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 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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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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Forex Market Update - 29/01/2008 - FOMC Outlook

FX Insights Moderator,

Because of the Fed's emergency rate cut last week, the market analysts and economists have been thrown for a loop as to what Bernanke will pull out of his bag of tricks tomorrow... I will not offer any speculations on what Bernanke will do, but I've been preparing accordingly and have tried to position my accounts for the "worst case scenario.

"Now, the "worst case scenario" can certainly carry different meanings to different traders, but to me, whatever the Fed does tomorrow is the worst case scenario, of which I see three worst case scenarios... so, lets take a look at each one...

And just as an aside... you might be wondering why I have three possible worst case scenarios... well, as a trader, economist, and a taxpaying U.S. citizen, the only best case scenario for the U.S. economic situation is for the Fed to begin raising rates, for the gov't to begin reducing the deficit, and for our trade balance to shrink and our GDP to expand, but this is a different conversation for a different time...

Worst case scenario #1:

25bps interest rate cut -- a cut of just 25bps would be just half of what the market is forecasting, and this would be slightly shocking to all markets, including our market... the equities market will likely take a hit and not only see stock sell-offs, but would also see less money flow into stocks, which would turn the USD supportive against the EUR. I think the dollar would actually gain some ground back on the EUR should the Fed only cut by 25bps.

Worst case scenario #2:

50bps interest rate cut -- all markets are forecasting and expecting a full 50bps cut from the Fed. Should the Fed come through with what the markets want and expect, I believe the equities markets all around the world would react very favoribly to this move, more specifically, the Dow and S & P would respond with upward gains and momentum, which would then correlate into the EUR gaining against the USD. In addition, should the Fed cut by 50bps, the interest rate differentials would then turn into 100bps in favor of the euro vs. the dollar... this cut would bring the Fed's rate to 3.00% against the ECB's rate of 4.00%... I think it's quite significant to have a full 100bps interest rate differential between the EUR and the USD...

As you know, bank money flows to the nation that offers the higher rate of return, so I believe would could see renewed upward momentum and upward gains for the euro vs. the dollar. I really cannot imagine why banks would buy up dollars and sell-off euros with a 100bps interest rate differential... of course, we can't always depend on logic in the spot FX market, but the Eurozone now offers a better rate of return and it actually pays to hold euro longs, which is something traders look upon with favor.

Worst case scenario #3:

No interest rate cut -- yes, I absolutely believe there's a reasonable probability that the Fed will keep rates on hold tomorrow. I think it's a distinct possibility because of the emergency actions the Fed took last week... Bernanke's move, in my mind, diminishes some of the need to hack up rates any further tomorrow...

I believe a no cut would be tremendously supportive of the dollar vs. the euro... you see, concensus continues to grow that the ECB will eventually have to cut rates later this year and I am one of those that feels this way... M3 money supply is falling in the Eurozone and that will put less inflation pressure on the ECB... plus, I think we'll see the Eurozone's CPI come down from the highs of 3.1%, but lets not get off track here...

Should Bernanke hold rates steady, this would be a tremendous shock to all markets... our market does not handle shocking interest rate policy with any degree of emotional stability... a no cut could easily send the EUR/USD falling back to support levels between 1.45 and 1.43 in the near-term...

If the Fed were to hold rates tomorrow, global equity indicies would take a hit and I think we'd see some intense sell-offs and losses, which would naturally lead to the euro dropping against the dollar, due to the correlation between the EUR/USD, the Dow, the S&P/500, the S&P/500 and Dow futures, and the EUR/JPY (yes, the connection can run that deep). Then, we'd see traders begin to liquidate gold and oil positions, and possibly take short positions on those commodities to catch the down move, and those short positions in gold and oil would basically equate to taking long USD positions, which would then correlate into more USD support vs. the EUR...

A no cut would lead to some big, nasty crap hitting the fan in all markets, and ultimately I could see the dollar coming out of this smelling like a rose...

Fed psychology:

First, there's quite a bit of speculation that Bernanke made a knee-jerk reaction to last week's global equities sell-off, which was triggered by the nutjob trader from SocGen in France. So, to save face on his move to do an emergency rate cut Bernanke could certainly give the markets the 50bps cut they want, and this would be his way of saying, "last week's cut had nothing to do with the equities issues."

If Bernanke wants to send the markets the message that his biggest concerns are the U.S. economic situation and the issues within the credit markets and with the bond insurers/bond rating agencies, the FOMC will likely "vote" in favor of the 50bps cut. Of course, that cut will do zero to stimulate the economy nor will it offer much relief to the credit market and the banks, again, that's another issue for another time... but at least it would help Bernanke and the Fed save some face...

A 25bps cut or a no-cut could and probably would send our market the message that the Fed is growing more and more concerned with U.S. inflation and less concerned about what's happening on Wall St. This perceived concern about inflation would be very supportive of the dollar vs. the euro. You see, much of the euro's strength against the dollar is due to the fact that the ECB is so hell-bent on keeping inflation under 2%, which equates to tight monetary policy and hawkishness on interest rate policy...

The Fed and the ECB operate on opposite ends of the spectrum... Bernanke and his henchmen at the Fed are nothing more than subservient slaves to Wall St. and the trillion-dollar banking conglomerate that basically control governments and world markets, and because the U.S. still has the most powerful influence over the global markets and global economies, the subservient slaves at the Fed must do two things:

1. Manipulate markets

2. Price fix

Market manipulation and price fixing is accomplished through the Fed's monetary policy... if you want a good example of what price fixing is, look at what happened when Bernanke cut rates by 75bps last week... that move "fixed" prices on all of the equities markets and kept them from continuing to sell-off... I could give hundreds of examples, but you get the idea...

Now, the ECB has a totally different mission and mandate, which is ensuring price stability -- Trichet is almost to the point of being neurotic when it comes to inflation and price stability, but you have to understand why... the German Bundesbank is very influential, and Europeans, especially Germans still remember the days of having to cart in heaps of cash to buy milk and bread... so because the ECB is coming from that angle, they are naturally going to be very tight on monetary policy and less likely to ease on rates even when growth begins to suffer, which is and will be the case this year... so as I said earlier, this is one of the main reasons why the euro has been so strong against the dollar for the past few years...

EUR/USD trading:

All possible scenarios for what could happen are stated above... now, how this translates into trading is a different story because no one truly knows what the Fed is going to slap us with tomorrow...

On last Friday's and this Sunday's updates, we gave the key level, on the downside of 4680 - 4660... it hit 4660 right on the dot on Sunday and has since move towards the top of the range, but unable to breach the 4800 level...

Clearly the market has fallen into a "wait and see" trading range because the banks are speculating just as much as the rest of us and will likely need to see what the Fed decides tomorrow...

It would not surprise me to see some movement out of this range as we draw closer to tomorrow's decision... don't forget that we have key GDP data tomorrow morning, plus, some banks may try to square positions ahead of the FOMC decision and these money flows could cause some movement...

As far as trading goes, I grabbed a 4794 euro short yesterday and will certainly hold this trade, unless of course the market moves against me, in which case the trade will be closed for +1 pips and I may look to re-enter short at a higher position...

On the long side, I am still long from 4385 and will hold all longs that are still in profit below the 4700 level... other than that, I've spent this week trying to flatten out and free up margin just to protect against the unknowns... this is not a situation where I really want to get caught going the wrong way because tomorrow could be monumental...

I'd really like to grab some better euro shorts should the market go up and give an opportunity to do so... as mentioned above, I think in the end of all this the dollar could come out smelling like a rose, even though fundamentally and logically it shouldn't be that way...

I encourage you to do your own analysis of the market and weigh each possibility against the other... I could be way out in left field, but I wanted to at least give you my view on things...

FX Insights

The Future Imperfect?

Waving Goodbye to Hegemony

By Parag Khanna

Turn on the TV today, and you could be forgiven for thinking it’s 1999. Democrats and Republicans are bickering about where and how to intervene, whether to do it alone or with allies and what kind of world America should lead. Democrats believe they can hit a reset button, and Republicans believe muscular moralism is the way to go. It’s as if the first decade of the 21st century didn’t happen — and almost as if history itself doesn’t happen. But the distribution of power in the world has fundamentally altered over the two presidential terms of George W. Bush, both because of his policies and, more significant, despite them. Maybe the best way to understand how quickly history happens is to look just a bit ahead.

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Financial Crisis Poised To Hit Europe

From Mish's Global Economic Trend Analysis

Financial Crisis Poised To Hit Europe

Three more nails in the were driven into the European decoupling myth coffin this past weekend. Let's take a look.Reuters is reporting Financial crisis to hit 20,000 London jobs.

"As many as 20,000 jobs in London's financial district are likely to be wiped out due to the financial crisis, a survey showed on Sunday.

The Sunday Telegraph reported that Experian, which provides data and forecasts to government and private bodies, had slashed its predictions for job growth in the City of London and Canary Wharf to a fall of up to 5 percent from its previous forecast of flat net employment this year.

Experian expects between 10,000 and 20,000 jobs to be lost over the year, with the majority going from the financial sector.

With up to 400,000 people employed in London's financial district, a fall of this scale could severely affect the economy, dragging commercial property prices down and hitting related industries such as IT and telecoms, it said. READ THE REST