Those who are expecting the US Dollar rally to end any minute are clinging to outdated prejudices.

Foreign Exchange Currency Outlook: We get some data on consumer behavior and sentiment today ahead of retail sales tomorrow, but the big release of the day is the trade deficit for June. It is expected to rise to $62 billion on the higher price of oil at the time, even though exports are booming. If it’s a deficit of $62 billion, it will be the highest in over a year. The forecast range from Bloomberg is $59 to $65.7 billion.

We say trade will not constitute an “event” this time. Traders are accustomed to the US running a huge deficit and huge deficits have lost the ability to shock. The deficit should be thoroughly priced in. The only caveat we have on trade is that if the rest of the world is going into a bigger slowdown than the US, the new conventional wisdom, US exports have to suffer—unless US exports are concentrated on the few spots where growth is not sagging, namely China, India, Brazil and a handful of other emerging markets.

We wrote a few weeks ago that the best of all possible worlds for the US Dollar would be bigger bad news from elsewhere than in the US, better US responsiveness to the liquidity crisis, and falling oil and commodity prices.

By some miracle, we did get all three.

After oil, probably the biggest sea-change is the outlook for the Euro.

We went from expecting two rate hikes this year only in early July to expecting none or even a cut in Q4 or Q1 next year—what a reversal!

As Market News writes, “Part of the reason for expecting a interest rate cut is a growing suspicion that the ECB may have underestimated the extent of the economic slowdown gripping the euro area, a notion given more weight today by ECB Executive Board member Lorenzo Bini-Smaghi. In an interview with Italian daily Il Messaggero, Bini-Smaghi offered some of the most dovish comments from an ECB member in many months. He said

the European economy is slowing more rapidly than foreseen, and at the same
time, inflation could begin to drop after the summer… Fighting against inflation, we can help relaunch growth.

What does that mean? Market News deduces that with Weber saying inflation will persist into 2009 but Bini-Smaghi thinking it could subside already this fall, the ECB policy committee faces a titanic battle between hawks and doves, and we shouldn’t expect Christmas cheer. But we wonder if it doesn’t mean the ECB is talking out of both sides of its mouth, again, as usual. It secretly wants a rate cut and has to see lower inflation and lower wage deals to justify it. The ECB, unlike the Fed, doesn’t cut to favor the financial sector-—but if credit is already contracting everywhere, it would be nice to cut rates to boost a little extra activity. Therefore, we smell a rising consensus that the ECB could be getting more dovish, and that’s euro dollar negative. A perceived bias toward lower rates adds to falling oil prices as a second leg for the US dollar. One more leg and we’ve got a stool.

Note: We made an error yesterday. We wrote that a 50% retracement of the 7-year dollar slide from October 31, 2000 at .8229 to the high of 1.6040 in July would be 1.3870. This is wrong. The right number is 1.2146. And note that a 25% retracement would be 1.4105. This is not a silly number, although we would have to expect such a big move to take several months.

Those who are expecting the US Dollar rally to end any minute are clinging to outdated prejudices. A correction must be expected, yes, but we say it’s a major new trend and we’re sticking to that story until something comes along to change it.

It would have to be something very ,very big, too.

Bye for Now

Barbara Rockefeller

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