UBS, which repeated yesterday that the euro exchange rate will fall to 1.2000 by year-end.

Foreign Exchange Outlook : As we wrote yesterday, a decline was the euros manifest destiny even as it was rising last week because it was inevitable that the ECB would not stand apart from the rest of the world, clinging to an outdated anti-inflationary stance in a disinflationary world. This was and remains the persepctive of major Foreign Exchange market players like UBS, which repeated yesterday that the euro exchange rate will fall to 1.2000 by year-end. The forecast itself from such an important name becomes a factor in its own right. Even if the ECB stays on hold or cuts by only 25 bp, the bank says, expectations of cuts next time will get built in. "Thus the euro rate is likely to remain a sell on rallies against both the dollar and the yen."



We say this is exactly right.

We expect an ECB surprise on Thursday. ECB chief Trichet said "this is no time for complacency." The current challenges are pressing and new challenges will arise. He was (evidently) talking about a "firm and credible implementation of the EU stability pact," i.e., fiscal restraint, but Trichet is a really smart guy and he must know that to complain about overspending (Germany will break the pact in 2010) is spitting into the wind. We expect Trichet to make some critical comments accompanying the rate decision.

In the background is some chatter, mostly from the lunatic fringe, about some countries being forced to leave the EMU (Italy, Greece, Spain, Ireland are the most-cited names). We say it's much too early to be thinking along these lines, let alone making trading decisions based on such speculation.

For one thing, there is literally no mechanism for a member to leave the EMU.

Nobody knows how that could be accomplished. Having said that, there is an explicit deal that the EMU will not rescue a failed member, either. This is not so odd - New York State doesn't have to step up and rescue Massachusetts, either. Still, stress on certain names is generally euro exchange rate negative, although Bank of New York economist Woolfolk says that a weak country leaving the EMU would be a euro exchange rate positive. Well, no. While pan-European integration has hardly been a full-scale success, leakage from a failed economy could be substantial, from loss of export sales to immigration. We think the EMU would indeed come up with a rescue plan… but for whom? Spain yes but Greece no?

Back in the broader market, there's almost too much data this week to keep it all straight, but we must pay attention to Bernanke's speech at the London School of Economics today. But again, it almost doesn’t matter what he says because "it's worse elsewhere." See all the grim data above in the UK, Germany, Spain (ratings). We have the secret weapon of Obama, of whom far too much is being expected… but he is our secret weapon all the same.

Nobody else has an Obama.

Nobody else has a federal structure, either.

And finally, nobody else is willing to experiment as wildly as the US, badly managed as it seems to be. Keep the faith - the US dollar exchange rate is on a roll.

Note to Readers: Next Monday, Jan 19, is Martin Luther King Day and a national holiday in the US. The market is closed and we will not publish any reports. The next day is the Obama inauguration, yippee.

Bye For Now



Barbara Rockefeller

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