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?"