Euro exchange rate needs to match and hold the end-Oct high at 1.3300 to believe that the dollar rally is really over

Foreign Exchange Outlook : The US dollar is starting to make some gains this morning after losing 648 points in the euro exchange rate from last week to yesterday morning (1.2433 last Friday to 1.3081 at 9 am yesterday). This could be a function of the foreign exchange traders buying euros to an overbought level ("too far, too fast"), in which case it’s a correction that reaches support around 1.2860 and a 50% retracement around 1.2760.

That’s if the euro rate upside breakout is the real deal, which is the outcome we get in two of three model systems.

If the euro move up was itself a correction of the bigger and longer-lasting euro downtrend, we may have seen the end of the correction. How you see it depends on the timeframe of the chart you are looking at. In the model system shown in the charts in this report, we do not yet have a true upside euro breakout, although it’s pretty scary. Looking beyond the euro, we see prices crossing over the short-term moving average, linear regression, or previous intermediate high in many cases.

One thing that a lot of analysts agree on-we need to see the euro exchange rate match and hold the end-Oct high at 1.3300 to believe that the dollar rally is really over. The high yesterday was 1.3081, or about 220 points under the benchmark. We would need to see it get hit and held before next Monday, which is going to make the rest of this week and Sunday night a fingernail-chewing, hand-wringing ordeal. The US closes shop early today for the Thanksgiving Day holiday tomorrow and while banks are open on Friday, it’s another short day. So here’s the question: do the Asian and European markets have the guts to set the trend in the absence of the US?

Market News sums up the situation neatly: "Foreign exchange market players do not trust the stock market rally seen last Friday and Monday, and therefore have little faith that the gains seen this week in the euro, sterling, Australian Dollars and Canadian dollars will be sustainable. The rise in stocks was being viewed as a "bear market correction," with renewed equity slippage likely when the rally has ended." According, the dollar exchange rate should come back up when these markets fall back down.

A second factor is emerging - old-fashioned fundamentals. For once we are seeing the Foreign Exchange market react to economic data and institutional responses to the economic crisis and not only knee-jerk reactions to developments in related markets like stocks, the so-called risk aversion theory of exchange rate determination. Pounds Sterling, for example, is well down from its high of 1.5534 yesterday to a low of 1.5290 so far on the 0.5% drop in Q3 GDP and associated gloomy data that reinforces the prospect of some big rate cuts to come.

Risk aversion still has a good grip, though, and as usual, it can be seen best in the Japanese yen. Dollar vs Japanese yen slumped from the Monday high at 97.42 to 95.45 at the US close yesterday and thence to 94.69 overnight, although it’s bouncing upward ahead of the US open. Sterling to Japanese yen is right on its hand-drawn support line on the hourly chart and probably breaking it today. A 50% retracement would take sterling down to 143,10 from the high of 148.61 yesterday. Euro to Japanese yen is also floppy, having run up from 116.39 last week to 126.24 on Monday. So far it has touched the 38% retracement at 122.48 and may do it again today, in which case the expectation would be for a further correction to 121.32 (50%).

This doesn’t make the Japanese yen a runaway or a screaming buy. If Foreign Exchange Traders like what they see as a necessary and sufficient government response to crisis - i.e., if confidence is at least partly restored, the US dollar will be rejected as the safe haven as Forex traders feel comfortable taking on more risk. The yen will get sold as the other half of carry trades into the higher yielders.

But Market News Asia reports this morning that "The failure of Asian stocks to continue their recent rally led to concerns among investors, who then cut positions inyen crosses. UBS said "At present we continue to see firm market demand forsafe-havens and the general flight to liquidity remains intact and there doesnot appear to be any shift in the perception of U.S. paper to serve this purpose. In addition, the overwhelming force of de-leveraging is firmly in place,especially in a weak growth environment."

Confused? You’re not alone.

Seeing the dollar/yen or any other yen cross rates a barometer of risk aversion or risk appetite is not working out too wellthese days.

Bye For NowBarbara Rockefeller
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Berlusconi government will announce a €80 billion stimulus package

Euros Exchange Rate Outlook: German import prices fell 3.6% m/m in Oct, the most since records began in 1962. Import price inflation is just 2.9% y/y, the lowest in a year.

The EU is going to reveal a region-wide stimulus plan today, but the FT carries a confusing story on it that doesn’t contain any hard information other than that the EU will not follow the UK in cutting VAT. Bits and pieces are dribbling out. On Friday, the Berlusconi government will announce a €80 billion stimulus package, with an emphasis on employment. This week Sarkozy promised the French auto industry that he wouldn’t let them down.

French consumer confidence rose today while business confidence crashed yesterday. INSEE’s French revised consumer confidence index rose to -43 from -46 in Oct, a 6-month high. The Italian business confidence index dropped to 72.2 from a revised 76.9 in Oct, a 15-year low.

Euro Pounds exchange rate currently 0.8400

Barbara Rockefeller
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Bank of England will cut interest rates to 2.5% at the Dec 4 policy meeting

Pound Sterling Exchange Rate Outlook : GDP fell 0.5% in Q3 from Q2, the fist drop in 16 years, although as expected. Consumer spending led the way, down 0.2% (the most since 1995) and fixed investment fell a whopping 2.4%. On the year-over-year basis, consumer spending rose 1.1%, though. This is the least since 1995 but not negative. The GDP report results in revisions to previously reported data like industrial production, now seen down 1.1%, and manufacturing, down 1.3%, in both cases worse than –1% initially reported. Construction fell 0.7%, less bad than -0.8% in the initial report.

Bloomberg points out that unemployment rose at the fastest pace in 16 years in Oct and jobless benefits are being paid to the highest number of people since 2001, while inflation fell the most in 11 years (to 4.5%). Therefore, the BoE will cut rates to 2.5% at the Dec 4 policy meeting, according to the consensus forecast.

Pounds to Euros 1.1905
Pounds to Dollars 1.5348
Pounds to Australian Dollars 2.3440

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Barbara Rockefeller
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Spanish and French Interest Rates to Fall by 1 percent?

Euro Exchange Rate Outlook : The IFO Nov index of the business climate fell more than forecast to 85.8 from 90.2 in Oct, the lowest in nearly 16 years (Feb 1993). The “current assessment” fell to 94.8 from 99.9 in Oct, while "business expectations" fell to 77.6 from 81.4 in Oct. IFO’s Nerb said he doesn’t expect a rapid increase in unemployment, although there will be some, and he expects the ECB to interest cut rates by 100 bp.

In economic data, eurozone new industrial orders for Sept fell 3.9% m/m and 1.1% y/y.

On Friday, the flash estimate of manufacturing PMI fell to 36.2 in November from 41.1 in Oct and an estimate of 40.5. Today Bini-Smaghi said the eurozone was holding up pretty well and the new euro exchange rates level was pretty good for exports.

We don’t quite know what to make of such remarks.

Barbara Rockefeller
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Foreign Exchange Outlook for the Pound Sterling

Foreign Exchange Outlook for the Pound Sterling : PM Brown has said monetary policy is not the only tool and it’s time to engage fiscal policy. The FT has a hysterical headline about Chancellor of the Exchequer Darling targeting the rich with a new 45% top tax rate to offset what will be massive government spending, together with a cut in the VAT of £12.5 billion to goose consumer spending. Darling presents a “pre-budget report” to Parliament today. Bloomberg says it will entail new bond issuance of £138.1 billion (an all-time high).

The NIESR says the UK economy will grow only 0.8% this year and will shrink by 1.5% in 2009 for 6 consecutive quarters of contraction. It recommends injecting around 10% of GDP into the banking sector (from 2.5% so far) and cut rates by 100 bp (or more). It advises a stimulus boost of £30 billion, or 2% Of GDP.

Pounds to Euros last 1.1720
Pounds to us dollars last 1.5098
Pounds to Australian Dollars last 2.3300

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Spanish Mortgage Rates to fall?

Euro Exchange Rate Outlook : It’s not clear that the ECB is on board with the themes of the day (deleveraging, deflation and downsizing). Yesterday Trichet said "I do not exclude that we will continue to decrease euro interest rates, if we have confirmation of the alleviation of risks to price stability." In other wrods, he wants everybody to think inflation is still the top priority and the bank needs proof it is falling before it will cut rates. Is now the right time to be trumpeting price stability as the only priority? The WSJ cites several foreign exchange analysts who say the ECB is moving too slowly. The Fed and Bank of England have moved much faster ,which is deemed appropriate for recession conditions. But the ECB points out that with the interbank market seized up, a cut doesn’t have much effect on activity. Still, the bank is expected to cut the first week of December by 50 bp to 2.75% and by as much as 75 bp by end-March.

Pounds to Euros currently 1.1950 to buy euros

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Barbara Rockefeller
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US dollar exchange rate is a little stronger against the pound and euro

Foreign Exchange Outlook : The US dollar exchange rate is a little stronger against the majors but continuing to slide against the japanese yen, albeit not yet to the crash-scenario level. The euro rose yesterday morning to a peak of 1.2761 around noon, but fell back into the close to 1.2641 and to 1.2570 overnight. Market News reports that a “major Dutch name” was behind the drop. Then the rest of Europe came in this morning around 4 am EST and pushed it up a bit.

More interesting is the US dollar to Japanese yen. From just over 100 near the beginning of the month (Nov 4), the US dollar to Japanese yen has slid progressively lower to 95.98 at 7 am this morning, punctuated by a spike to 94.44 last week. Conventional wisdom has it that the Japanese yen is destined to return to the low and beyond it to 90 or 85. The reason is that the Japanese yen is a safe haven for those to whom the yen is the home currency and those who seek refuge from riskier and higher yielding currencies/assets. Some currency analysts also hold the view that Japan will outperform the US and Europe in the current crisis, which is the triumph of hope over experience. The government said today that it will consider a bigger, second stimulus (when we don’t have clarity on the first stimulus plan).

But near-term, we see a hand drawn technical support line at 94.64 on the hourly chart, so we are in “prove-it” mode. Another facto rears its ugly head intervention by the BoJ, which some observers expect with full confidence if the yen hits 90. If the BoJ were not to sterilize intervention proceeds, money supply would rise, which is probably not a bad thing in the context of Japan’s contracting economy.

Pound Sterling continues to get a lift from profit-taking and some buying Pound Euros on the sense that it had been terribly oversold, but it lacks any real momentum in its own right. As for the oversold story, consider that it was at 2.0150 in July and fell to the new lowest low of 1.4555 last Thursday. A rebound to just over 1.5000 is not abnormal in light of such a crash, even if unsupported by the bad data released yesterday and universal expectations of huge rate cuts yet to come, perhaps another 200 bp. Market News notes that sterling buyers yesterday included Asian central banks. But a technical rebound has technical boundaries. Sure enough, the pound peaked right at the linear regression trendline on the hourly chart overnight (1.5090) and may be dipping now.

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Barbara Rockefeller
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