The ECB spoiled the USD recovery efforts

Nothing much came out of the ECB keeping interest rates unchanged. It was widely expected after all.

However, great insight was given in the posterior Trichet conference. Trichet took such an aggressive stance on inflation that the EUR/USD would quickly return to its usual levels. The market learned that the ECB is leaning more on the side of raising interest rates than lowering them. In fact, today's interest rate decision was not unanimous as some members argued for an interest rate hike!

Very bullish news for the Euro.

Some statements from Trichet Conferece

The ECB decided to keep interest rates unchanged at 4%. This was mostly expected, however Trichet took a very aggressive stance on inflation.

Below are some statements coming from this conference...

-Recent data confirmed upside risk to inflation pressure

-Economic fundamentals remain sound

-Will continue to pay close attention to developments in financial markets

Q3 07 GDP at .7% GDP, inline: domestic demand remained main force in euro zone , sustained nature of economic expansion, robust employment growth, annual gdp growth expected 2.4 to 2.8% in 2007; 1.5 – 2.5% in 2008; 1.6 – 2.6% in 2009.

-sustained GDP growth, US weakness will be offset by emerging economies

-annual inflation rate increased strongly

-energy prices having strong upward impact on inflation

-inflation rate expected to remain well above 2% in coming months and expected to moderate in 2008

Dollar is Staging a Recovery

The Dollar is staging a recovery in a day when the Bank of England lowers its interest rate to 5.50%. This is a surprise move by the bank as most analysts were still expecting the money price to remain unchanged. Some, however, were starting to consider a cut.

The GBP/USD has lowered to 2.02 while the EUR/USD is testing significant trendline at 1.4520.

With minutes to go for the European Central Bank to makes its interest rate decision, another surprise could provoke some greater volatility to the forex market. It is expected to remain unchanged.

Speech from Bernanke on Nov. 29

We see a fairly neutral stance from the Fed president. A close eye will be kept on future macroeconomic references until December 11 meeting.

Excerpt from Bernanke's speech...

With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

Core inflation--that is, inflation excluding the relatively more volatile prices of food and energy--has remained moderate. However, the price of crude oil has continued its rise over the past month, a rise that will be reflected in gasoline and heating oil prices and, of course, in the overall inflation rate in the near term. Moreover, increases in food prices and in the prices of some imported goods have the potential to put additional pressures on inflation and inflation expectations. The effectiveness of monetary policy depends critically on maintaining the public’s confidence that inflation will be well controlled. We are accordingly monitoring inflation developments closely.

The incoming data on economic activity and prices will help to shape the Committee’s outlook for the economy; however, the outlook has also been importantly affected over the past month by renewed turbulence in financial markets, which has partially reversed the improvement that occurred in September and October. Investors have focused on continued credit losses and write-downs across a number of financial institutions, prompted in many cases by credit-rating agencies’ downgrades of securities backed by residential mortgages. The fresh wave of investor concern has contributed in recent weeks to a decline in equity values, a widening of risk spreads for many credit products (not only those related to housing), and increased short-term funding pressures. These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors. Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.

full speech

Why the pressure is all on the FED

The fact is that the evolution of the global markets is mostly relying on the shoulders of the Federal Reserve. This is not really a good thing as any decision to be taken by the Fed will have negative consequences. It does not really have as much wiggle room as other central banks.

Take the ECB (European Central Bank) for example. Its decision is actually helped by the Fed's activity. The ECB has to balance price stability with economic growth. With Europe suffering increasing inflationary pressures at the same time as a slowdown in economic growth, the decision on whether to tighten monetary policy becomes difficult. If it lowers interest rates to boost the economy it could get a real inflation risk. Raise interest rates and the economy could take a further hit.

However, general market forces will help the ECB to make its decision as well. Although the strong euro has been strongly criticized, the fact is that it is not really hurting exports as much as economists feared. With exports sustained, the ECB does not have to greatly worry about it hurting economic growth. Why are exports sustained?, because the Euro mostly revalued against the dollar. Therefore, exports are simply moving away from the U.S. towards China and other emerging countries. On the other hand, Europeans are seeing an increasing buying power. This helps imports increase as foreign products are getting relatively cheaper. Furthermore, cheaper products help control inflation. For example, with oil priced in dollars, the high euro makes up for part of the higher oil prices.

SO, the higher euro is helping Europe fight inflation. However, the latest indicators show that inflation might be starting to increase in Europe. Therefore, increasing interest rates is not out of the question just yet.

Although economic growth is slowing down in Europe and the credit crisis is being felt, boosting the economy is not as urgent for ECB since the FED is already lowering their interest rates. After all, the credit crisis originated in the United States and more dire measures will have to be taken in that country.

In other words, the FED cutting interest rates is helping the ECB with its objectives. Lower interest rates for the dollar is helping to ease the credit crisis and will help mitigate the spill-over effects to other countries. At the same time, it drives a weaker dollar which in turns helps Europe control inflation, especially on dollar-denominated commodity prices.

U.S. inflation could head into real danger. Consumer prices have been remarkably resilient so far as it remains very close to the 2% level. However, with the Fed passing more cuts, it sets up a real inflationary risk with a steeply declining dollar.

US Data..Just Released

US GDP revised to 4.9%... meets estimates.

Weekly Initial Claims = 352K vs expected 330K.... continuous claims highest in 2 years


No major reactions to currency markets

Thanksgiving & Black Friday, A Transitory Period

Thanksgiving is a big enough holiday to have the markets close in the United States. As investors and everyday traders we should probably take the time to reflect and be thankful that the crisis has not extended much deeper into the economy...at least not yet! The strong Q3 GDP was something to be thankful for; it had put aside fears of recession although now they start to show up again.

With our thanks expressed, "Black Friday" will be time to move on and look ahead. We should place plenty of emphasis on this weekend. On Monday we will get the first result from retailers and this should set the tone on whether we will have an end of year rally. Some analysts estimate that this will be the worst Christmas season in five years. This weekend will probably indicate how resilient U.S consumers are. Strong retail numbers will give the stock market a chance for an end of year rally. It could also mean that the crisis remains constrained to the housing and credit markets.

New Record for the EUR/USD !!

The EUR/USD has set a new all-time high at 1.4793.

It has drifted back a bit to 1.4785 but everything seems to indicate that there could be another attempt today at 1.48. We will stay tuned.

Also coming up today, the minutes from the FED's latest meeting. This could provide some helpful insight to what Fed members were considering about future interest rates.

Crude inventories are up, decline was expected

Crude oil inventories are up -> Crude oil prices are down

U.S. CPI: Meets Consensus Estimate But Inflation Is Getting High

Inflationary pressures are finally being felt by consumers. Investors have been wondering how long it would take for the high energy and food prices to filter through to other sectors.

High inflation is a bullish indicator for a currency. As such, we saw a correction on the EUR/SD to 1.4620 after the release of this data.

USD/CAD - 250 pips in yesterday session

The USD/CAD made more than a 250 pip moving during yesterday's session to go from 0.9452 to 0.9704. During this same session we must note that the crude oil prices also saw a significant drop. This serves as a good reminder of the high Canadian Dollar correlation with crude oil as Canada is a big crude oil exporter and actually the number one exporter to the US!

Note, you want to trade crude in the currency market?, try the USD/CAD!

Possible entry point for EUR/USD

The EUR/USD is reaching its 200 hour moving average after a significant recovery in the dollar. These short-term corrections could prove to be good entry points if today's dollar rally does not continue. The currency pair has already bounced off its support once in the last hour.

Possible trade setup:

Long at 1.4550 – 1.4570 with stop order 5-10 pips below today's low of 1.4547. Good reward to risk ratio.

Volatile Stock Markets

The last two afternoons in the NY stock market was extremely volatile. The DJ had gone lower by about 200 points to only close with a -33 point close. The market was attentive to Bernanke's conference with Congress and apparently saw indications of low probability for a December rate cut.

However, what we now have is a very hawkish ECB leaning on the side of inflation control and a FED that is leaning on boosting economic growth. Furthermore, there is a better chance of the ECB increasing rates than the FED lowering them. This could prove incredibly bullish for the Euro. 1.50 is definitely not out of the question (and more!!)

Bernanke is speaking to Congress...

Bernanke states that the FED is anticipating moderate but positive economic growth for the following quarters...

Seems to be a fairly positive assessment of the economy. Hoping to see a bottoming out of the housing market by spring 2008

Concerns are being expressed for home owners, and desire for agencies to help homeowners keep their homes

"Market outside of housing has been remarkedly resilient."

See my review of the FOMC statement here


"For the first the trade sector has been positive to U.S economic growth." This statement was made in reference to higher U.S. exports (driven by USD weakness). See the post,

Just One Reason Why The Economy Will Remain Strong

ECB keeps interest rates steady at 4.00%

As was widely expected the ECB kept interest rates at 4.00%.

Muted reaction on the EUR/USD, currently steady at 1.4655.

Close attention will be paid to Trichet's statement! A hawkish statement could drive the euro higher, investors will be looking out for this.

The webcast could be watched from the ECB website at 8:30am EST, here

Followup: Trichet cites sustained economic growth... strong increase in inflation indicator... expects inflation to be above 2% in following months before moderating in late 2008... positive sign from labor markets... upwards risk to price stability... [crisis led to] large monetary shift to safe, liquid monetary assets ... ready to counter upside risks to price stability

EUR/USD at 8:47pm EST: 1.4660. Market is not surprised

Bank of England keeps rate at 5.75%

No change...

ECB interest rate decision to be released within the hour

At 7:05am EST... GBP/USD = 2.1074

British pound was drifting lower to 2.1018 minutes before the announcement and spiked up 60 pips on the release.

This decision was widely anticipated by the market but perhaps some traders were looking for cut indications because it possibly suffers the most impact from the housing and credit crisis, after the U.S.

Follow up: Bloomberg just reports that some doubt was creeping in regarding rates because not yet clear if further losses would be acknowledged from crisis. For the most, however, this decision was expected.

USD drops to new lows

The USD drops to new lows on news that China will diversify its currency reserves. A Chinese official stated that it preferred stronger currencies over weaker currencies. China has a huge amount of U.S Treasury Bonds. If it starts selling them, it will add greater pressure to dollar weakness.

A great article by Kathy Lien of DailyFx explains why the EUR/USD is unstoppable and heading towards 1.50.

As explained, Australian and Sweden increased interest rates. This means that other central banks are willing to increase rates in this economic situation. Only the FED is lowering rates and this change in interest rate differentials is clearly the catalyst for USD weakness. Today's move to 1.4730 most likely reflects anticipation for a hawkish ECB. Most expect ECB to keep rates steady. However, the statement will probably favor the control of inflation. This would mean that the ECB along with other central banks will test the limits of their economies before loosening rates. The FED does not have this luxury because of the credit crisis and can not further restrict liquidity.

In a strange twist, raising interest rates might not have a strong impact on economic growth because it will help Europe offset higher crude oil prices!

Incredible Price Levels

If we take a step back and look at the general picture we must realize that we are at price levels that could have seemed unimaginable a few months ago. Investors must also realize that this could mean that we are in a dangerous predicament.

On the one hand, according to the popular phrase "the trend is your friend," we would be encouraged to jump in and take some long positions...

Crude oil...$97.00 (all-time high)
Gold ounce...$825
Euro/Dollar...1.4570 (all-time high)
Chinese stock market... near 6,000 and unstoppable.

We must start considering how much of the valuation is based on speculation and how much is based on fundamentals. While it may be correct to join the trend in the long-run we must be careful of possible bubbles forming and that many markets could be overvalued in the short-term.

Speech by Governor Frederic S. Mishkin, Financial Instability and Monetary Policy

Below are the concluding remarks of the speech...

"As I have argued here, under the mandate it has been given by the Congress, the Federal Reserve has a responsibility to take monetary policy actions to minimize the damage that financial instability can do to the economy. I hope I was clear in communicating to you that policies to achieve this goal are designed to help Main Street and not to bail out Wall Street. Pursuing such policies does help financial markets recover from episodes of financial instability, and so it can help lift asset prices. But this does not mean that market participants who have been overly optimistic about their assessment of risk don't pay a high price for their mistakes. They have, and that is exactly what should happen in a well-functioning economy--which, after all, is what the Federal Reserve is seeking to promote."

In the following paragraph, Mr. Mishkin describes the characteristics of high-risk investments like what happened with the mortgage subprimes...

"Adverse selection arises when investments that are most likely to produce an undesirable (adverse) outcome are the most likely to be financed (selected). For example, investors who intend to take on large amounts of risk are the most likely to be willing to seek out loans because they know that they are unlikely to pay them back. Moral hazard arises because a borrower has incentives to invest in high-risk projects, in which the borrower does well if the project succeeds but the lender bears most of the loss if the project fails."

It is worth mentioning that Mishkin emphasizes that the FED works to restore financial stability and is not promoting a bail out of Wall Street. It also differentiates this instability from economic risk but that the first could filter through to the latter.

This is an interesting speech and I recommend reading it.

Just One Reason Why The Economy Will Remain Strong

While the world economy has been moving along led by U.S. strength for many years, it will now be time for the favor to be returned. That is what is so great about globalization. Weakness in one place could be offset by strength somewhere else.

With dollar weakness, demand will no longer have to rely on U.S. consumers. Dollar weakness could easily be what makes the U.S. economy withstand recession and financial market turmoil. Exports are already picking up. Companies outside the financial sector are still generating good income growth. Dollar weakness is not necessarily a bad thing for the U.S.

The tourism sector is just one example...

Check out this Yahoo video about tourism in NY picking up.

EUR/USD, Back above 1.45

The Eur/Usd is back above 1.45. The job creation data was positive, however, the worries about the financial sector dominate the market.

The SEC investigation into Merrill Lynch possibly delaying write-downs just shows us that there could be lots of losses waiting to be seen in future quarters.

UBS also downgraded Fortis for lack of transparency about their exposure to the U.S. mortgage markets.

The focus is squarely on the financial sector and the problems they could be facing.

Maybe We Should Question Business Practices and Not The Economy

We could be a little more relaxed about the general economy as the numbers show that although we could be facing a slowdown, a recession could be avoided. Corporate earnings excluding the financial sector still shows solid growth. The labor markets seems fine as well. The situation at the "general" level is not as dire as some make it seem.

What we should question is not the health of the economy but the health of business practices. The whole subprime crisis stems from creditors facilitating high risk loans to unqualified consumers. With the housing market so strong, greedy lenders just kept taking more risks. There was no shortage of investors that would buy bonds backed by these risky mortgages. It really is amazing that risk was not better assessed. But I would say part of the reason is greed. Investors are constantly trying to look for higher and higher yields. Beating the S&P average is clearly not enough. Speculators do a great deal of good to the economy by providing capital but sometimes things get out of hand and there is just too much risk out there. Risky hedge funds, alternative investments, and emerging countries all compete for capital but it seems to me that people easily forget to study their fundamentals.

Why should the individual consumer suffer at the hands of the big institutions? Thankfully, consumers are showing resilience and the reason is basically that the general economy is too big and powerful to fall immediately from problems in one sector. We must be careful with the domino affects. Down the line consumers could still suffer as more and more people are getting their houses foreclosed, which leads to lower consumer confidence, lower consumer spending, etc.

Hopefully the big financial institutions find solutions and not just try to hide their losses. UBS downgraded Fortis for lack of transparency in showing their exposure to the US mortgage market. Today the SEC started investigating Merrill Lynch for perhaps delaying acknowledgement of subprime losses. (see WSJ article). Is this all just an extension of corporate scandals to the likes of Enron?

This does not seem to be a problem with the economy, just a consequence of bad business practices. There will likely be a continued housing correction but hopefully it won't extend too much beyond that.

"Much of the recent dollar weakness has been the result of the currency market pricing in just such a dour scenario [possible US recession]."

This article by DailyFx gives some support to my argument below. A U.S. recession might not be so imminent and this could be very optimistic for the USD.

Dollar Bounces as Relief Rally Takes Hold

Tomorrow we have the important Employment Report and a good reading could produce a tremendous USD rally.

FED Rate Cut... Has a Balance Been Reached?

According to yesterday's FOMC statement...

"The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. "

The tone taken by the FOMC statement seems to have a very neutral stance. Could it be that things have balanced out?

We must also remind ourselves that there was actually one vote in favor of keeping the rate unchanged (9-1). The Committee judged that some inflation risk remains which does not seem like an overwhelming concern, especially when they decided to the cut the rate. They also cited economic growth as solid, so why lower rates? This along with a successful earnings season (for the most part) means that the credit crisis could be overdone. The FED must believe the economy could easily weather the storm and that is why they changed their stance in the statement to a more neutral tone.

In short, it looks like the Fed is hinting that it has realized two rate cuts as a 'momentary' measure to ease recovery from housing and the credit crisis. I would go on to state that perhaps other members wanted to keep the rate unchanged but a strong signal would have been needed to go against expectations. A signal like the turbulent money markets that sparked a 50bp cut in September.

Not withstanding future macroeconomic indications, I would say things look relatively optimistic for the U.S. economy in that the crisis will be limited to housing and credit markets. There appears to be a good chance that there will be strong corrections to the housing bubble, the eur/usd, and commodities looking out to end of 2007 and first half 2008. The focus might then return to inflationary pressures when dollar weakness and oil strength resumes its trend.

FED CUTS RATE TO 4.5%

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

View the FED's press release

Several Positive Economic Readings In The United States

Just as Europe revealed some negative indicators, the U.S. motivates with encouraging numbers.

To summarize:

Q3 GDP = 3.9% vs. expected 3.1%
GDP Price Index = 0.8% vs. expected 2%
ADP = +106k new jobs vs. expected +60k
Job cost index: +0.8% quarterly vs. expected +0.9%

Europe indicated higher inflation and slower growth while the U.S. shows the reverse with controlled (more than expected) inflation and better than expected growth.

The positive news concerning the U.S. economy could be seen by the USD recovering positions in the crosses right after the GDP data. The move was limited however and we must conclude that had it not been for the highly anticipated FED interest rate decision the move would be greater.

Even though some say that an interest rate cut is discounted by the market, the potential for some wild volatility is certainly there.

Several Negative Economic Readings In Europe

With hours away from the FED interest rate decision, several unfavorable economic indicators were released in Europe. As such, inflation figures are starting to reflect what seemed inevitable with the higher food and commodity prices. Not only has the CPI in Spain and Italy recently been higher than expected, but the overall annual CPI estimate for the Euro Zone was 2.6% when 2.3% was expected. Furthermore, Euro Zone economic confidence also came in less than expected. Finally, the busy morning includes an unemployment rate that is worse than expected.

Increasing inflation along with a slowing economy is a mix that greatly complicates things for the central banks and their monetary policies. As such, the question at hand when looking at the Eur/Usd for the medium-term might be, "Which of the two economies is in the least worst shape?" and "Which economy will recover first?."

The European economy was starting to prove very resilient and might have been the cause to the recent Euro rally. The important exports were resisting the higher euro, and high energy prices weren't being passed to the consumer just yet. Today's data could start to question all this although we still need more concrete indicators.

The inflation pressures could incite the bank to increase rates but could it really afford to do so and further hamper economic growth with a Euro that is already so high and turbulent money markets?

Correlation between U.S. interest rates and oil price

An article on CNN Money correlates lower US interest rates with higher crude oil prices.

How a Fed rate cut raises oil prices

The reason is that lower interest rates spurs economic growth which in turn means higher demand for energy. In addition, since oil is priced in dollars, the cheaper dollar (which is implied with lower rates) means that oil will be cheaper for foreign consumers and thus incites demand as well.

According to CNN Money, "The real question is this: Is a rate cut already priced into the cost of a barrel and, if not, how much higher is crude expected to go?"

Sweden (Riksbank) Raises Interest Rate

The Riksbank has decided to increase the interest rate by 0.25% today and states that it is probable that it will raise them further in the future. The bank already forecasts the rate to be 4.25% in the first half of 2008. The entity cites increased cost pressures.

Sweden repo rate at 4%

Sweden sees its economy still going strong, however, it can not ignore the slowdown and financial turbulence that is being faced by the gigantic U.S. and European economies. The bank continues its plan of curbing inflation by raising rates as the aforementioned economies would have done had it not been for the troubled financial markets. The rising oil and food prices is an ongoing concern as well as the tightening labor market. Therefore, Sweden will undoubtedly keep a close eye on international markets.