Rejoining of the Unholy Matrimony

ECB may follow Fed and BoE in rate cut
By Ambrose Evans-Pritchard

The European Central Bank has ditched its bias towards interest rate rises, preparing to join the US Federal Reserve and the Bank of England in easing monetary policy to head off a sharp downturn.

Jean-Claude Trichet, the ECB's president, acknowledged that risks are now largely on the "downside" after January's precipitous fall in Italy and Spain's services index.

"It is a total capitulation," said Jacques Cailloux, eurozone economist at the Royal Bank of Scotland.

"The ECB was wrong in thinking that Europe could decouple from the US and has misjudged the loss of momentum. We think they will start cutting rates in April," he said.

Ken Wattret, an economist at BNP Paribas, said cuts could come as soon as March, warning of a "vicious spiral" as the credit squeeze and sliding confidence feed on each other.

The euro plummeted to $1.4450 against the dollar as Mr Trichet's comments flashed across traders' screens. Funds have taken massive 'short' positions, betting that the euro's six-year march to record highs is over.

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FX Insights Trade Team Update 07/02/2008

By FX Insights Moderator

Did you enjoy today's 200 pip drop as much as you enjoyed it on Tuesday? I hope so... we surely did, these are the kinds of days we live for as traders!

So what drove the euro down today? Very simple -- his name is Jean-Claude Trichet, and right now, I'd love to shake his hand!

As expected, the ECB held interest rates at 4.00%, but it was what Mr. Trichet had to say at his press conference that caused the euro to get beat up in today's trading... lets re-cap:

Back in November we started giving warnings that European growth would slow in 2008 and that the ECB would eventually be forced to cut interest rates, hopefully those of you who were around back then and read the updates will remember... in fact, I've probably devoted a dozen or more updates over the past few weeks talking about this and now we're finally starting to see the market respond to Europe's weakening fundamentals and the market's speculations of ECB rate cuts.

At this morning's press conference, Trichet was the most dovish about European growth as I've ever seen him... in addition, he basically said that current interest rates would be just enough to stabilize European inflation... plus, he indicated European inflation would subside while downside risks to growth would grow! He almost seemed relieved to get all this off of his chest, it was very odd to watch and observe his body language, but that's an important thing we do because it can signal how the market will decide to react, which was clearly to bring the euro down...

In nutshell, Trichet told the markets the following:

*Rates are on hold and will not need to be raised = EUR-
*M3 growth is slowing = EUR-
*Inflation pressures will subside this year = EUR-
*Growth facing serious risks to the downside = EUR-
*Risks to GDP are on the downside = EUR-
*ECB will not surprise markets = EUR-

Basically, Trichet gave the market six major, mega, no-brainer reasons to short the living crap out of the EUR/USD and to likely keep shorting it in the near-term...

With Trichet giving the market the greenlight to unload euros today, his comments triggered a chain reaction of profit taking, loss taking, and shorting of the EUR/USD, which took us down another 200 pips from yesterday's topside resistence at 1.4638... and as far as today's down move goes, the EUR/USD held to its very reliable pattern of not making a move (up or down) of more than 200-220 pips during a trade day. It moved exactly 201 pips from the top of the range at 1.4638.

As we indicated, sustained break of 1.4550 would open the doors to the downside and we certainly saw this play out in today's market action...

So now we have the EUR/USD making two 200-pip moves down so far this week... if patterns hold true, we'll likely see a retracement back up as the market is slightly overextended and exaggered itself this week... that being said, we have seen EUR/USD patterns where it'll move 500 points in a week, but this is very rare and I'm not expecting this to play out before we see a bit of retracement...

EUR/USD trading...

As we indicated, the break below 4740 took away the market's momentum to push the euro up any higher and now the break below 4550 has opened the doors to test lows we haven't seen for weeks and months.

For most of last year the market punished the dollar for its weak fundamentals and then for the Fed rate cuts... the dollar has recieved the worst of its punishment in the near-term...

The market has yet to fully begin punishing the euro for it's weakening fundamentals because the Eurozone's fundamentals have just barely started to show signs of decline and weakness, which means we have a potentially long road ahead of us... then, the market will need to punish the euro for the ECB rate cuts that are likely coming this spring or sometime early in the second half of this year...

By that time, we'll be in a full-blown U.S. recession, and the global markets as a whole will be crumbling all around us... we've already talked about what a recession will do to gold and the dollar, so I'm not going to take time to get into that now, you can read those posts...

As far as trading goes, I'll be shorting the rises, as indicated in yesterday's update and in the chat today... the only time I'll likely take a euro long is when we trigger a signal... on an intraday trade basis, I will likely be short when I trade within a range...

I would love to tell you where the market will decide to find a bottom or find the next top, but please understand that the landscape is in the beginning stages of shifting...

The dollar's been beaten up left and right, up and down all last year... the market already knows the fundamentals are crap, that interest rates are abysmal, that the jobs market is fickle, and that growth is slowing to recessionary paces -- there are no more big secrets to reveal about the sad state of affairs with the U.S. economy...

For Europe, on the other hand, the secrets are just now coming out and the market has just begun licking its chops to do to the euro what it did to the dollar... at least this is how I see things playing out... I could be dead-wrong, but I'm going to stick with this same forecasting we've had since last November and I'll have to trade it accordingly and consistently...

Lets look at some key levels to keep an eye on:

Downside:

4429
4401
4384
4364

Upside:

4495
4512
4538
4554

For me, the plan is simple, short the rises unless price action dictates otherwise...

Early this morning Yeno gave those in our chat a killer EUR/USD short on a live trade call:

Click on Image

And I just have to give a big congrats to one of our community members who goes by the screename CK33 -- this smart and patient trader took the live trade call, shorted at 4636 and held his short all the way to 4445, picking a perfect bottom to close out and bank 191 pips... we love hearing those success stories!

Fundamentally tomorrow, we only have one noticeable piece of data which is German Industrial Production, which very likely could disappoint this go around...

As far as the market goes, I don't expect another 200 pip move tomorrow, but I'm ready for continued volatility should the market decide to stay active...

Currently, we are in a signal which will close out at 1.4513 should we stay above our last buy level of 1.4420... so far, we've held above this level... I feel confident this signal will payout just as all the others have... if this signal is making you squirm, find me in the chat so we can discuss it

I think that's all for now... see ya in the chat...

-FX Insights

FX Insights Trade Team Update 06/02/2008

By FX Insights Moderator

Another boring day in the market with little volatility to speak of. We do, however, have some important things to cover in today's update... a few different topics we need to talk about...

I'd first like to talk about the signal that was triggered this morning and why we had to "cancel" it... very early this morning we triggered a buy signal and decided to make our first buy level at 4600. The signal triggered exactly at the price of 4608. Based on the time of day and based on market conditions, we felt as if the market would come down to at least the 4600 level and determined this to be a good place to take our first entry.

The market, unfortunetly had some other ideas and decided not to come down, but to take off from the exact point where we triggered the signal. When the market reached 4635, we decided to "cancel" the signal because our first buy level was never reached. This is only the second time in the history of our signal that we had to cancel it for this reason.

Why do we cancel a signal if the market takes off before our first buy level is touched? It's all in the name of risk managment... you see, we knew the market would go up at least 20 pips from the place where the signal was triggered, however, we also knew that if it first went up only to come back down, it may continue down and or stay down today. So, in managing risk, we simply let the market do its thing... the market did go up to 4672 today, so even if you bought in at the trigger price of 4608 when you got your SMS, you still would have made some great profits even though we had to cancel out the signal.

I just wanted to clarify why we did this in case there was any confusion. I don't want anyone to think we are playing games or manipulating things, but rather this is something we had to do to ensure proper risk management during these odd market conditions. If you have any more questions about this, please let us know. Thanks.

Now, let take a look at the market...

As we talked about this week, I see continued aversion to risk happening in the market, which I believe is a big contributing factor in why the euro is under the gun against the dollar... so, lets break this down:

Equities -- overnight the Nikkei closed down over 600 points, signaling continued fear of risk in Asia. Today, the Dow closed down 65 points, closing at 12,200 on the dot. Now I'm hardly an expert on the Dow, but I have to believe that a break below the 12,000 level would put renewed selling pressure on the Dow and Dow futures. For the euro, these declines in the equity markets will only get it pressured against the dollar, and will keep the EUR/USD at the bottom of the range.

Recession -- After yesterday's abysmal ISM services data, once again the markets were talking recesion... not just the U.S. recession, but a global recession. These recession fears are real, not unfounded. Fundamentals point to true recession happening. The problem with this recession issue as it relates to the euro and the dollar is where things get a little weird and tricky.

I'm still firmly believing that a full-blown U.S. recession will negatively impact growth in Europe and will negatively impact the value of the euro and will negatively impact demand for the euro. Logic would tell you that a U.S. recession should keep the dollar under the gun and keep it weak against higher yielders like the euro, but almost by the day I'm more convinced the dollar is somehow going to come out smelling like a rose as the year rolls on.

And here's where I start thinking like a bank would think -- if the U.S. causes a global slowdown which would directly effect European growth, are the banks going to be as over-the-top bullish on the euro as they were in 2007? No way. Much of the euro's strength is built upon strong growth fundamentals, a very hawkish central bank, a central bank that so far has been very tight on monetary policy and hawkish with rates.

At the same time, the euro rose to stardom the past few years on the back of the U.S.'s weakening fundamentals and the fore-knowlege from the banks that the Fed would eventually have to slash rates. In addition, the EUR/USD was bolstered by rising gold, rising oil, lower bond yields, and skyrocketing equities markets.

But in today's market landscape, we need to paint a different picture... many of those factors that have compelled the banks to keep buying the euro and to keep pushing it higher against the dollar are turning the other direction...

We've said it a million times, but growth in Europe is slowing and will keep slowing -- the European fundamentals will be weak this year overall. The ECB while remaining hawkish on price stability, will have to cut rates later this year because Trichet eventually will have to address Europe's growth issues and the only way central banks deal with slow growth is to cut rates.

If we do fall into recession, commodities should level off or decrease in value. Equities may have a tough time this year. And if the markets decide to go heavily into risk aversion mode, this usually means they flock to so-called save havens like U.S. securities, and believe it or not, the USD.

I hope you don't think we're beating a dead horse here, but I just want to explain why our concerns about the euro are mounting as the year rolls along. I want to state our case clearly... and give you some food for thought.

EUR/USD trading...

With the EUR/USD meandering in the low 4600's, this pair is in what I consider to be a very precarious spot... with the euro falling under the 4740 level, this leaves the door wide open for more downside testing... staying below that level removes much upside momentum and potential. That being said, staying above the 4550 level also leaves some room for buyers to emerge to push the pair back up towards the top of the range... so, this is why I say we're in a weird spot at the moment.

As far as trading goes, there's no clear direction to trade with any fair degree of certainty unless we can sustain a break above 4740 or sustain a break below 4550... based on current market conditions and what's happening with the global indicies, I can't really be biased one way or the other -- my personal risk management rules will not allow me to go heavy long or short at the moment... this means I'm tightening up my accounts, not trying to catch a big move, but playing the intraday, taking a few pips per trade and getting out. They key is that I do not want to get caught going the wrong way should the market decide to go nuts and make another 200+ pip move...

Playing the intraday for me has meant shorting the rises... I've felt more comfortable shorting the rises the past 48 hours, and this bias is based on what I see with price action, what I see with gold, oil, the Dow, and the 10-year... speaking of the 10-year, yields have made a strong comeback in recent days which has put even further downside pressure on the EUR/USD.

Tomorrow...

Tomorrow is the big day -- ECB interest rate policy at 0745 EST, followed by Trichet's press conference at 0830 EST. Trichet will hold rates at 4.00%. With Eurozone inflation running at 3.2%, there's really no way he can cut rates while remaining so vigilent on price stability. Of course, the market will be watching closely to what he says about the near-term future...

The past two press conferences Trichet has been somewhat dovish on growth. He's not made a single reference to possible rate cuts, in fact, he's said a rate cut option was not on the table.

Now there's no way I can predict what the man will say tomorrow, but I'm warning you now, if he ups the rhetoric on Europe's slowing growth, and if he says Eurozone inflation will subside later this year, the euro will stay under pressure. In addition, if he says all of those things and even slightly hints at possible ECB rate cuts happening this year, I fully expect the market to hammer the euro.

I will be tightening things up as we draw close to the rate decision and following press conference. As Yeno says, expect the unexpected...

I don't believe we'll see any mega moves before tomorrow morning as the market should fall into a wait-and-see mode. Should we dip below the 4600 level, some buyers may emerge to push the euro back up, so keep that in mind over the next 12 hours or so...

You'd be well served watching Trichet's press conference tomorrow. You can view it here.

-FX Insights

Shadow of European Slowdown Looming

LONDON (MarketWatch) - Central bankers meet Thursday in London and Frankfurt, shadowed by growing evidence that U.S. economic woes are threatening prospects for growth in the United Kingdom and in the 15 European nations that make up the euro currency.

While recession fears have seen the Federal Reserve downplay inflation worries to slash interest rates, the Bank of England has eased at a cautious pace and the European Central Bank has held its fire.

In recent weeks, Bank of England Governor Mervyn King has signaled that slowdown worries slightly outweigh inflation concerns, analysts say, while ECB President Jean-Claude Trichet has remained steadfast in emphasizing price stability as the all-encompassing concern of continental monetary policymakers.

Markets now widely expect the Bank of England to trim its key lending rate by a quarter point to 5.25% Thursday, while the ECB is still expected to hold its key rate steady at 4%.

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Taking a Dump

Ambrose Evans-Pritchard is reporting that Switzerland's central bank is to dump a further 250 tons of gold. The stink you smell is manipulation.

There are two ways in which you can look at this situation:

1. Gold has continued to rise over the last seven years, amid Central Banksters dumping their Gold reserves. Without this overt manipulation, who knows where the price of Gold would have been today? Central Bank Inflation will continue to play a major role over the next couple of years. Trying to hide it by pushing down the price of Gold , will have the opposite effect on the price of Gold in the long run. You can fool some of the people some of the time, but you can't fool all of the people all of the time.
2. Huge sell-offs like these might drive the price of Gold down, but inadvertantly, that creates an opportunity to buy more Gold at a lower price. Also, remember that the cost for mines to produce an ounce of Gold has gone up immensly. If the price of Gold is too low, there will be little incentive for mines to consider investing in future mining projects. On top of that, South-Africa's production levels are decreasing at an alarming rate. As of January 2008, China has overtaken SA as the world's number one gold producer.

Therefore, unlike the Central Banks, I don't have any intention of taking a Golden dump.

FMM comment: Please note that I'm not dishing out any investment advice. I'm just sharing my oppinion.

FX Insights Trade Team Update

By FX Insights Moderator,

Sorry for the delay in getting today's update posted... was a crazy day with meetings and such.

As far as the EUR/USD is conerned, we had an extremely boring day... tight ranges, no decent price action... once again the Dow stumbled, which didn't help matters.

So I'm going to use today's update to cover a few things that are on my mind in regards to the market and the EUR/USD... some food for thought stuff...

One question that is on many trader's mind is why we're not seeing a lot of volatility or decent price action the past week... there are a few factors contributing to the market being seduced into a lull...

Lets start with risk aversion... banks, hedge funds, institutions, wealth managers, and traders are simply not taking on risk under current market conditions. With all the uncertainties of a U.S. recession, global recession, slow growth coupled with rising inflation, central bank fears, tightened credit markets, shaky equities, an unstable employment sector, and a cautious consumer sector, those big money players are playing things ultra tight and conservative.

Prime example -- the carrytrade... the carrytrade is off the table for now. Once this extreme risk aversion set in, that opened the door for pairs like the EUR/JPY, USD/JPY, and GBP/JPY to drop hundreds, if not thousands of pips... the yen has strengthened tremendously while the market is in extreme risk management mode and fear mode... it won't be this way forever, but for now, expect those once brave risk takers to play it safe.

So how does this season of risk aversion effect the EUR/USD? Quite simple... for the big money players it's not an attractive buy while at the same time it's not an attractive short... with the banks being on lockdown and the institutions dealthy afraid of taking more losses, buying the euro at 1.4800-1.4900 is not going to happen... the alternative would be to buy the dollar, and with the dollar remaining fundamentally weak and the prospect of the Fed cutting rates further, who seriously would buy the dollar right now?

The market is in desperate need of not just a good, but a safe reason to either buy the EUR/USD or short the EUR/USD. The central banks are not helping matters either... both the Fed and the ECB is keeping the heavy EUR/USD bears in hibernation for now... with the Fed in a rate cut cycle and with the ECB remaining hawkish on rates and price stability, euro bears are not going to push the EUR/USD down, they really can't at this point.

Fundamentally, the U.S. economy has shown little signs of life. In the Eurozone the coming economic slowdown has yet to begin, which is another factor why we're just floating in a tight range...

Hopefully this sheds some light on why the market is behaving the way it's been behaving the past week or so...

EUR/USD trading:

I believe the market is also in a holding-pattern as we wait for Thursday's ECB rate decision, and more importantly, Trichet's press conference...

Early tomorrow morning we have key PMI and retail sales data out of Germany and the Eurozone... PMI may come in above forecasts while retail sales could possibly dissapoint, regardless, I don't expect this to have any major market moving effects...

Later in the morning we get very important ISM Non Manufacturing data, which I believe we should see come in USD+... whether or not the market decides to make any big moves is not something I'm looking at, but I'll certainly be prepared for...

As far as trading goes, I remain euro long -- cautiously long -- this means unless we get a signal I and I feel comfortable, I am in no way, shape, or form adding any euro longs at these levels... all of my longs are below the 4750 level and I'll keep it that way for now... any moves above the 1.4900 level would be an area I'd like to add a euro short, should price allow...

I do have some key downside/updside levels:

Downside key levels --

4801
4783
4752
4738
4708

Upside key levels --

4852
4878
4893
4920
4954

Lastly, in today's Q and A session we talked about the Team doing more live trade calls in the chat... I'm going to do a post on exactly what and how this will work...

Posted below is a chart from two calls we made last night and early this morning, just to give you an idea:

Click on Image

That's all for now... we'll see ya in the chat!

-FX Insights

The ECB Rate Rebels

By Nico Isaac

On January 28, the annual International Monetary Fund meeting was held in Davos, Switzerland. There, the world’s economic leaders came together to address the central concerns facing the global marketplace.

Result: the European Central Bank was put under more fire than a spit-roasting pig.

The short version is that the ECB has opted not to join the U.S. Federal Reserve’s rate-cutting crusade; instead, holding rates firmly to a six-year high of 4% since June 2007. Lofty rates, so say the "experts," keep the euro at record-high levels, which further compounds the setbacks currently facing Eurozone economic growth.

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FXI EUR/USD Calendar 2/3 thru 2/8 2008 (with commentary)

By FX Insights Moderator,

Before we dig into this week's fundamentals and market outlook, I want to talk about last Friday's NFP...

As we indicated in Friday's update, last month's NFP data was revised up, the unemployment rate, however, was knocked back below 5.0%, which was opposite of my forecast... with new and continuing jobless claims and vastly diminished new hiring, it's very difficult to understand why the unemployment rate dropped to 4.9%...

We also indicated, we'd see downward pressure on the EUR/USD, which certainly played out Friday, but to a slightly greater degree than I had anticipated... as we stated in the update, though, I still believe the EUR/USD has the potential to re-test the top of the range...

NFP showed a net loss of 17K jobs, which is certainly dismal, but lets keep one fact in mind -- of all the months in the year, January typically shows the biggest decline in new jobs and this is because of the BLS's birth/death model... so, I'm sure we can expect another upward revision next month...

Friday was a great example of why most NFP's are not 100% cut and dry like many traders expect it to be... and although the EUR/USD made an initial push towards all-time highs, in the chat we strongly cautioned against taking any longs on Friday and to simply let the market play out as it wished...

Moving on...

Fundamentally, we have an interesting week ahead of us... not quite as challenging as previous weeks, but there are some key events we need to focus on.

Monday -- The only real key data piece is U.S. factory orders. We'll also get a speech by the Fed's Kroszner... although data is light on Monday, don't necessarily expect the market to be quiet... Monday holds the potential to give us some decent moves and volatility...

Tuesday -- We get some key Eurozone inflation data with German and E-zone PMI and Italian CPI... we may see a bit of contraction in those PMI numbers... another key piece of data is E-zone retail sales. Forecasts show a decent rise from the previous decline... I'm not quite as confident on hot retail numbers. Should we see a downside surprise in retail, this will certainly put some pressure on the EUR and renew talk of possible ECB rate cuts...

Key U.S. data on Tuesday is ISM Non Manufacturing... I believe the market will pay close attention to this release as it will give us a current look at what's happening within the service sector. The service sector is one that has remained resilient while other sectors have stumbled the past 6 months... I don't expect a downside surprise with this data, however, should we see anything below 51, the market could certainly react very negatively against the USD...

Wednesday -- Nothing but USD data today... we start out with Non Farm Productivity... I normally wouldn't pay a whole of attention to this particular piece of data, but I think the market and the Fed will be watching, so I'll be watching too... basically, NFP Productivity is a combo growth-related and inflation-related report, but there's a few weird aspects to this report... in a nutshell, basically the FX market wants to see lower NFP Productivity because that correlates into higher wages being paid for less output, which is inflationary, and inflation is good for a currency as it could lead to rate hikes or less rate cuts... make sense?

OK, we also get three Fed speeches -- Lacker, Kroszner, and Plosser... of course, the market will be looking for any clues on future monetary policy, specifically what the Fed's next move on rates will be in March.

Thursday -- Our biggest fundamental day of the week... early in the morning we get key German factory orders data which I believe will be weak... however, our biggest events of the day is the ECB's decision on interest rates followed by Trichet's press conference...

I absolutely, positively, cannot see the ECB cutting rates on Thursday... I do not believe this option is on the table. In fact, there's a higher probability of the ECB raising rates than there is of them cutting rates... I firmly believe Trichet will keep rates on hold at 4.00%... the biggest factor is that CPI rose from 3.1% to 3.2% which is keeping intense inflation pressure on the Eurozone and is keeping inflation well above the ECB's target rate of 2%.

We also get key Initial Claims data on Thursday... last week jobless claims rose to a staggering 375K... we could certainly see that number revised down this week, which would be USD supportive... keep an eye on this week's headline number... if it stays above 340K and we don't get a downward revision to last week's data, the USD could face renewed sell-offs...

At 10:00 we get Pending Home Sales which the market is expecting to "not be as bad as last month." I'm not really buying it... we've not seen the bottom yet, banks are not lending, consumers aren't qualifying for mortgages, there's a 9-month backlog in home inventories, prices paid are way down... it's still a disasterous mess, so I don't expect any mega upside surprises here...

Friday -- Two key pieces of data out of Germany: German Trade Balance and German Industrial Production... trade balance should back down from last month's number as the euro has remained very strong and global economies are starting to slow... as far as industrial production, I'm not very bullish on this one either...

As far as the Fed goes, we get a speech from Yellen very early in the morning, followed by Lockhart and Pianalto speaking later in the afternoon... don't expect anything groundbreaking from that braintrust...

EUR/USD:

If the market wants to keep correcting down, to me, this is not a sign of the dollar gaining strength... nobody is buying dollars at this point... those corrections we've seen and could see are attributed to profit-taking, loss-taking, fluctuations with gold, oil, and equities... basically all the market correlated variables...

There was very little liquidity in the market on Friday, which also puts downward pressure on the EUR/USD... as far as trading goes, I'm still euro long -- cautiously long, of course... and I will likely look at any further downside correcting as another buying opportunity...

In case you missed it, I did a post on the gold-EUR/USD correlation... please take a moment to check it out as gold is one of the most important market correlated variable... As always, take care to manage your risk and money very closely... do not overleverage your account under these current market conditions of uncertainty and risk aversion...

Lastly, I'll do a live audio Q & A in the chat tomorrow at 1100 EST...

-FX Insights

EURUSD Financials 2-3-08 thru 2-8-08.xls

Gold, the Euro and the US Dollar

By FX Insights Moderator,

If you’ve spent even just a brief amount of time at FX Insights, surely you’ve noticed how close we watch and track the EUR/USD’s market correlated variables… and just to give the term a proper definition, my definition of what a market correlated variable is:

"A non-Forex factor that has direct connection to the EUR/USD and to the EUR/USD’s price fluctuations."

To put it another way, market correlated variables are factors happening outside of the Forex world, yet have major direct impact on whether the EUR/USD goes up, goes down, and to what degree these moves may occur.

Trading: Primarily, gold is traded on the NYMEX. For gold, there is a spot market, a futures market, and an options market. Gold is traded by everyone from the small potatoes retail investor all the way up the ladder to large banks, hedge funds, institutions, and further on up to the central banks of the world.

Major reasons why gold is purchased: Gold is purchased as a hedge against inflation. Gold is also purchased in “response” to a weakening currency, which in the case of the EUR/USD, gold is and would be purchased as the value of the dollar falls against the euro. Gold can be bought and gold can be shorted, just like a currency can in the spot FX market.

Gold and central banks: Although both the dollar and the euro are fiat currencies, the Fed and ECB have vast gold holdings within their reserves. One way the Fed and ECB control and manipulate the value of their respective currencies is by trading their vast gold reserves. The ECB is especially notorious for dumping many tonnes of their gold on the market at certain times of the year to “cool down” the value of the euro against the dollar. Gold is a powerful market manipulation tool at the hands of the central banks, and the market usually only learns of a central bank’s gold operations after the fact…

Key gold facts: The main reason why the commodity of gold is highly correlated to the EUR/USD is because gold is denominated in U.S. dollars. Gold and the USD share an inverse correlation… think of it this way, when gold is purchased, the USD is sold… the selling of any currency will naturally devalue that currency, so as gold is purchased and the price of gold rises, the value and “price” of the USD must fall because of the inverse correlation that exists between gold and dollar.

It’s my understanding that in 2001 gold began making a very strong resurgence which has ultimately led to this commodity making all-time highs in the $940’s…

This past week the USD/CHF went to post-World War II lows while gold was making all-time highs. Going back to 2001, look at the EUR’s climb to dominance over the USD… looking at the big picture, the EUR/USD has moved up in tandem with gold, while the USD Index has moved against gold and the EUR/USD…

Other key facts about gold and the USD: As we mentioned earlier, gold is denominated in U.S. dollars. So lets think about it… if the dollar is strong, you could buy more gold, literally getting more bang for your buck… a weak dollar buys less gold… here we have yet another reason why the weak dollar will only keep upward momentum going for gold – as long as the USD stays weak, the market stays bearish on the USD, gold naturally has to stay strong and has to rise, which then naturally correlates into the EUR staying bullish against the USD.

Gold and inflation: Back in the late 1970’s and early 1980’s U.S. inflation was absolutely out of control, and this runaway inflation issue took gold up to almost the $900 level, which must have been a staggering price back in those days… the Fed had to raise interest rates several hundred basis points very rapidly to slow inflation and this eventual mega rise in interest rates caused gold to loose half of it’s value and by 1983 gold was in the $400’s.

So as you can see, inflation is another key factor in the value of gold… when inflation rises, gold rises, but when a central bank steps in with interest-rate-raising tactics to slow inflation, gold will fall in value accordingly… and following this natural progression… higher rates = less inflation = weaker gold. Higher rates = a stronger dollar and a stronger dollar = weaker gold…

In many ways inflation is reflected in the price of gold which is then reflected in the price of the EUR/USD as more times than not gold leads the EUR/USD…

Practical exercise: I’d like to pause and take you through a practical exercise… this is how I think things through and how I attempt to forecast the market and formulate a predictive view of the EUR/USD… this is the kind of stuff that goes on in my head, so I’m going to do my best to communicate it as simply and clearly as possible…

First, I always start with interest rates… interest rates, as you’ve heard me say a katrillion times are paramount in the spot FX market…

For now I see the Fed in a rate cut cycle and the ECB in a rate hold cycle, at least through the spring of this year… I think the Fed can cut rates another 50bps or more before it’s all said and done. So going forward starting with interest rate cuts, here’s how I think it through:

1. Fed rates stay at 3.00% and possibly get cut further

2. Low rates and rate cuts weaken and devalue the USD

3. The weak USD correlates into higher gold prices

4. Higher gold prices correlate into the EUR/USD continuing to make bullish gains

5. Rate cuts and weak USD lead to rising U.S. inflation

6. Rising inflation leads to buying of gold, driving gold prices higher, driving EUR/USD higher

7. Rising inflation causes the consumer to slow spending, which further weakens the USD

So, that’s my logical way of thinking through what’s happening within the market under current conditions. The Fed seems reluctant to combat inflation and hell-bent on trying to stimulate growth and appease global markets with heavy rate cuts, so I believe this will naturally lead to more gold gains which should keep the euro supported against the dollar, at least until the Eurozone fundamentals really start turning south and the ECB begins following the Fed with rate cuts of their own, at which time we should see some rapid declines in the value of the EUR vs. the USD.

Gold and recessions: Currently, the hot debate is whether or not the U.S. is in a full-blown recession, the start of a recession, or a few negative GDP reports away from a recession… I’m not a college-degreed economist, so I can’t give you the textbook answer… personally, I look at two key things to help me determine a U.S. recession situation, and those two factors are gold and the employment situation (which then trickles down to the death of the consumer).

The rapid rise in gold prices and the rapid decline in new job creations, the loss of construction and manufacturing jobs, the rise in new and continuing jobless claims and the almost 100bps rise in the unemployment rate signal a real recession… and I think these signals were obvious many months ago when gold really started taking off…

But here’s where it gets a little weird with gold and recessions – believe it or not, history has shown us that when the U.S. is in a full-blown, established, and recognized recession, the price of gold has stabilized and or declined! So this means if all the world’s economists put their heads together and officially declare that the U.S. is in a recession, we could see the price of gold level off or drop, which could push the value of the USD up against the EUR…doesn’t make much sense that the USD could strengthen during a recession, but it’s certainly possible…

Gold and trading the EUR/USD: Here’s where we get practical when it comes to using gold as an indicator to trade the EUR/USD…

Quite simply, I am watching the spot gold market just as much as I’m watching the EUR/USD price action… moves in the price of gold more often than not will lead moves in the EUR/USD… gold is a tremendous leading indicator… if I’m trading the market intraday, I’m watching every little uptick and downtick with gold… I watch the NY spot gold market like a hawk…

If you’re one of our many tech traders trying to wean off the techs and learn how the EUR/USD really moves and why it really moves, you’d be well served watching the spot gold market as a key indicator… do yourself a favor and compare a 1-week gold chart to a 1-week EUR/USD chart, pick any week really, and you’ll see what I’m talking about…

There’s really no way I can glamorize the gold-EUR/USD correlation… it’s fairly simple and fairly cut and dry… it’s not a magic bullet indicator, and as I always say, there’s no such thing as “always” in the FX market, but gold is a highly probable and fairly consistent market correlated variable.

If you don’t track it or use it as a trading indicator, I encourage you to begin doing so… it’s only going to enhance your trading and give you more wins vs. losses as it will paint a clearer picture of market direction.

When the spot gold market is volatile you can expect the EUR/USD to be volatile… when gold decides to find its next top and correct, you can likely expect the EUR/USD to correct with it… the overall euro fundamentals do not warrant the value of the EUR/USD to be north of 1.4200, however, because of market correlated variables like gold being on such a bullish run, the euro naturally has to come up with it…

Again, of all the market correlated variables like oil, bonds, and equities, I believe the tightest overall correlation exists between gold and the EUR/USD.

Lastly, based on past experiences, I know there’s somebody or several somebodies out there who’ve read this and are thinking, “So if gold goes up, what does the EUR/USD do?” If you’re not sure, find me in the chat and ask, I can always use the amusement…

-FX Insights

Stagflation dilemma haunts euro

But other analysts say European growth worries are premature

LONDON (MarketWatch) -- When it comes to the threat of stagflation, the European Central Bank has appeared much more worried about the inflation portion of that dreaded compound word than signs of a stagnating economy.

But some foreign exchange analysts say Thursday's muted reaction by foreign-exchange and fixed-income markets to another round of troubling euro zone inflation data increased the likelihood that policymakers may soon pay more heed to signs of slowing European growth.
Stagflation describes a period of low or negative growth and high price inflation. Signs of the latter have been evident for a while, and more evidence emerged Thursday.

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The Failure of Inflation Targeting

By Axel Merk, January 30, 2008

Inflation targeting is yet to be formally adopted by the Federal Reserve (Fed), but recent market and Fed actions already prove that it is a failure. At the whim of trouble in the markets, Fed Chairman Bernanke has made it clear that he is inclined to flood the markets with liquidity at any cost; he said: “We stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.”

Contrast that with John-Claude Trichet’s comments: the head of the European Central Bank (ECB) recently said that during times of financial turmoil, it is imperative that inflationary expectations remain firmly anchored. The Fed’s increasing isolation is also apparent from recent comments by Mervyn King, the governor of the Bank of England who said that investors had been mispricing risk for far too long and that “the repricing of that risk … is not a process that we should try to reverse.”

Let me be clear: we have no problem with a central bank to switch into emergency mode per se. But the way the Fed has wobbled into emergency mode, claiming to be vigilant on inflation while debasing the dollar in the process smells of hypocrisy. A central bank’s role is to keep the financial system running, not to run the financial system. Ben Bernanke has very clear views on how the financial system ought to be running. In February 2004, when he was freshly sworn in as a Fed Governor, Ben Bernanke published a report called “The Great Moderation.” In this report, he praised how monetary policy has contributed to a reduction in volatility of output and inflation since the mid 1980s. At first sight, it seems difficult to argue with such analysis; this work may have contributed to his appointment as President Bush’s Chief Economic Advisor, and subsequently to his current role as Chairman of the Federal Reserve.

While we do not deny that low volatility has positive implications, where there is sunshine, there is shadow: in our assessment, the seeds of the current crisis have been planted in the process. Even if you are not an economics Ph.D., you may recall the saying “if there is one thing the market does not like, it is uncertainty.” The less uncertain the world is, the more daring speculators become. Homeowners believing their jobs are secure, or their wages will rise, are more likely to take out a high mortgage. Any speculator is willing to take out more leverage when the future seems certain. Financial institutions have become increasingly “sophisticated” over the past decade and introduced widely acclaimed Value At Risk (VaR) models; these models assess the risk of loss given different scenarios. Put simply, the less volatility, the less uncertainty there is, the more capital may be put at risk. In recent days, there has been talk that banks may require over hundred billion in additional capital should mortgage insurers be downgraded. That’s because the banks’ models suggest that less capital is required for assets classified as safe; however, if someone spoils the party and says the world is a risky place, banks suddenly have a greater portion of their capital at risk, requiring them to either sell off risky assets on their balance sheets, or to raise more capital.

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