Europe just starting to feel the pain already much in evidence in the UK and US

Foreign Exchange Outlook : The market is flirting with a return to risk appetite that is most visible in price rises in some commodities (copper, oil) as well as equities. At the same time, traders are girding their loins against really bad economic data, of which Friday’s payrolls is the most important. Market News reports the median number in its survey is a drop of 490,000, with a forecast range of 450,00 to 567,000. This comes after 533,000 job losses in November and 320,000 in October.

Offsetting the economic gloom is a rising sense that a can-do Obama administration really can create growth in some areas and that the reduction in fear is itself a pro-growth factor. Market News reminds us that when Reagan came into office in 1981, the US Dollar Exchange Rate was just coming up off a crisis level of 1.7250 against the DM. The previous Oct (1980), Fed funds had reached 20%--remember Mr. Volcker? While the US Dollar was already rising off the lows of the 1980 year when Reagan took office, he gets credit for the can-do attitude, even if Reaganomics had very little valid underpinning. Persisting today is a near-worship of Reagan by some but even those who thought the supply-side ideas were dumb have to admit that sheer attitude and the force of Reagan’s personality and charm were effective in restoring confidence. (He could also construct a whole sentence, too.)

Foreign Exchange Analysts point out that it’s impossible to untangle the psychological factors and the "real" economic and market forces at work. We say three things are critical. First is Obama convincing foot-draggers in Congress to shut up and go along with his plans. He will make a major speech tomorrow on recovery initiatives.

The second is greater confidence in the institutional infrastructure. The Fed's US mortgages market actions are already seen as a huge success two days into the initiative, if not grabbing headlines in the financial press just yet. Now we need success like this on every front, including the SEC. Numerous articles are appearing reviewing what happened, who or what is at fault, and how to prevent it next time. A lingering worry is that the guys who got us into the mess (Geithner, for example) are still the guys in charge of getting us out. We need to see a change in mind-set and not just personnel.

The third thing is perception of "how much is enough." This is one of the lessons every junior banker learns in credit school - is the borrower asking for the optimum amount of money to make the new business plan workable?

Right now it looks like the Obama plans will encompass $1-2 trillion, with $775 in stimulus spending and $300 billion in tax cuts (so far), on top of the $700 billion in TARP money plus whatever the Fed is doing.

Is that enough?

If the markets perceive that it is, they will open their wallets. A ton of money is sitting on the sidelines. In particular, corporations are stuffed with cash and refusing to invest in capital spending. So we not only need to see corporate bonds become acceptable paper again, we need to see corporations spend some of their own money.

Nothing spells confidence like capital spending.

We say that tax and other incentives to boost capital spending (as opposed to consumer spending) are the key to the success of the Obama plans. If tomorrow we start getting confidence in this aspect of the recovery initiatives, the payrolls number the next day will lose its sting. Yes, this means we think the psychological factor (returning confidence and hope) can outweigh bad data. The psychological factors are forward looking while the data is, by definition, backward-looking. Markets like to anticipate, and none so more than the Foreign Exchange market. With Europe just starting to feel the pain already much in evidence in the UK and US, hope is more likely to arise on this side of the Atlantic. So far Asians seem to be willing to believe in the Fed, and let’s face it, Asians are the ones with the money these days. Meanwhile, Middle East sovereign wealth funds and other official and semi-official asset managers are licking their wounds and watching the oil price fall—but they will be back someday, if only because of the dearth of safe investment opportunities in their own region.

Now let’s look at the calendar. Jan 19 is a national holiday in the US and the inauguration is the next day (not a holiday). Analysts say mid-Feb is the earliest we can expect Obama initiatives to hit the streets, but we guess the can-do effect will hit before then. This could be wildly US Dollar - favorable.

We just need this dratted correction to end first.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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falling oil prices that set the stage for the us dollar currency recovery

The Feb NYMEX oil contract closed at $48.81 from $46.34, breaking the 20-day moving average to the upside as well as the linreg channel top. This is quite frightening since it was falling oil prices that set the stage for the us dollar currency recovery. Overnight it went to $50.04, not seen since Dec 15, on reduced Russian supply of natural gas to not only the Ukraine, but Southern Europe, too. The FT names Turkey, Bulgaria and Romania. Oil is the alternative. Separately, Bloomberg reports that Kuwait and Qatar plan to cut oil shipments to Asia starting in January, fulfilling the cuts promised at the OPEC meeting on Dec 17.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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Buy US Dollars - Even the strongest rally doesn’t move in a straight line

Foreign Exchange Outlook : We get some US data today, including the ISM service sector index for Dec (probably a decline to 36.5), existing home contracts, factory orders, and the minutes of the Fed Dec 16 meeting. The Fed minutes will be interesting because they will disclose the reasoning behind taking rates to a range of zero to 25%. Today is also probably the day that Friday’s payrolls come onto the radar screen.

Still, the overriding factor is the ECB rate cut now universally expected next week and the associated rhetoric as well as the amount (25 bp or 50 bp) and the pace of future cuts. Bloomberg reports that ECB policy member Constancio said yesterday (before today’s inflation numbers) that the bank is prepared to cut interest rates if necessary to keep inflation on target. If price growth slows below the goal of "just below 2%," the bank will respond with rate cuts. This is nothing more than confirmation of what we already know, but central banks have their own intricate dance with the market and it's necessary for the bank to disclose its intentions out loud. We can’t wait to hear from the BBK's Weber. As for the extent of cuts, Bloomberg says its survey shows ECB rates down from 2.5% to 1.5% by end-June, or a total of 100 bp in cuts. We think the market may reward the euro exchange rate with a bump up if the first move is a biggie, at least 50 bp.

Also, we need to look at two intermarket factors, the rise in US 10-year note yields and the price of oil. We are seeing a rise in yields and steepening of the yield curve in part on hope that the Obama team can drive recovery. As a general rule, this is US dollar rate - favorable. But not to the mind of former Bank of England policy committee member Buiter, who says Americans must prepare themselves for a "massive collapse" in the dollar as investors around the world dump US assets, according to a piece in the Telegraph newspaper. This is a tabloid newspaper that loves shocking headlines, although Buiter is a reputable source. Buiter says there will be increasing disenchantment with the US economy and thus an exodus of foreigners.

Well, probably not. Recently both the Japanese and Chinese have affirmed that they will continue to buy US government paper for reserves, even though China has already said Q4 reserves will show a drop because of the dollar's decline late last year. Some forex analysts say this is no big deal - these reserve managers have a distinct lack of other good assets to choose from. Even European bonds are not a real alternative to US paper since the European bond market is made up of individual country paper and some of it is getting the benefit of the doubt from the existence of the euro exchange rates and not because of good underlying fundamentals (like Italy). We are inclined to accept the no-good-alternative argument. If Buiter were right and the dollar exchange rate gets dumped as the Treasury holds auctions and nobody comes, the global financial system would face a bigger Shock than anything we have seen so far. We may not like it, but as goes the US economy and the US government bond market, so goes the rest of the world.

Oil is a more immediate and pressing problem. We complained all last year that the inverse correlation of the dollar and oil was silly (beset by circular reasoning whereby oil traders said they were buying oil as a speculative asset because the dollar was falling and currency traders said the dollar was falling because oil was rising). This correlation is not a necessary one—we have had periods when the dollar and oil moved the same way and not inversely. But the speculative psychology could easily come back and give us wildly higher oil prices, and perhaps a wildly lower dollar, on very little evidence. We still want to see greater regulation of the oil market in some way - when oil is treated as a financial asset and not a commodity, it becomes less linked to valid supply and demand determinants and takes on the irrationality of financial markets. Oil is too important to be controlled by greedy, nasty yuppies at Goldman Sachs. But critics are right that regulating this market may cause more trouble than it cures. Who exactly would be qualified to do it, and how? Net-net, we see oil as the biggest threat to the dollar rally, not US economic fundamentals (and we are not certain that the Obama rescue plans will work in the first place).

Finally, today is Tuesday and we often get a pullback on Tuesdays, or so market lore has it. Even the strongest rally doesn’t move in a straight line. But keep the faith - it’s a true new trend and unless something comes along to derail it, we have more time to enjoy it.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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commodity price bust is going to keep going, and so will the stock market decline, and these moves will not be orderly

Foreign Exchange Outlook : Analysis of the day’s rate cuts will occupy most of the morning today, but by midday foreign exchange traders will probably turn their attention to the payrolls report at 8:30 am tomorrow. Yesterday ADP forecast the private sector component at a loss of 250,000 and other estimates are all over the place, with some whisper numbers as high as 400,000.

The problem will assuming that a really bad number tomorrow will be dollar exchange rate negative is that it’s already built in - isn’t it? Usually we get a two-way spike, both down and up, on the release. Payrolls is the most unforecastable of all the economic numbers, and so has become the most important. It’s not clear that the Fed views it as the most important, but never mind. This time we already know the news is going to be bad, and revisions will probably be worse. Depending on what happens to the automakers, it could get a lot worse before it starts getting better.

We are guessing that a bad payrolls number might have a US dollar rate -negative effect in the US dollar to Japanese yen exchange rate but not elsewhere. After all, falling employment is “good” in that it means the race to the bottom is proceeding at a rapid pace in the US, while it lags everywhere else. This is the FIFO argument from a few weeks ago (first-in, first-out) and while there’s a lot wrong with this idea, it can have a powerful grip on traders’ imaginations. Foreign Exchange Traders always try to anticipate. Obama has said employment is key and recovery plans will aim to create millions of jobs. So far we believe him.

Not getting enough attention is the report from the Government Accountability Office, which said on Tuesday "There is heightened risk that the interests of the government and taxpayers may not be adequately protected and that the program objectives may not be achieved in an efficient and effective manner." In other words, the Treasury has been throwing money out of windows, perhaps more than $3 trillion so far and easily another trillion or two to go, without being able to pin down exactly who got it and why. Someday the US dollar rate is going to fall on the blazingly obvious incompetence and mismanagement of this ad hoc rescue effort.

But we also think the commodity price bust is going to keep going, and so will the stock market decline, and these moves will not be orderly. Fear of volatility alone may suffice to support the US dollar exchange rate. Dollar bulls do not want to see commodity prices and stocks to rise, which is surely a bad thing in its own right.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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risk aversion is rising and rising risk aversion is dollar exchange rate favorable

Foreign Exchange Outlook : The USM service sector report is due today, probably a drop to 42 or the lowest since the index was invented in 1997. We also get the ADP Macro forecast of private sector jobs ahead of Friday’s critical payrolls report. This is oddly not much on the radar screen yet, even though on Monday the DJ Newswire reported a median estimate of 200,000 jobs lost. Potentially disturbing is a story in the WSJ asserting that Paulson is thinking about asking for the other half of the 700 billion in TARP money authorized by Congress. Originally his idea was to leave half of it for the incoming Obama administration. He would act next week if he acts at all (he leaves for China today or tomorrow, a wasted trip if ever there was one). This raises the question of what Paulson knows that the rest of us do not.

We hate to say it, but if stocks are down today, that implies risk aversion is rising and rising risk aversion is dollar exchange rate favorable. Bah. This is no way to run a currency market. With average daily ranges shrinking and little directional guidance, we have to expect a breakout at some point - but probably not today. We may have to wait for Friday’s payrolls for that, unless tomorrow’s rate cuts do the job.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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Australia and New Zealand Dollar, the prospect of rate cuts is currency-negative this time.

Foreign Exchange Outlook : As we have been emphasizing, one major reason for the US dollars firmness during this crisis is "it's worse elsewhere," making the dollar a safe haven. The news from the UK is particularly dire. The Reserve Bank of Australia, Bank of England and ECB are all expected to cut interest rates this week, a move that traditionally weakens a currency but recently has been seen as a good thing because it may unclog the credit pipes and also demonstrates responsiveness. With central banks wagging an admonitory finger on credit quality behind the scenes, it’s not clear that lower rates have their accustomed power to goose lending and activity, though.

Still, in Australia (and New Zealand), the prospect of rate cuts is currency-negative this time. After a tame inflation report in Australia, the Australian Dollar fell on the widening view that the RBA could cut as much as 75 bp to 4.5% at the policy meeting tomorrow. Curiously, the Australian stock market fell on the rate cut outlook.

Aggressive rate-cutting around the world may be a dollar exchange rate supportive factor-or may not. A lot depends on the rhetoric. Too much fear and panic expressed out loud by central banks is good for the US dollar rate, while too smug a view (by, for example, the ECB) is also good because it shows a lack of responsiveness. In short, central banks have to perform a real balancing act. The appearance of desperation is also dollar friendly via the oil and other commodity price connection. We continue to think the oil - dollar correlation is more important than any other intermarket analysis.

In the US, we get a ton of data this week, including the ISM's manufacturing sector data for Nov and a Bernanke speech today, plus the usual barn-burner, the payrolls report on Friday. The ISM report is likely to show a contraction in manufacturing for the 4th month in November, perhaps to the lowest in 28 years, according to Bloomberg. This is bad for the economy and for confidence but very nice for the price of oil resuming its downtrend.

Most of the factors are lining up for a dollar rally today and perhaps all week. We worry a little that normally dollar exchange rate negative factors are being ignored, thought. Any development along those lines (terrorism, China, payrolls) could cause a confusing halt in the run.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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We can't name the event that will end the US Dollar rally, but at a guess, we haven’t seen it yet.

Foreign Exchange Outlook: At last the Treasury and Fed have launched an initiative that the market likes and is responding to. At last the government is doing something about housing directly and not indirectly through credit default swaps or capital injections to banks. At last the government is listening to the market, since the structure of the TALF was something proposed by player (according to Market News). This is tremendously good news. Unable to force banks to lend—the one big missing ingredient in the Citi bailout and the earlier capital injections-the government has found a way to "incentivize" the banks. And it took only three months, if we count from end-August. For a country as big as the US with so many conflicting lumps of self-interest, this is actually not too bad.

Ironically and perversely, though, a workable initiative is dollar exchange rate negative, since it means global risk is down and opportunity is up. It’s nice to have greed plus fear back again and not just fear and fear, but some issues do remain-not the least of which is “Is it enough?”

We may get a hint today in the form of personal income and spending, with spending expected down a big 1% after -0.3% in Sept, according to the Bloomberg survey. Who ever heard of the US consumer reducing spending? We say the UK is about 9 months in front of the US on this and many other fronts. Household spending fell to a multi-year low in the UK and we probably have to expect it here, too. We also get data on durable goods order, new home sales and consumer confidence.

The other big factor is prospective interest rate cuts in the UK, Europe and US in December. Remember that rate cut were a currency favorable event in Australia (with the Australian Dollar exchange rate ralling) and the UK a few weeks ago, since they showed "responsiveness." If the ECB is seen as recalcitrant or dragging its heels, the euro exchange rate could get punished for that lack of responsiveness more than rewarded for having a favorable yield differential. (Foreign Exchange Traders dont need a reason to Sell Euros at the moment)

This is a topsy-turvy world.

Similarly, Foreign Exchange Traders will buy pounds if the Bank of England is aggressive, as seems likely. We are holding to our story that all the bad news is not out yet and any fresh instance of systemic failure will fall to the US dollars favor. This includes a retreat in equities, renewed weakness in commodities (especially oil), a big bank failure somewhere (anywhere), and so on. This doesn't even include all the terrible things that can happen in the political or natural world-riots, assassinations, earthquakes, and the like. It seems improbable that a giant rate cut in China will restore everything to conditions before. In fact, we think it really is a new era.

Downsizing is serious business.

We can't name the event that will end the US Dollar rally, but at a guess, we haven’t seen it yet.

Bye For Now

Barbara Rockefeller
Foreign Exchange Trading
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