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.