ECB obviously knows the rate hike will support the euro

Currency Outlook: As we noted yesterday, there are three factors today—the ECB rate hike, the Trichet press conference and US payrolls. The ECB hike information comes out at 7:45 am ET, payrolls is at 8:30 am ET, and the press conference is scheduled for 10 am ET.

After a month of advance warning, the ECB is pretty much obliged to hike and by the full 25 bp. Any idea of 12.5 bp went out the window when inflation came in at 4%. The ECB obviously knows the rate hike will support the euro and while they don’t like it so high (because it may harm exports), inflation is the first priority (and signaling extreme caution on inflation is good for inflation expectations). Oil is high and rising, so at least a higher euro can be accepted as an offset. There is almost nothing Trichet can say that will prevent the market thinking a series of hikes has to be in store. Is it possible he will threaten intervention? No. Trichet is a very good central bank gov and will show grace under fire today.

US payrolls is released between the ECB action and the Trichet press conference. We have already reviewed the numbers at length—a range of –15,000 to –150,000. Yesterday ADP Macro contributed its estimate for the private sector component—-minus 79,000. A bright spot is that small firms added some jobs, although even the service sector was a net loser. (We get the service sector ISM later this morning, too.)

All three events are thoroughly priced in already, although that won’t stop traders from taking the euro much higher if the outcomes are worse than forecast. The probability of three dollar-supportive surprises is almost zero. Even if the ECB hikes by only 12.5 bp, Trichet promises “one and done” and by some miracle US payrolls are strong and positive, nobody will believe it’s anything other than an anomaly.

We often get a spike up and a spike down in the euro dollar at a central bank meeting and at payrolls, so today is doubly dangerous. We might get a rebound in the dollar once the bad news is out, which often happens—but it tends not to last very long, and today is a short day in all the US markets ahead of the holiday tomorrow. Senior traders are off the desk, leaving the juniors behind to follow orders, which certainly can’t be to go long the US Dollar into the long weekend.

An opinion piece in Market News says that usually markets like uncertainty and volatility. “This go-around, however, the uncertainty and volatility have left traders, salespeople, analysts and investors frazzled, fearful, bitter, confused, unsettled and just plain exhausted. The housing/credit crisis has gone on for over eighteen long months and there is no end is sight. And throughout those long months new problems kept cropping up along the way and there does not seem to be an end to those problems either…

“An analyst said ‘A virtuous cycle of increasing leverage and easy credit (2003-2006) has turned into a vicious cycle of deleveraging (2007-present)… whenever asset price growth outstrips real economic growth, especially by so large an amount over such a short period of time, it is a sign that intangible (i.e. phantom) wealth has been created. The current unwinding of leverage is painful, but necessary, to normalize the long-term rate of growth in asset prices to that of the real economy.’ The strategist also says that an alternative to deleveraging is very high or "hyper" inflation - something that is worrying the Fed right now.

We say this is exactly right. We are not getting the wished-for hawkish Fed comments, but surely they are in the pipeline. First the banking sector has to get cleaned up some more. Only the Fed knows where it sees stress cracks—it’s not telling us. If all the damage is already done to the big financial institutions— maybe more than enough, if critics of FAS 157 are right and assets worth something have been marked to zero—-maybe it’s the smaller fry at risk. The point is that as soon as the Fed can decently act, it will. Fed action may be postponed but it’s not lost and forgotten. We do not buy the idea that the Fed is any less anti-inflation than the ECB. As Kudlow puts it, where is Bernanke’s “inner Volcker”? We expect the Fed to act and act strongly with a series of hikes once it thinks the minefield is cleared. That means there is hope for the dollar at some point at the end of a long and winding tunnel. We can’t see the light yet but it is there.

In the meanwhile, gloom is the order of the day.

Bye for now!

Barbara Rockefeller

Note to Readers: Tomorrow is a National Holiday in the US (the 4th of July, Independence Day), and we will not publish any reports.