COMMODITY REVIEW AND OUTLOOK

195 Route 6A, Suite 6, Orleans, Massachusetts

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(July 2, 1997) CURRENCIES: Concerns about the fate of the EMU continues to bedevil the Swiss and the mark. In Germany the debate has been heated, as it also has in France. The mark made a new contract low, a negative development. The UK budget will be out on July 2. Government shakeups in Japan are keeping bulls queasy. The Fed is meeting this week. The overall trend of the currencies remains in doubt, but the dollar seems to be getting nothing but fairly good news, and the European currencies, at least, remain troubled regarding the EMU. Being long the dollar may be the best way to go.

RECOMMENDATION-The September pound is still range-bound. Conservative traders should stay on the sidelines. Resistance may appear near the high of 166.88-166.92 and 165.80. Buy pullbacks to 165.00 if aggressive, or 164.00 if conservative. Use stops of 100 points. Objective is open, but the 168.00's may be achievable. The September Canadian Dollar is back in its range. Support lies in the low 7200's. Taking out 7196 would be very bearish. However, the currencies have been range bound for a while, so false breakouts could very well occur. Resistance remains near 7290, 7310-7315, 7340-7350, 7370 and 7400. Taking out 7400 is positive and implies the low is in. Play the range, buy a dip to 7250-7230, and/or sell rallies to the low 7300's with stops over 7400. Aggressive traders could contemplate buying in the 7270's with 50-100 point stops.

The September Mark making a new contract low is very negative. The

mark has had a series of lower highs, suggesting the selling is becoming more aggressive. Now we are seeing a lower low. The potential is there for a decline to 5700 or so, possibly nearly 5600. Traders might continue to sell rallies to the upper 5700's area with stops over 5870, looking for new lows. Strong resistance remains near 5850 or so. The mark may have substantial downside in its future.

The September yen remains dangerous and most traders should use options if trading the yen. Resistance remains near the 8840's, with support near 8800 or so. The yen, like the rest of the currencies, has had little follow-through, so aggressive traders might sell the yen on rallies to the 8840's with stops of 50 points or so. If 8695 is taken out, aggressive traders should sell there with 100 point stops looking for a hard break. Option trader could consider puts at current levels or if the downside breakout occurs. Objective is open, but a decline to the mid-8500's, possibly lower may be coming.

M. Steven Morgan      Top

COMMODITY INSIGHT

152 Ennis Lake Road, Ennis, Montana

(June 29, 1997) CURRENCIES: The big news in the FOREX markets this week was when the Bank of Canada raised interest rates. The result of that move was a hard rally for the Canadian Dollar. Thanks to the B.O.C., the Canadian appears to have established a major low. My work now suggests that the Canuck is headed for the 0.8000 to 0.8400 level.

On June 24, my website went long the Canadian Dollar at 0.7233. For some brokerage clients here, we went long as low as 0.7215. For the next five days, buy (1) September Canadian Dollar at 0.7233 or lower.

Jerry F. Welch     Top

THE REAPER

P.O. Box 84901, Phoenix, Arizona

(June 26, 1997) CURRENCIES: There are a whole slew of financial turning points clustering between late June and mid-July. The U.S. Dollar has moved sideways since mid- February. The strongest currencies are the Japanese Yen and the British Pound. As the Euro is undermined, investors favor the British Pound, U.S. Dollar and Japanese Yen. The U.K. central bank meeting July 10 is expected to raise interest rates a half-of-one percent. Short term, the open interest drop in the currencies is a sign of end-of-quarter book squaring. Elsewhere, in Canada, the Liberal party is barely a national party. A crisis in the EMU should strengthen the German D-mark and Swiss Franc. The trading public is too bearish on the German D-mark, Swiss Franc and Canadian Dollar and too bullish on the British Pound.

RECOMMENDATION-Futures investors may purchase September U.S. Dollar Index on a strong close above 96 or sell short on a weak close below 94. Risk $1,000 per contract from entry point. Futures investors may lightly buy September Canadian Dollar on weakness with .7187 open protective stops. Futures investors may lightly buy September British Pound on weakness with 1.6380 open protective stops, holding for a test of 1.70. Futures investors short September Mexican Peso use 1.231 open protective stops.

R.E. McMaster, Jr.     Top

PRUDENTIAL SECURITIES, INC.

One New York Plaza, New York, New York

(June 30, 1997) CURRENCIES: RISING VOLATILITY-The dollar finished the week on a strong note, gaining on nearly all of the major currencies. However, the foreign exchange market continues to be characterized by rising volatility and a lack of clear direction as it has since the April G7 meeting. The yen has traded in a wide range against the major currencies, reflecting the conflicting fundamental forces in the Japanese economy. European currencies have been generally soft while sterling and the U.S. Dollar have been firm. Meanwhile, Canada and Australia have parted ways for what looks to be quite some time.

Next week may mark the beginning of a clearer up trend for the dollar. The economic data due out for the U.S. should revive the risk of further tightening in monetary policy in the second half of the year, even though we don't look for the FOMC to move at next week's meeting, Meanwhile, data from Japan should confirm a slowdown in domestic demand after the first quarter's surge and hence point to the likelihood that the Bank of Japan will keep rates on hold into the fall or beyond. With interest rates on hold, fears that Japanese investors would liquidate U.S. Dollar holdings should abate.

EMU STILL BEARISH FOR EUROPE-In Europe, EMU remains the major issue. Next week's comments from German Finance Minister Waigel will likely provide reassurance on Germany's determination to keep EMU on track. The market remains convinced that EMU will go ahead on schedule with a wide band of countries, including the Mediterranean countries. That means that the terms of the Maastricht accord will be loosened and expectations will be that the Euro will be a soft currency, In fact, Europe needs soft currencies right now to help boost economic growth. Recoveries remain spotty, driven largely by exports while domestic demand remains very weak amid record high levels of unemployment. Restructuring of industry in Europe is proceeding slowly and unevenly which means ongoing sluggish growth is likely for the time being. The DM, French Franc and Swiss Franc are likely to remain the weakest of the major currencies. The U.K. budget announcement will be of particular interest given the recent rise in sterling to a five-year high versus the DM. Positive surprises will need to be seen to keep the currency in its strong uptrend. In all, it is likely to be a fairly volatile week ahead.

DOLLAR OUTLOOK STILL POSITIVE-Longer term, we expect the dollar to breakout of its trading range to the upside in the months ahead. The major reason for remaining bullish on the dollar over the intermediate term is our expectation that the economy will continue to grow at a strong enough pace to warrant further tightening in monetary policy by the Fed. The wide interest rate differentials which have contributed strongly to the dollar's two-year uptrend are likely to remain intact or widen even further. In addition, the current budget being negotiated in Washington looks likely to deliver fiscal stimulus to the economy later this year or early next year in the form of a substantial tax credit to families. The "corresponding" spending cuts to offset the tax cut are not scheduled until several years down the road. Hence, fiscal policy will be loosening while monetary policy is likely to tighten-a combination which typically is bullish for a currency.

In contrast, economic conditions in Japan and Europe, although improving, are not likely to lead to higher interest rates until much later in the year or even into 1998. Moreover, fiscal policies are tightening in those countries which is contractionary and usually bearish for the currency, Until the rest of the G7 have solidly expanding economics, the dollar is likely to be strong. A strong dollar continues to serve as a means of re-distributing growth from the U.S. to the rest of the industrialized world. The process is working slowly but won't likely reach critical levels until early 1998.

BRITISH POUND-Sterling was one of the strongest currencies last week, reaching five-year highs against the DM and a five-month high against the U.S. Dollar before falling back. In fact, the BP is now back at the level it reached in 1992 before failing precipitously out of the ERM. Strong economic growth, expectations for higher interest rates and a structurally improving economy have contributed to sterling's strength.

The recent surge in the BP is really the culmination of a long process. The British economy has changed structurally over the past decade as free market policies were adopted and the influence and size of the government declined. The economy is now benefiting from those changes as economic growth powers ahead without significant inflation pressure. Britain also has the benefit of some longer- term demographic forces. The population is among the youngest in the industrialized world and the government's total and projected debt levels are among the lowest. Hence, there are no obvious "smoking guns" on the horizon to threaten the longer-term outlook. More recently, the move to strengthen the independence of the Bank of England is a positive structural change as well, in that it has lowered inflation expectations.

In terms of business cycle activity, Britain appears to be reaching a fairly high level of growth, Q1 GDP growth came in at 3.1% driven largely by strong domestic demand. In fact, the central bank's major concern appears to be that domestic demand will cause the economy to overheat and generate inflation. Hence, rates have been raised twice in the recent past and most expect another rate hike on the horizon. However, there has been some deterioration in the external sector. The recently released trade figures point to the negative impact that sterling is having on exports. Both the global and non-EU trade deficits are expanding, a factor which will eventually slow the industrial sector and the overall economy. In addition, the upcoming budget is expected to result in some fiscal policy tightening. An end to some corporate tax breaks is expected, which could both slow the economy and the pace of business investment.

At current levels, the BP has gotten overvalued and although it may remain overvalued for some time to come due to high interest rates, we would look for a setback in the near term. The budget release on July 2 could prove to be a negative for the currency in the intermediate term. We favor short positions from current levels looking for a setback to the 1.6300-1.6400 region.

DEUTSCHEMARK-The DM fell to near the lows for the year, reflecting disappointment at the pace of the recovery and ongoing EMU concerns. These two factors appear likely to keep the DM in a downtrend over the intermediate term.

On the economic front, the data were mixed but a reversal of the DM's downtrend will require some evidence of a sustainable pick up in economic activity. Although the manufacturing sector continues to benefit from rising exports, the domestic economy is still very soft. Last week's IFO survey illustrated this disparity. The industrial survey pointed to rising orders and output while the retail survey was soft. Moreover, the ICON consumer sentiment index actually posted a decline, reflecting ongoing record unemployment and uncertainty over EMU. Next week's data are likely to be more of the same. Industrial production is expected to post moderate gains to a 2% year-over-year gain. Manufacturing orders for May are likely to be somewhat less robust, but remain firm on a year-over-year basis. In all, the economic data are likely to remain moderate at best. Meanwhile, the focus is increasingly on the political front. Last week's budget talks underscored to the degree to which EMU has worked itself into every political debate. There is a risk that Kohl's ruling coalition becomes split over the budget with various factions taking advantage of the public's doubts about EMU to their political advantage. Trimming the deficit is not the major issue as no one really expects the deficit to make it to 3% of GDP this year. The issue is really whether the coalition can hold together in the spirit of keeping EMU on track. As long as EMU looks to be moving forward on time, the DM is likely to be under pressure.

We continue to anticipate a further decline from current levels. Although the economy is showing overall signs of improvement, Bundesbank policy is likely to remain unchanged through the year. In addition, the central bank has been tolerant of a dollar/DM exchange rate in the 1.50-1.80 range since the Plaza Accord. Hence, a test of the lower end of the range for the DM is not likely to elicit any intervention or rate changes by the Bundesbank, We continue to favor short positions looking for a test of 1.7800- 1.8000 longer term.

SWISS FRANC-The SF also declined sharply during the past week, reflecting weak economic conditions and very low interest rates. The economic data confirmed a very slow growing economy with very low inflation, hence leaving the door open to further easing by the Swiss National Bank.

After six years of recession, the economy is actually expected to post a modest gain of 0.5% in 1997. The first quarter's positive growth rate was modest but given the decline in the currency over the past two years, there are tentative signs of recovery. Tourism, which has fallen as much as 60% from its peak levels a decade ago is now beginning to pick up for the first time in the 1990's. Exports are growing as well. The key to a further expansion is ongoing softness in the currency, As a result, the Swiss National Bank continues to call for a further decline and facilitates it with ample liquidity and very low interest rates.

Whenever a central bank sets out to weaken the currency, they usually succeed because they control the supply of money. So even though there still appears to be healthy demand for the SF as a safe haven currency outside EMU, the SNB's ability to print more money has helped the currency continue sliding. We are willing to go with the central bank on this move. We favor holding short positions for a test of the 1.5200-1.5500 level longer term.

JAPANESE YEN-The Japanese Yen traded all over the place last week. Initially the yen surged on suggestions from Prime Minister Hashimoto that Japan has considered selling its stock of U.S. Treasurys. In addition, signs of export strength buoyed the currency as well. Later in the week however, the yen declined as it became evident that the recovery is not yet strong enough to warrant higher interest rates.

Although Hashimoto's remarks appear poorly timed and rather self-defeating overall, they do underscore an important point. The U.S. and Japan are economically intertwined in such a way that it is necessary for both sides to cooperate in order to avoid huge imbalances in their domestic economies. Japan needs access to the U.S. consumer market which is the largest in the world, particularly when their domestic economy is weak. On the U.S. side, the need for imported capital supplied to a large extent by Japanese savers requires avoiding a confrontation about trade. Without the inflow of capital from Japan, U.S. interest rates would be higher, the dollar weaker and inflation rising. Hence, it was not too surprising that both Japanese and U.S. officials tried to downplay their differences. Nonetheless those differences are intact and that means whenever the issue of trade is on the front burner, the yen is likely to spike higher.

Meanwhile it is obvious that the much feared rise in Japanese interest rates is probably still a ways off on the horizon. The Tankan survey indicated that large manufacturing companies are optimistic about the future of their businesses, clearly reflecting the pick up in exports resulting from the yen's weakness. However, small and non-manufacturing businesses are more pessimistic about the future, reflecting the absence of domestic demand. In addition, industrial output which rebounded in May is forecast to slow in June and July, resulting in a downturn for the quarter. Unemployment has risen back to record levels and retail sales are plunging. The economy which surged in the first quarter on front-loading of consumption ahead of the April 1 tax hike is now entering a slump. The Bank of Japan is not likely to raise interest rates in this environment. They have repeatedly indicated that they want to see a sustainable recovery which is broad-based. That will probably mean keeping policy on hold until later in the fall or even well into the fourth quarter.

We expect the yen to work lower over the intermediate term largely due to the ongoing wide interest rate differentials vis a vis the U.S. and other dollar-bloc countries. However, due to never-ending trade tensions with the west, the path to a weaker yen is likely to be quite volatile. For the next few months, the range could be 112 to 116 but it would not be surprising to see a test of the 120 level in the next six months. Once Japan's economy turns the corner, then the yen will likely rally strongly, but the market has probably once again, been premature in anticipating the recovery.

CANADIAN DOLLAR-The long-awaited hike in Canada's interest rates sent the currency sharply higher late last week. The Bank of Canada lifted the floor for rates from 2.75% to 3.25% by 25 basis points to 3.0% to 3.5%. The timing of the move caught the market by surprise, but it was clearly foreshadowed by the booming domestic economy and the deterioration in the Monetary Conditions Index. We view the upturn in the Canadian Dollar this week as a major turning point for the currency.

The only real question about the Canadian rate hike is what took so long. The economy has been booming for over a year and the recent data suggest that the strength in the export sector has pushed over into the domestic economy. Unemployment is falling, incomes are rising, retail sales are rising by more than 7% year-over-year and everything from housing to autos is moving fast. Meanwhile, exports remain healthy with the surplus running about C$2 to C$3 billion per month. Although the output gap is still wide in Canada, it is shrinking and the recent weakness in the Canadian Dollar suggested the need for some tightening in monetary policy. The central bank pegs the output gap at 2.5% which means that if GDP growth reaches the 4% level this year, which is our estimate, then the gap would probably disappear by mid-1998. Hence, despite ongoing low inflation, the Bank of Canada should be tightening policy somewhat. Moreover, the strength in exports suggests that the Canadian Dollar has been undervalued for quite a long time.

We see the recent rate hike as the start of a series of gradual tightening moves which will narrow the gap between U.S. and Canadian short-term interest rates. The gap has widened sharply over the past two years, taking the Canadian Dollar lower. As the gap narrows, the Canadian Dollar should rebound. Our intermediate-term target is the 7500-7600 region but our longer- term target is the 8000-8200 level. Given Canada's favorable structural fundamentals, it may be that at some point in the next five years the Canadian Dollar trades at even money with the U.S. Dollar again. We obviously favor long positions.

Kathy Jones       Top