US dollar exchange rate is softer at the start of the week

Foreign Exchange : The US dollar exchange rate is softer at the start of the week, led by the Canadian dollar for once, as the prospect of a US stimulus plan and perhaps formation of a "bad bank" encourages less risk aversion. Both oil and hold rose strongly on Friday, too. But this week we get an overwhelming amount of new data and information, nearly all of it bad, including a flood of US company earnings reports. The market has recently retreated from panic mode - and panic favors the safe-haven dollar - but panic could or should be building again this week.

Bye For Now

Barbara Rockefeller
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the US dollar is the best of a bad lot

Foreign Exchange Currency Outlook : One Currency analyst in the FT said sentiment is turning toward the idea that “the US dollar is the best of a bad lot.” This is a somewhat insulting version of the FIFO idea, that the first to enter crisis is the first to emerge from it. A key aspect of this version of events is that the Fed may not have rate hikes on its mind, whether to normalize or to fight inflation, but the ECB will be forced to cut interest rates to boost growth by Q1 next year.

The more we think about this line of thinking, the less we like it. For one thing, not every country that goes into a crisis does emerge from it. Think Argentina or Russia. The US is a special case, of course, but even to put it in the same company as other “developed” countries in Europe or Japan is wrong. Both the private sector and the public sector in the US act far faster and with bigger initiatives than elsewhere, for one thing. While the crisis may be less in other places, like Japan, their recovery will trail the US by a long margin. Japan barely came out of a decades-long deflationary slump before the newest crisis. There is nothing inevitable about the course of economic cyclicality.

We have been here before—the US coming out a cyclical turndown (and note that we haven’t seen that yet) while the rest of the world suffers a hangover for a considerably longer time. The longer the US problem, the longer the other guys’ recovery. But there’s a fly in this ointment and it’s named BRIC. Brazil, Russia, India and China have the economic heft to overwhelm US effects on other economies. We already saw China and India siphoning direct investment away from the US, and emerging market demand generally causing the oil price spike. One estimate has it that all the increase in demand for energy comes from emerging markets, which subsidize it heavily. This is a transfer of wealth from one set of emerging markets to the oil producers, and oil producers don’t give all of it back in the form of trade or investment.

So far the US is a beneficiary of this, but the US is hardly out of the woods on financial sector woes. Global investors can still be spooked by developments in the US. This week we get additional housing sector data that bears directly on the health of US financial institutions. If investors start disliking the US and the dollar gain, cui bono? We honestly don’t know.

Britain is in the soup.

Europe is hiding problems.

Maybe Australia and Canada again on commodities alone.

Bottom line—it’s not a straight line out, for anyone.

Another reason to dislike the FIFO scenario is that the policy goals of the two key central banks are different. The ECB cares only about inflation. To say it will be “forced” to cut rates to goose activity is to ignore the nine years of its existence. To believe in an ECB rate cut is to fail to heed Mr. Trichet and Mr. Weber, too, and to believe in fairies at the bottom of the garden. Unions are already girding their loins for the next wage round, most of which comes in

Q1. Rate cut in Q1? Not likely.

And so here we are back again at the bottom line—and it’s oil. Housing prices and existing or new home sales can be any number, but if oil doesn’t cooperate by resuming and maintaining the downtrend, it won’t matter. Oil is everything. Well, it’s not everything because the economy rolls on at any and all prices for oil, but for the US Dollar trend to secure its place as a true multiyear trend, oil simply has to keep falling. It’s as simple as that. We need to watch demand from China and we need to follow the ridiculous stories about Russia, Georgia and other places with names we can’t pronounce.

Sentiment is becoming ever more pro-US dollar as this move proceeds, and that’s nice but it can’t be counted on. A giant screw-up with Freddie/Fannie, or a big bank failure, could postpone the resolution of the financial sector problem. Several big-time analysts like former IMF economist Rogoff have warned about additional failures, including among regional banks. This wouldn’t derail the dollar like oil, but it can’t be dismissed, either. So the dollar has two potential strikes against it, oil and the financial sector. We think the US dollar is safe for the moment, in part of the technical analysis, which are powerful in their own right.

But we need to be alert—the US Dollar is not out of the woods.

Bye For Now

Barbara Rockefeller

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Record High Euro vs Us Dollars only a week ago - Read that again!

Foreign Currency Exchange Outlook : Today we get, in addition to the usual unemployment claims, existing home sales. We already know it will be bad and that is priced in, right? Just as traders are starting to feel that pessimism was overdone about the US financial system and the high price of oil, maybe housing will come back to bite us on the rear end. After all, the housing and mortgage data is pretty bad. The first rumblings of rate hike talk could be just smoke. Realistically, the US Fed can’t hike rates until the housing bottom is in. How will we know the bottom is in? Well, it’s not in as long as delinquencies and foreclosures are still rising. The housing bubble hasn't finished bursting and we might consider it the “first cause” of the current problems from which all else flows.

It’s interesting that the Foreign Exchange Market spends almost no time on the housing crisis. It has mostly priced it in and moved on. It’s conventional wisdom that the stock market “leads” the economy but we wonder if it might be the US Dollar, instead. If so, then “moving on” may have been premature and the US dollar is due for an unhappy shock.

Existing home sales (due at 10 am ET) are forecast to fall by 1% to an annual rate of 4.940 million units in June, down from a rate of 4.990 million units in May. May was an oddball piece of data, the second rise in a 10-month slide. The number of unsold homes remains near all-time highs. The Office of Federal Housing Enterprise reported earlier this week that home prices fell by a record 4.8% y/y in May, with some analysts still forecasting another 15-25% to go. Will the Fannie/Freddie rescue change that? Probably not, although it may help marginally, with some 400,000 distressed homeowners targeted in the bill. But Foreign Exchange Traders are prone to take the attitude “don’t bother me with the facts.”

It’s nice and may suffice that oil is falling, the Fannie/Freddie bill gets passed, financial stocks are okay, and US yields are rising. On the technical analysis side, the US Dollar has recovered more than 50% of the move from the May-July euro move up to the record high only a week ago.

Read that again—we had the record high Euro vs Us Dollars only a week ago.

This is an exceptionally speedy correction and we have to be careful to keep calling it a correction until we feel more confident it’s a true trend reversal. It’s not a reversal until additional conditions are met, including a lower low than the last intermediate low (1.5612) and before that, 1.5303.

The euro has to go all the way past the May low of 1.5284 to call it a trend reversal.

From a trader’s perspective, this is silly. We wouldnt want to lose the opportunity to make gains on another 400 points. But in the Big Picture, for position traders, it’s the only conservative way to look at it. If Foreign Exchange Traders fall out of love with the US Dollar —and they are fickle—because oil zooms up or some other reason, watch out.

We always get a correction after a new historic high and they can end very fast.

Bye For Now

Barbara Rockefeller

falling oil prices and the newest technical charts in Foreign Exchange

Foreign Currency Exchange Outlook: Keep in mind the phrase “What have you done for me lately?” The US Dollar got lucky yesterday. The GSEs are going to be saved (not new news). The stock market accepted regional banks losses (stock markets are always foolish).

The US Treasury Secretary spoke in support of a strong dollar (golly).

The only thing real behind the dollar rally is the price of oil falling so dramatically.

We need more of the same in oil and also for upcoming housing data tomorrow and Friday to be as expected. We have to assume that bad numbers are already priced in, so better-than-expected numbers could potentially be US Dollar friendly. We also get the Beige Book today, which could be salted and peppered with bad adjectives, but the Beige Book seldom moves the Foreign Exchange Market one way or the other. We also get the usual Wednesday Energy Dept inventory report today, probably again showing a drop in demand in the US.

In sum, The US Dollar has only two things going for it—falling oil prices and the newest technical charts in Foreign Exchange. These are not exactly a sound basis for a continuation rally—we’d really rather have some fundamentals, too. But a breakout on the chart is nice, and may suffice, subject to the caveat that oil must continue to fall or at least stabilize around $120-125.

Bye For Now

Barbara Rockefeller

But distrust about the US financial scene is just starting.

Foreign Exchange Currency Outlook: At 8:30 am today we get CPI, probably a rise by 0.7% in June after 0.6% in May or 4.5% y/y, the most since Sept 2005. The range of forecasts is a wide 0.2-1.1% for the monthly version. Core probably rose a lot less, 0.2%. Today we also get industrial production (probably a small rise) and the TICS report on capital flows.

Yesterday, June wholesale prices rose 1.8%, or 9,2% y/y, the biggest one-year gain since 1981. Wholesale prices do not feed consumer prices in the US as directly as in Europe, but it’s clear that we have what is called pipeline inflation pressure.

Higher inflation and slowing growth in the context of financial market “stress,” as Bernanke put it, is just about the worst-case scenario. The only thing worse would be widespread regional bank failures with big banks lacking the capital to take them over.

Some analysts, such as the chief currency strategist at BoA, think that when all the bad news is already priced in to the dollar, we have to expect a relief rally, and probably a lasting one. This point of view has it that, as Market News reports, “the time has come to position for a gradual euro decline in the years ahead… recommending a euro selling around $1.5920, with a stop on a two-day close over $1.6250, and an eventual return to the Jan 22 low near $1.4365.”

Others say the euro “topping out process” could last 6 months or more. We have no evidence the new euro high yesterday was a head-fake. We probably have a range of 1.6175-$1.6200 or 1.6250-75, with euro support on the downside around $1.5710-25.

Currency Traders are not looking so much at individual data points or even broad general statements from officials as trying to puzzle out the relationships among oil and the dollar, financial markets and capital markets, and growth and inflation—Big Picture relationships. It’s silly to say slowdown in the US (and Europe) “should” cause oil prices to fall if real demand from emerging markets is going to overwhelm small declines—and this has been the consensus so far. In other words, there is virtually nothing the US can do to re-balance supply and demand in energy markets, at least in the short run.

Therefore, the drop in oil prices yesterday was based on little or nothing to do with fundamentals and everything to do with speculators re-arranging their positions. Economists say this is a one-time anomaly so it would be really, really interesting to see a further rout in oil that has a more lasting effect. We don’t predict it, but it’s certainly not out of the question. That would make all the economists reconsider their attitude toward supply and demand. Demand doesn’t have to be “real” for it to influence prices. We have accepted that inflation expectations influence real inflation—-so why not accept that speculative demand influences overall demand the same way?

On the horizon are two big developments—oil prices continuing upward (or not), and the US regional banks. As we start getting earnings reports from financial institutions today through Friday, the outlook for the regionals will be clearer. We expect a few failures. We suspect the Fed and Treasury know which ones, too. Unless oil were to continue to fall in a meaningful way (clearly trended), we think the ongoing financial market turmoil is going to be US dollar-negative. This will not come from Freddie and Fannie, which were rescued. That story is over.

But distrust about the US financial scene is just starting.

It’s not severe yet.

It will become severe.

We will see runs on banks as we saw with IndyMac.

This may be foolish since just about everybody’s deposits are insured and safe, as Bush was careful to point out yesterday, but panic knows no sensibility.

We're not far off the capitulation point for the euro

Outlook: The third week of every month is the busy data week and always a tough row to hoe for those trying to put it in summary form and analyze it. This week it’s especially burdensome because we have earnings reports, too, something most Foreign Exchange Traders don’t have to spend much time on.

According to Wall Street guru Sandi Lynne (www.wallstreetinadvance.com), we get earnings from Wells Fargo on Wednesday and then a flood on Thursday--KKR Financial, JPMorgan, MGIC Investment, Bank of New York Mellon, CIT Financial, Comerica, PNC Financial, Capital One, Merrill Lynch, and Zion’s Bank, all before Citigroup reports Friday morning. Lynne notes that all week, in Boston, something will be held named the Annual Corporate Fraud Conference. In addition to the financials, also reporting are a slew of companies, including IBM, Microsoft, Google, eBay, Advanced Micro Devices, Coca Cola, Harley Davidson, and Mattel, to name just a few. Friday is options expiration day.

The economic releases are June PPI and retail sales on Tuesday, with CPI, industrial production and the May Treasury capital flow report on Wednesday. Also Wednesday is the National Association of Home Builder’s July Housing Market Index. Thursday brings June housing starts and building permits and the Philadelphia Fed July survey.

Institutional information usually trumps data and tomorrow we get Bernanke testifying before the House and then the next day to the Senate. The goal of the testimony is to offer the Fed’s economic forecasts and at least some of the underpinnings of how the Fed thinks about monetary policy going forward, but we imagine a great deal of time will be spent on trying to measure how much wasted time is going to be spent on the financial crisis.

We have almost no doubt that the Fed and the Treasury will succeed in tamping down hysteria over the potential failure of Fannie and Freddie. They are literally too big to fail—having underwritten one way or another over $5 trillion in home loans. It may turn out that they hold or sold more bad paper than we now suspect, but never mind—too big to fail means precisely that. Eventually panic will subside, perhaps as early as this week, but then we move on to the next thing—more regional bank failures like IndyMac. It seems likely that the Fed and Treasury will be preoccupied with these matters for a long time to come and talk of rate changes will get back-burnered to after year-end, as several forecasters have predicted.

The good news about the Fannie and Freddie debacle is that now it’s out in the open, having festered under a cover of hot air and misdirection for at least 20 years. Can Europe say the same? Nobody knows the quality of the paper used as collateral at the ECB. As we saw from various German bank failures over the years, Europeans may have higher credit standards and less fraud than the US, but their bankers are no more competent and sometimes a lot less competent than their US counterparts. On a one-to-one comparison, it’s not clear that the US financial system is more fragile or risky than Europe’s.

And when the mess does get cleaned up, US growth is almost certain to be earlier-appearing and more sprightly than in inflexible old Europe. Labor is the pivot point. In the US you can hire and fire someone without a problem, whereas in Europe to fire someone requires acres of paperwork. It’s that simple. Most analysts perceive that European recovery will lag US recovery when it does come, and that should be dollar-friendly. As UBS wrote last week, we may get another hike from the ECB but then it is expected to be cutting in 2009 to boost activity—at the same time that the US could already be on the recovery path. Bloomberg writes that “The ECB will cut the key rate a quarter-percentage point to 4 percent by the end of June 2009, according to the median of 30 economists in a Bloomberg survey.”

Out of such perception may come a dollar rally scenario. This seems to be the view of currency analysts at Bank of America, Morgan Stanley, BNP Paribas, and surprise! Bill Gross at Pimco, not a perennial dollar bear, after all. London forecaster Calyon says “We're not far off the capitulation point for the euro.”

This is almost certainly premature, and the relief rally of the dollar may not have much lasting power if data continues to come in bad this week. A lot depends on Bernanke’s tone tomorrow. If he sounds sacred, everyone else will get scared, too. And there is, of course, a very large fly in the ointment—commodity prices in general and oil in particular. No matter how much reassurance is issued and believed about the ultimate fate of the financial sector, oil looms over everything. Higher oil prices—and $150 is within smelling distance—is not US Dollar friendly. In short, we are not ready and willing to buy into a US Dollar rally scenario just yet.