So how Low can the euro go?

Foreign Currency Exchange Outlook: Market prices of securities do not move in a straight line, of course, and some analysts are already talking about the dollar move as already over, or nearly so. Bloomberg reports that Foreign Exchange analysts at Barclays, Merrill Lynch and Morgan Stanley, among others, say we shouldn’t bet on any more US dollar gains.

This is because the economic situation doesn’t support a rising US dollar—big problems remain, like the trade and budget deficits.

To say the US dollar rally is over or nearly over is to fail to recognize the power of technical analysis.

Yes, fundamentals can always trump the technicals, especially unexpected fundamentals. The technicals serve to measure trader sentiment, which is mostly determined by the fundamentals. But as George Soros says, the technicals become a factor in their own right when a move is big enough. This is because cascading waves of the newly convinced keep joining the new move. After the first and second corrections, additional waves of the newly converted jump on the bandwagon.

We need corrections to bring in the new Foreign Exchange Traders. Corrections are bad only if your stops were set too close and you miss the second and third waves. The use of the word “wave” is descriptive and doesn’t suggest that we buy into any “wave” theories, Elliott or otherwise. But the price progression on the chart during a big move does look like waves and we are not willing to give up a perfectly good word just because some nutcase theorists are trying to grab it for their exclusive use.

So how Low can the euro go?

Estimates are all over the place. One idea is that the euro tends not to fall more than 2% under the 200-day moving average, which would cap the move at 1.4920. We say the sky is the limit.

How about 1.4366, the Jan 25 low?

The 50% retracement of the move from the Nov ’05 low to the July peak is about 1.3870. If the current move is a reflection of worsening conditions in Europe and the rest of the world while the US is already seeing recovery at the end of the tunnel, this is not a silly idea. Or to take things to an extreme, how about a 50% retracement of the 7-year dollar slide? It started October 31, 2000 at .8229. The high, as we know, was 1.6040 in July. A 50% retracement would be 1.3870. And why not?

We can afford to think big.

Bye For Now

Barbara Rockefeller - Rockefeller Treasury Services

For the Best Euro Exchange Rates contact IMS Foreign Exchange

US Dollar faces worst credit crisis since the Great Depression

Foreign Exchange Currency Outlook : The Fed statement will be released at the usual time of 2:15 pm ET today and we will all be glued to the radio or TV to hear it. Nobody expects a rate change but everyone wants to hear some perspective on how the Fed sees inflation. This is measured by how many members dissent and prefer a US Interest rate hike. Bloomberg writes that Bernanke may “need to sound tougher on inflation to avert the sharpest public disagreement among policy makers in more than a decade. The fastest inflation in 17 years adds to the risk that three members of the Federal Open Market Committee will dissent for the first time since 1992. Gary Stern, president of the Fed's Minneapolis bank, and the Philadelphia Fed's Charles Plosser joined Dallas's Richard Fisher since the last meeting in June in calling for an increase in rates to limit price increases. The trio wield more clout than usual because two seats assigned to Fed governors on the 12-member panel are currently vacant. That means Bernanke must craft a consensus that's responsive to the their inflation warnings while still heeding tumbling housing prices, a faltering economy and the worst credit crisis since the Great Depression.”

We agree that three dissents would be a lot and could be seen as a challenge to Bernanke’s authority. Remember, this was one of the main reasons that Paul Volcker resigned as chairman—he felt the Board should let him have the final say. We say this is almost certainly not a crisis in the making but it may roil the bond market. In the end, two dissents is probably what we will get and that will be digestible.

The recent economic numbers are not adding to clarity. The Q2 GDP version of PCE has a slight drop while the income/spending report version yesterday for the single month of June has a rise. Does the Fed see a contracting economy as a remedy for inflation? After all, there’s nothing it can do about the price of oil perniciously wending its way into consumer behavior. If the Fed thinks inflation is caused mostly by commodity prices increases that will iron themselves out (chiefly via reduced demand), then it has no incentive to raise rates. In fact, the Fed may be seeing incentives to cut, such as the desire to keep banks profitable and if not profitable, at least liquid and solvent. Thus a refusal to change rates can be viewed as hawkish.

While the Fed is the single most important institution in the world, let’s be honest and admit that the level of the US dollar exchange rate has nothing to do with monetary policy today and everything to do with the price of oil. Now that it has fallen under the old low from June, it’s wrong to say we cannot see a trend. Of course we can see a trend—we just need more confirmation of trendedness. The 10-day moving average is under the 20-day—there’s a confirmation of sorts. Better would be meeting the next historical lows ($110.30 from May 1 and $98.65 from March 20).

As an aside, those who favor alternative energy should be ruing the current downward trend in the price of oil—it removes incentives to find a fix, and fast. It also has the side-effect of reducing the political conflict between those favoring offshore drilling and those opposed. We say the knee-jerk “drill, drill, drill” of the tiresome Kudlow and his ilk is a dollar-negative. It’s far more dollar-positive for the US to be investing heavily in energy alternatives—it creates jobs and puts American innovativeness (and idealism) on parade as well as reducing stress on the environment.

In any case, we see the correlation of the US Dollar and oil as continuing. It’s very high, about 90% (depending on what timeframe you use). If we imagine that downward trending oil will get grabbed by the technical crowd, we can expect a retracement of the price rise by some pre-ordained amount, like 50%. Let’s say oil took off in Oct 2007 when it surpassed the old high from July 2006 at $78. A 50% retracement off the highest high of $143 is $112, and that is also near the bottom of the current upward sloping linear regression channel. It is therefore a perfectly reasonable forecast. (Note that $143 is the high for the current contract. At the time, the then-front month contract hit a high of $147.90 on July 11.)

It’s also only $7 away from the closing price yesterday, implying the move may be ending soon. In short, we would need to see oil go under the channel and under $100 to get a truly heavy-duty new trend instead of only a retracing trend. By this definition, we say we do indeed need to surpass the old low from March at $98 to be certain of a downtrend. But in the meanwhile, lower prices should be dollar-friendly in the extreme.

Conversely, if something evil happens and oil does a U-turn back to the recent highs,

the dollar will fall off a cliff.

Can it be that simple?

Yes.

Bye for Now

Barbara Rockefeller

For the Best Exchange Rate contact IMS Foreign Exchange

Australian and New Zealand Dollars

As an interesting tidbit, Market News reports that in Japan, the Tokyo Financial Exchange reports that margin traders have “defiantly bought the Australian and New Zealand Dollars despite expectations for interest rate cuts. They boosted their net kiwi long positions to 211,032 on Friday, the highest on records going back to mid-2006 and roughly doubling in less than two weeks. The New Zealand dollar rose 0.3% to ¥78.45…”

Well, if they have to unwind these trades, the yen would benefit across the board, so it’s a rocky outlook.

Bye For Now

Barbara Rockefeller

NYMEX crude oil contract settled at $125.10

The Sept NYMEX crude oil contract settled at $125.10, more than $1 over the close the day before, having made a higher high ($128.60) but not a lower low. This is a stall or pause rather than a reversal but everyone is watching the bar components like a hawk.

Oil rose to $126.35 in Asia overnight but the price is $125.11 at 11:18 am in London, according to Bloomberg, which doesn’t reflect the possibility of Tropical Storm Edouard turning into a hurricane, which it’s likely to do. This is a splendid instance of normally price-negative news being brushed off in a downtrend. But Galveston is battening down the hatches for landfall tomorrow.

And there’s another one forming in the Caribbean.

Commitment of Traders Report

Commitment of Traders Report: Market News reports that futures speculators capitulated and went long the US Dollar against both the euro and yen last week. In the euro, foreign exchange traders went from net long 4071 the week before to a net short by 16,218 as of last Tuesday July 29). “This compares to the April 29 net euro short of -21,315 futures contracts, which was the first speculative net euro short position since December 2005.” In the yen foreign exchange speculators were net long 10,524 the week before and lipped to net short by 6,280 contracts. They had been long the yen by a sizeable 50,105 contracts in the July 15 week.

cautiously optimistic about the US dollar rally

Foreign Currency Exchange Outlook

The July service sector ISM tomorrow is probably the biggest threat to the US dollar ahead of the Fed meeting—it will likely show a small gain (see the WSJ calendar below) but if it’s worse, the dollar could suffer. Services provide a very large chunk of GDP.

For some reason, not much weight is put on personal income and spending, but it perhaps should be. Incomes are expected down 0.2-0.3% after a rebate-fuelled 1.9% in June, with spending rising by about 0.5% (although Bloomberg says the forecast range includes a rise of 0.9%, which would be due to euphoria spilling over from the rebate checks). But as Peter Bernstein says in an opinion piece in the NY Times over the weekend, household earnings and spending are what we have to watch. The consumer is still the driver of the US economy.

If Bernstein writes it, we have to read it, and

if Bernstein is worried, we need to be worried, too.

As for the Fed even talking about rate hikes to tame inflation—forget it. The financial sector is on the edge of the cliff and the Fed feels responsible for not kicking it over. In fact, extending emergency funding plans to January could well be a hint that none of us are smart enough to take—no rate changes until after January, except perhaps an emergency cut. This should be a US Dollar negative but evidently foreign exchange traders give it low credibility. This shows only that they don’t know how banks work. At their core, banks take deposits and make loans (or invest in government paper). The spread is how they make money, and boy, do they need to restore earnings. It is in the Fed’s best interest to keep deposit rates low and asset rates higher, hence the desire for a steeper yield curve.

The sentiment is growing that everybody would really like to cut rates but nobody wants to be first. The ECB has painted itself into a corner with hawkish rhetoric, the Bank of England is at sixes and sevens, the BoJ has to contend with a stimulus package that almost certainly will fail, and the Fed would really rather do nothing for a while until the financial sector calms down—rate changes are only a distraction at this delicate moment.

That pretty much leaves the Reserve Bank of Australia and perhaps the Bank of Canada to take a leading role… the RBA is given only about a 30% chance of changing rates this time, but may make comments cementing the idea of a rate cut next time out. The rate cut idea is by no means universal yet, but we imagine it could gather momentum. Even if the ECB is not seen as being able to cut while inflation is so high, Trichet can decline to use the word “vigilance” or otherwise signal a more relaxed tone. If so, traders will sell euros as it gets another leg knocked out from under it.

We remain cautiously optimistic about the US dollar rally.

Bye For Now

Barbara Rockefeller

US Dollar Exchange Rate

Foreign Currency Exchange Outlook:

The drop in the price of oil, and let’s hope it keeps going to surpass the June low closing ($121.61), really gets most of the credit for the dollar’s rally. The codeword of the day is “demand destruction,” but realistically, Buyers of NYMEX Crude Futures (including exchange traded funds and other “investors”) must be pulling back. The question is at what point they decide that stocks and bonds are a pretty good place to invest over commodities. This becomes a technical issue as well as a simple arithmetic calculation of breakeven. At what prices did they get in? At a guess, about $80. Does that mean the price can go back there?

Why not, and further.

In second place behind the US Dollar rally is not-too-bad data from the US but fairly bad data from elsewhere, indicating trader bias is shifting. Normally when anti-dollar bias is strong, good news is brushed off and bad news is exaggerated. These days, bad news from elsewhere is getting more attention than usual. We like to think it’s because there is recognition somewhere in the back of the collective trader mind that when the US makes a move to adjust and adapt, it works a lot faster than elsewhere. Japan still has the mindset of the lost decade,” for example, and Europe has not even discussed a consumer stimulus initiative, while in the US, the bill was passed quickly and the money has already been spent. The problem comes in the form of “what have you done for me lately?” Markets demand on-going proof of responsiveness, even if little real progress gets made.

Payrolls this morning has the power to change everything, although it would have to be considerably worse than the drop by 65,000-75,000 now forecast to unhinge traders. If the number is at or near the consensus, we may not get the usual payrolls two-way spike—it could be a single spike, US dollar exchange rate up. Let’s say ADP Macro is right and it’s a gain, not a loss—zowie, get out of the way. The dollar could make it to important technical hurdle levels like 1.5350, even if it doesn’t close there.

Don’t count on it, of course.

Longer term, we must expect manufacturing to contract today (PMI expected down to 49 from 50.2) and let’s also keep an eye on the prospect of a Fed rate hike. Market News reports that one estimate has it that the odds of a rate hike in Sept are down to 16% from 40% only on Wednesday. The Fed is simply unwilling to prod the economy when it’s slowing down. While we may assume that the ECB is not feeling as hawkish as it would like to feel, the probability is higher than in the US that a hike could be in store, or that a cut would be more delayed. The relative rates do count. That’s why we name it “the main event.” If US yields are falling, it takes a continuous drop in oil to offset. This makes the dollar rally a shaky and precarious one that can turn around at any time. A currency needs more support than a single commodity price!

So while we welcome the dollar rally, we remain suspicious of its durability.

Let’s get back under 1.5250 first.

If that happens, then the whole picture shifts, like the picture that is sometimes a vase and sometimes a lady in profile.

Bye for Now

Barbara Rockefeller