbalances. One of the imbalances is excess liquidity in Asia related to FX manipulation. High commodity prices are a by product. It is in the interest of all nations to simmer down inflation expectations and the price of commodities. The Chinese displayed two signs of restraint:

· China raised their one year lending rate about 30 bps.

· The government is talking about restraining activity in overheating sectors.
In addition to China, India has been undertaking some aggressive reverse repos, while tightening bank lending standards. It seems to be fighting off excess liquidity. Today, the Indian Central bank also announced it will resume selling stabilization bonds on May 3rd. It is difficult to know the ebbs and flows of money market operations in India (I’m no expert), but the actions by the Indian monetary authority line up with more restrictive policy. If the G7’s desires play out, look for the following themes:



· Commodities will be less attractive, as demand could be undercut.



· The dollar is likely to weaken. This seems perverse given the first point, but excessive liquidity in Asia has helped to drive commodity prices higher. The dollar has been relatively firm against the yen and euro in the face of higher gold, silver, and oil prices.



· US large cap equities could become more attractive due to a softer dollar. They benefit from a weak dollar. Small cap shares could lose their luster. Their fate has been tied more closely to global economic growth and the run up in commodity prices.

· The composition of equity market strength may change with players moving away from material/commodity shares and working toward defense sectors like healthcare, consumer products, and maybe financials.

· Watch interest rates. Dollar adjustment could reduce the demand for US fixed income. However, it will not disappear – Asia is not going to let the dollar plunge. Look to see if credit spreads widen as growth slows down. The Fed is not easing, so it is hard to get excited about a major rally in treasuries. Slower global growth could reverse some of the weakness at the long end of the curve. Treasuries were hurt by excessive Q1 economic strength. Inflationary pressures could ease modestly if commodity prices drop off.