Key News
• Obama Is Said to Favor About $775 Billion for U.S. Economic Stimulus Plan (Bloomberg)
• Dollar Rally Fizzles in Emerging Markets as Fed Awakens Appetite for Risk (Bloomberg) ... [Editor’s note: Are you sure?]
• European Inflation Slows, Increasing Scope for ECB to Lower Interest Rates (Bloomberg)
• EPA 'Cow Tax' Could Charge $175 per Dairy Cow to Curb Greenhouse Gases (Business and Media Institute)

Key Reports Due (WSJ):
7:45 a.m. ICSC Chain Store Sales Index For Jan 3: Previous: -0.5%.
8:55 a.m. Redbook Retail Sales Index For Jan 3: Previous: -0.5%.
10:00 a.m. Dec Non-Manufacturing Index: Expected: 37. Previous: 37.3.
10:00 a.m. Nov Pending Home Sales: Expected: 0.4%. Previous: -0.7%.
10:00 a.m. Nov Factory Orders: Expected: -2.2%. Previous: -5.1%.
2:00 p.m. Dec FOMC Minutes
5:00 p.m. ABC/Wash Post Consumer Conf For Jan 3: Previous: -49.

Quotable
“If you can count your money, you don't have a billion dollars.”

     J. Paul Getty

FX Trading – Stocks AND Dollar to Rally in the First Half? Keep Hope Alive

So was it Obama yesterday? Was it his words that sent the US dollar chugging higher? Did stocks rally sharply on Friday in anticipation of Obama?

So it goes, Obama’s newest proposal to drag the US economy out of the ditch it’s in went above and beyond the plans he’d been expected to unroll. The larger-than- anticipated amount of “stimulus” taking the form of tax cuts seemed to have caught many off their guard.

Of course, he’s still got big plans for creating new jobs, etc. And this is said to be causing the US dollar and US stock markets to rally because, hey, recovery is now right around the corner ... right?

Careful.

I’m in agreement that recovery will be a boon to the US dollar’s performance this year. Now, I don’t think we’re at a point when recovery is so close we can taste it. But I do think the growth differential between the US and competing economies will eventually improve for the buck as the US becomes the first to lift its head and creep out of the muck.

Could this potential have started the dollar off on the right foot this week? Sure.

But what about stocks? I wonder if it’s not too soon to start thinking a recovery 6-12 months (or more) down the road is good enough to drive share prices higher. Sure, I’m a believer that markets tend to lead major economic turning points. But you’ve got to think it’ll still be a while before the earnings and employment picture even stabilizes.
There’s been a pretty serious negative correlation between the US dollar and stocks (risk-taking assets.) The US dollar can rally NOW because foreign exchange trading is a relative game -- the fundamentals of one currency versus the fundamentals of another.

With stocks though, there’s not really a lesser-of-two-evils ... the relative game idea doesn’t really apply when we’re talking about companies within a single economy. Of course some companies are better off than others during in this environment, but when the current is moving heavily in one direction it doesn’t make a whole lot of sense trying to fight it.

So are the risk-appetite and negative correlation trends to be thrown out the window? My best guess would be “No, not yet.” I believe the US dollar will test its November 2008 high in the next month or two. If stocks don’t roll over to test their November 2008 lows simultaneously or soon thereafter (or vice versa and I’m completely wrong), then it may very well be time to jettison risk-aversion theme and put all the chips on a US recovery.

Of course, by the end of this month Obama won’t just be a President-Elect anymore. Things could change quickly at that point – for better or for worse.

Regards,

Jack&JR

Key News
• U.K. Rescue Fails to Spur Loans (WSJ)
• Japan's Central Bank Weighs Measures to Curb Stronger Yen (WSJ)

Key Reports Due (WSJ):
7:00 a.m. ICSC Chain Store Sales Index For Jan 3: Previous: -0.5%.
10:00 a.m. Nov Construction Spending: Expected: -1.2%. Previous: -1.2%.

Quotable
“How charming is divine philosophy!
Not harsh and crabbèd, as dull fools suppose,
But musical as is Apollo’s lute,
And a perpetual feast of nectared sweets,
Where no crude surfeit reigns.”

  John Milton

FX Trading – We’re Bullish on the US Dollar Today ...  and Tomorrow!

Do you remember what economists used to tell us about the global economy? If not, let me remind you. 

I remember the mantra-like chant from very clearly: There are major imbalances across the global economy.  Some countries save too much, others borrow and spend too much. 

Of course the US seemed be the one to blame no matter the shape or weaknesses elsewhere.  The gut wrenching credit crunch of 2008 is a symptom of global rebalancing.  And there’s no reason why it won’t continue well into 2009.  But my guess for 2009 is this: the United States economy could get a lot uglier, but the pain of rebalancing will be even more severe in Europe, Asia, and Latin America and hit those economies a lot harder than is now priced into the market.

I think the US relatively good on that score!

Whether you believe he was being self-serving or not, I think Treasury Secretary Paulson nailed it in his recent comments to The Financial Times newspaper:

“The US Treasury Secretary said that in the years leading up to the crisis, super-abundant savings from fast-growing emerging nations such as China and oil exporters – at a time of low inflation and booming trade and capital flows – put downward pressure on yields and risk spreads everywhere.

This, he said, laid the seeds of a global credit bubble that extended far beyond the US sub-prime mortgage market and has now burst with devastating consequences worldwide.

“’Excesses . . . built up for a long time, [with] investors looking for yield, mis-pricing risk,’ he said. ‘It could take different forms. For some of the European banks it was eastern Europe. Spain and the UK were much more like the US with housing being the biggest bubble. With Japan it may be banks continuing to invest in equities.’”

Put another way, the US financial system became saturated trying to recycle all the excess savings from the export-model and oil exporter countries.  It is their lack of internal investment alternatives and their decision not to invest into their own economies, for both political and economic reasons, is why there was virtually free-money available for the creation of massive levels of new exotic derivatives and one of the core reason for the lack of US consumer savings.  

US consumers were saving through their assets, i.e. booming housing and stock market (401K wealth) values; why save?  As you know, the two main wealth drivers in the US economy—housing and stocks—have been hammered.  And guess what: The US consumer is saving again!

In short, the US isn’t recycling excess savings flowing to the US from China and oil exporters because China’s exports and oil prices of have evaporated.  Of course through typical knee-jerk reaction, many commentators imply this is very bad for the US.  But these same commentators fail to mention this situation is much worse for economies dependent on creating wealth through exports, and the category here includes a whole host of countries: China, energy exporters (Middle-East, Russia, and Latin America), and emerging markets dependent upon foreign bank funding (which represents the majority). At the core of this is the US, as it’s no longer providing the funding.  As I said, US consumers are saving and US institutions are deleveraging. 

So, the pool of savings being created by the US consumer will help replace much of the lost reinvestment into the US from outside.  US institutional deleveraging is painful, but the process of cleaning away dead wood for potential future growth is continuing.  And remember, the US has funding mechanisms others don’t have—deep capital markets and flexible fiscal and monetary policy.

If I am right about a major sentiment shift about debt and risk taking going forward, the adjustment process in many other countries will be much more painful and take much longer than it will in the US.  They will have to make major changes to their model of export-Export-EXPORT.  This means developing a viable domestic market.  That means transferring economic and political power.  And that means a bunch of social unrest could be in the cards in 2009.

Consider…

• Emerging markets of all stripes have been cut-off from their funding sources and are unable to make it up through exports in a world where the character of consumer demand may be changed for some time.
• Russia’s pure energy dependence economy is imploding and unrest is rising; some believe the Putin regime itself is in trouble of being toppled.  This adds to the potential Russia will lash out in order to whip up nationalist frenzy to divert attention from dwindling economic alternatives and freedoms.
• Social unrest in Russia will add to the riskiness to any investment into Eastern and Central Europe adding to the chances of country defaults in the region—Ukraine is teetering! This will add to the woes of European banking; they are hugely exposed to emerging markets in Europe and elsewhere.
• Rising tensions across the Eurozone only adds to already rising risk within the system as Greece and Italy fiscal status deteriorates by the day.  Unrest in Greece among youth and anarchist could be the tip of the iceberg for broader unrest across the Eurozone as unemployment rises.
• Global demand for exports has evaporated and China, the world’s biggest exporter is feeling the pain in a big way. Factories across China are closing and unemployment is rising fast.  Social tensions are rising.  This is a real wildcard.  China knows its dependence on exports primarily for growth is coming round to bite them.  Transition from export-oriented to consumer driven doesn’t happen overnight.  China was already moving down the path of consumerism, but in the foreseeable future rising unemployment and falling reserves and corporate profits will likely crush expected Chinese growth in 2009.
• Latin America is highly dependent on commodities prices and exports.  Already Ecuador default on its bonds because of falling revenues as oil prices have tumbled.  The prospect for a big rebound in commodities prices looks dim because global demand continues to weaken.  Tensions are rising across the region here too.

And yes, the US economy is in trouble too.  And it could get much worse for the US as unemployment seems set to climb a lot higher.  But keep in mind it’s all relative.  And relative to the potential for a lot more pain elsewhere, US financial assets could surprise.  It’s why we remain bullish on the dollar.

Regards,

Jack Crooks&JR

Key News
• China cut interest rates for the fifth time in three months after trade growth collapsed because of recessions in the U.S., Europe and Japan.
• The German economy is to contract by 2.7 percent in 2009, the Kiel-based Institute for World Economy, or IfW, said on Monday, slashing its previous forecast as Germany's exporters feel the effects of a global slowdown. (Reuters)
• Russian oligarchs are lining up for $78 billion of Kremlin loans to survive the credit squeeze, handing Prime Minister Vladimir Putin the opportunity to increase government control of the nation’s biggest companies. (Bloomberg)

Key Reports (WSJ):
No economic events are scheduled for today.

Quotable
“Doubling up has ruined a lot of people.  In order to double up, you must go against the flow.  You are saying, ‘I know that the market is going to turn and prove me right.’  No one knows when or how!”

   Edward Toppel

FX Trading – Can we rest? Gold may lead the way. 
The volatility has been humongous in currencies, you might have noticed.  The huge run in the euro recently seems to have a lot of Johnny Come Lately dollar bulls changing their tunes, and now suggesting the dollar move is done.  It’s time for the dollar dirt nap again seems to be the new lament.  But it’s a very tough call in a market where volatility is spiking to all-time high levels to suggest a multi-day move means this or that. 

Our fundamental story hasn’t changed, as you know.  And today’s news (above) that China is cutting rates and Germany will contract more than expected are a big part of our dollar story—global demand has evaporated (Japan recently reported that November exports dropped at the sharpest rate on record). But….open we must remain because price action we must respect. 

Below is a daily chart of the euro.  Notice how the rally was stymied at the 61.8% Fibonacci retracement level, and now it is looking “overbought” based on the oscillators:

EURUSD Daily:
 
Now, might this be the first leg of a bigger move higher in euro?  Absolutely possible…but so far, gold has confirmed the recent corrective high in euro (or low in the buck)…

Gold Daily: Series of lower highs and lower lowers and so far capped by the downtrend line going back to June. Oscillators are turning down from “overbought.” We think gold goes a lot higher if the dollar does a dirt nap (and vice versa):

 
Gold vs. US$ Index (Inverted) Daily:  Same chart from above, but we have overlaid the inverse of the US dollar index (red line).  As you can see, they continue to track.  This chart shows as gold goes higher the dollar weakens (red line going up) and as gold goes lower the dollar strengthens (red line going down). 

 
 
So, maybe gold is the key indicator to watch.  A break above the downtrend line going back to June for gold could tell us the buck gets bashed again.  But then again, head fakes seem to be what this market is made of lately.

Stay tuned and keep you risk levels tight.  Thin volume going into the Christmas and New Year’s holidays could make it even more interesting, if that’s possible.  

Jack&JR

P.S. We will be publishing through Wednesday.  Then we will be taking off from Christmas day till January 5th.

Key Reports (WSJ):
No economic events are scheduled for today.

Quotable
O farewell,
Farewell the neighing steed, and the shrill trump,
The spirit-stirring drum, th' ear-piercing fife;
The royal banner, and all quality,
Pride, pomp, and circumstance of glorious war!
And O you mortal engines, whose rude throats
Th' immortal Jove's dread clamors counterfeit,
Farewell! Othello's occupation's gone.

Shakespeare, Othello Act 3, scene 3, 350–357

FX Trading – Underestimating the power of deflation is dangerous!
Sometimes we are a bit absurd in this morning missive in an attempt to make a point.  Looking back at a recent issue, from the 2nd of December, titled “Can you say 1% Treasury Bond Yield?” we noticed the 30-year bond futures price has risen a bit since then; yields have fallen.  Yes, yields have plunged faster than expected—by us, and I imagine by many others.

If you pay some attention to this stuff, barely a day goes by now when you aren’t being told by someone that Treasuries are the next major bubble.  It will burst soon so it’s time to start getting short. 

Now, we can’t pretend to forecast interest rates—no one honestly can—but in our issue of 2nd December we did make reference to the Fed’s pending quantitative easing, which is now on full display, and the fact that US policy seemed to be shaping up much like Japan’s during those deflationary years. 

I remember back when Japan was in the midst of that mess (still are interestingly), because I remember that great sage from Morgan, Barton Biggs—mostly wrong but usually a lot to say—pronouncing that shorting Japan Government Bonds as they approached 1% yield would be the “trade of the decade”, if I am not mistaken.  He may have said it’s the “trade of the century.”  Well, had you been unfortunate enough to take that trade and shorted those JGBs you would have broken even in about 15-years. 

Japanese Government Bonds (JGBs) 1991-2006:
 
Source: Golden-Eagle

So, the lessons to me are: 1) Don’t ever—never—believe I can forecast interest rates; and 2) Never underestimate the power of deflation! It does strange things to markets.

This isn’t to say that maybe there isn’t a major Treasury bubble, we don’t know.  But it is to say that if Jim Grant is this excited about and investment idea, a Treasury bubble, we have to be on guard.  For as wonderful as Mr. Grant is, and as darn smart as he is, and as brilliant a writer he is, he is usually wrong on the investment stuff at the key moments—I’ve noticed.  This doesn’t detract one bit from the depth of information and knowledge one can gain from his excellent newsletter, “Grant’s Interest Rate Observer.”  We are “paid up subscribers” and will continue as long as we follow the markets.  But, Jim’s stridence here has us a bit worried.  We think he may be underestimating the power of deflation.

And if we are underestimating the power of deflation, I think it might be a good time to examine our premises on what constitutes value in here.  Junk bonds look incredibly attractive, is a new theme.  Even if one accounts for outsized default potential, goes the argument.  But, this is a different environment. And 20-50 basis points added to the all-time worst default ratios in the past for junk may be woefully conservative given the deep destruction of wealth we’ve seen and continue to see.  So just be careful when that “new” hubris-filled idea rolls your way.  It may be wonderful, we don’t know.  But bet small, you can always add. 

So, the game is this: If Helicopter Ben and friends have done what’s needed to pull the nose if this vessel up from this death spiral, then the Treasuries are in a major bubble crowd reaps. Again, the jury is still out. 

What’s our evidence the jury is still out? What is the one thing if we had to pick and choose that says wealth destruction has a lot farther to go—crude oil is it!

John Authers, in his “Short View” column appearing The Financial Times yesterday summed it up well when he said, “That oil has not responded to the huge stimuli of zero US interest rates, a much cheaper dollar, and a record output cut, suggests that there has been a drastic fall in demand.”

Bingo!

US$ Index vs. Oil Daily:
 

The dollar is back under 1.40 against the euro today; after EURUSD spiked to 1.47 yesterday.  Yes, that was not a misprint.  Over an eight-cent swing in one day.  And heck, it’s early, we’ve got all day left till this crazy market closes. 

EURUSD 240-min chart: An 8-cent haircut in 31-hours!  Amazing!
 

So, enjoy your day.  Be careful out there. And have a great weekend.

Jack&JR

Key News
• Ukraine's Currency Plunges as Debt Concern Grows Despite Yushchenko Pledge (Bloomberg)
• ECB May Cut Deposit Rate to Jolt Banks Into Lending More to Revive Growth (Bloomberg)
• German Business Confidence Drops More Than Estimated to Lowest Since 1982 (Bloomberg)
• Germany is fighting with Europe. Can China be far behind? (China Financial Markets, Michael Pettis)

Quotable
I Want to Be a Consumer

“And what do you mean to be?”
The kind old Bishop said
As he took the boy on his ample knee
And patted his curly head.
“We should all of us choose a calling
To help Society’s plan;
Then what do you mean to be, my boy,
When you grow up to be a man?”

“I want to be a Consumer,”
The bright-haired lad replied
As he gazed up into the Bishop’s face
In innocence open-eyed.
“I’ve never had aims of a selfish sort,
For that, as I know, is wrong.
I want to be a consumer, Sir,
And help the world along.

“I want to be a Consumer
And work both night and day,
For that is the thing that’s needed most,
I’ve heard economists say,
I won’t just be a Producer,
Like Bobby and James and John;
I want to be a Consumer, Sir,
And help this nation on.”

“But what do you want to be?”
The Bishop said again,
“For we all of us have to work,” said he,
“As must I think be plain.
Are you thinking of studying medicine
Or taking a Bar exam?”
“Why, no!” the bright-haired lad replied
As he helped himself to jam.

“I want to be a Consumer
And live in a useful way;
For that is the thing that’s needed most,
I’ve heard economists say.
There are too many people working
And too many things are made.
I want to be a Consumer, Sir,
And help to further trade.

“I want to be a Consumer,
And do my duty well;
For that is the thing that’s needed most,
I’ve heard Economists tell.
I’ve made up my mind,” the lad was heard
As he lit a cigar, to say;
“I want to be a Consumer, sir,
And I want to begin today.”

    Patrick Barrington

FX Trading – Consuming Forces Shaking Ukraine, Germany ... and China

You’re probably kicking yourself for holding on to those hryvnia for a couple days too many.

If you don’t know what I’m talking about, I’ll tell you: Ukraine’s currency – hryvnia – took a nosedive. In the last two days its value has plunged 17%. And even though Ukraine’s President pledged to support the currency, it fell to an all-time lows versus the US dollar.

You can check out the Bloomberg story at the top of today’s issue if you want to read more on how the IMF tried bailing out Ukraine, or that Ukrainian credit is currently the third most risky in the world behind Argentina and Ecuador, or that the President is forcing the central bank to crack down on fx speculators ...

But what is most important to get from the article is that Ukrainian credit is hugely at risk of default. And a swooning currency makes domestic loans denominated in other currencies that much more expensive to afford.

As was the case with Ecuador’s recent admission of its inability to come even on large amounts of debt, Ukraine is walking a similarly ominous line. These two examples highlight a good part of what’s shifting in this global economy. In emerging economies things will probably still get worse before they get better.

On the flip side, a much larger country and economy is dishing out disappointment too. A steady stream of weak data continues to flow from Germany. And while their downturn has seem to come more slowly than other countries in the Eurozone and around the world, concern is growing that Germany isn’t taking sufficient precautions to help bring about a more timely recovery.

Many have lost confidence that Germany’s fiscal policy will do what it takes to stop the bleeding until it’s too late.

We discussed a very important point in Currency Currents last week regarding the dynamic between deficit countries and surplus countries in times of economic contraction.

As was the case during the great depression, the United States was a surplus country. The change in landscape after the stock market crash required the US to make considerable adjustments. As it was, they bore the brunt of the depression where deficit countries skirted by less battered.

Now we’re at a point where the US is the deficit country. The surplus country that stands out in the current environment is China. They over-produced throughout the recent boom, but now have no over-consuming buyers in the face of the ongoing bust. Their excess capacity is now a considerable drag and needs dramatic adjustment.

Germany is in a similar boat. And with global trade on the fritz with no certainty of when the bottom might arrive, Germany will struggle and the rest of the Eurozone will feel the fallout.

Regards,

Jack&JR

Key News
• Trichet Sees Limit to Interest-Rate Cuts, Signals ECB May Pause in January (Bloomberg)
• Chinese Central Banker Plans More Rate Cuts as Investment, Economy Weaken China’s central bank Governor Zhou Xiaochuan said interest rates may fall again this month after exports declined, inflation slowed and a report today showed property investment cooled. (Bloomberg)
• The Treasury Market Reaches Breaking Point www.euromoney.com/Article/2060042/CurrentIssue/65745/The-treasury-market-reaches-breaking-point.html

Key Reports Due (WSJ):
7:45 a.m. ICSC Chain Store Sales Index For Dec 13: Previous: -0.8%.
8:30 a.m. Nov Consumer Price Index: Expected: -1.3%. Previous: -1%.
8:30 a.m. Nov CPI, Ex-Food&Energy: Expected: +0.1%. Previous: -0.1%.
8:30 a.m. Nov Housing Starts: Previous: -6.3%.
8:55 a.m. Redbook Retail Sales Index For Dec 13: Previous: -0.4%.
2:15 p.m. Dec FOMC interest rate decision expected, Federal Funds Rate: Previous: 1%.
5:00 p.m. Dec 13 ABC/Washington Post Consumer Confidence Index: Previous: -52.

Quotable
“It is important to say all the great thoughts again, without knowing that they have already been said.”

     Elias Canetti

FX Trading – I Love the Smell of Rate Cuts in the Morning

Interest rate decision out of the FOMC today – Mr. Ben Bernanke and his busy policy-makers announce their latest decision on interest rates this afternoon in the US. Will Ben schmooze the media like Trichet? Doubtful. Estimates say rates will drop another 50 basis points, down to 0.50% from 1%.

Unless Benny B. decides to save some of what little ammo he’s got left for future FMOC get-togethers, I expect the consensus estimate of 50 basis points off will prove accurate. But what will that do to the market?

My guess would be very little. As seems to be the case, the market correctly expects the rate cuts but doesn’t care about the nominal decision. The thing that matters is their reasoning and accompanying message.

Obviously the Fed understands their words can cause more than a little ripple through markets. That’s why they so carefully solder together each and every word of the announcement following these FOMC decisions. With rates nearing zero, the question is what the Fed will do as the situation remains increasingly difficult for the US economy.

First, this question assumes rate cuts have actually helped ease some pain. Second, it assumes Americans (and the markets) have any confidence the Fed CAN discover new, successful ways to ease the pain.

On the table so far is talk that the Fed may try to fuel the economy with cash by purchasing US Treasuries. This week’s FOMC meeting was originally only supposed to be a one-day affair. But they added an extra day for the sole purposes of discussing liquidity-inducing options – opening up their balance sheet, as it’s being called – that they might be able to take to shore up economic activity.

There probably won’t be any concrete decisions announced today, as they seek to further narrow down their possible avenues, but they will seek to make sure of one thing: that the market (or economy) doesn’t feel like it’s been left hung out to dry.

Based on the way the Fed has behaved over the last year, it seems to me they must say something today to keep hope alive. And should things actually happen that way, stock markets will probably finish the day on a positive note. Of course, based on the recent inverse correlation, we know that means the US dollar won’t be as fortunate.

We’ve explained that a more-significant correction was in order for the buck. That looks to have gotten underway last week and is continuing this week. Many analysts are jumping on this price action as an end to the US dollar’s mid-year rally (also known in dollar-bear lingo as an “anomaly”.)

Could they be right? Sure. Do we think they’re right? Definitely not yet.

Dollar bulls and bears alike are pointing at a head-and-shoulders technical pattern now set to drive the dollar lower. Based upon how you typically calculate the size of the subsequent breakout below the neckline, the buck would fall down to roughly 81542 before it stabilizes.

Looking at how near we are to that target, it appears that the sharp, immediate sell-off could already be reaching a stabilization point. After that it will make sense to reevaluate whether further weakness is needed.

My point here: don’t look to this head-and-shoulders pattern as the be-all-that-ends-all. There’s no denying it is a powerful reversal move and more downside could very likely be on the way. But be careful not to read too far into this chart pattern. The markets will need to digest plenty of key fundamental data over the next couple months. You can be certain that the bad stuff isn’t going to only fall on the US economy.

Regards,

Jack & JR

Key News
• European policymakers must not tear up the rule book when launching emergency economic rescue packages, ECB President Jean-Claude Trichet said. (Reuters)

EURUSD Daily: Euro continues to be the big winner against the dollar lately.  Next key Fib retracement resistance daily comes in near 13600-level.

(Chart unavailable.)
 
• Japan reported its sharpest crash in business sentiment in three decades on Monday and industrial output in China grew at its slowest pace since 1999. (Reuters)

USDCNY (Chinese yuan) Daily: Despite continued bad news on growth flowing from China, the currency has managed to gain against the buck lately, possibly alleviating concerns the Chinese may weaken the currency to help exports.  But would a weak currency matter when no one out there seems to be buying?

(Chart unavailable.)

 
• Turkey's economy continued to feel the impact of the global financial crisis as official figures released Monday showed gross domestic product growth slowing and unemployment rising. (AP)

USDTRY (Turkish lira) Weekly: Stabilized after a test of the high?  Or is it the calm before   the storm?

(Chart unavailable.)
 
• Crude oil rose after OPEC’s Secretary-General Abdalla El-Badri said the group needs to make a “sizeable” production cut at this week’s meeting in Algeria. (Bloomberg)

Crude Oil Daily: Crushed!  A bounce would be no surprise. 

(Chart unavailable.)
 

Key Reports (WSJ):
8:30 a.m. Dec NY Fed Manufacturing Index: Expected: -26.5. Previous: -25.4.
9:00 a.m. Oct Treasury International Capital Flows: Previous: $57.2B.
9:00 a.m. Nov Industrial Production: Expected: -0.6%. Previous: +1.3%.
9:15 a.m. Nov Capacity Utilization: Expected: 75.8. Previous: 76.4.
1:00 p.m. Dec NAHB Housing Market Index: Previous: 9.

Quotable
“"People who look for easy money invariable pay for the privilege of proving conclusively that it cannot be found on this earth."

Jesse Livermore

FX Trading – Euro as new safe haven currency?
We don’t think so—at least over the longer term.  But no matter what we think near- or long-term, the market likes euro compared to the other players.  The euro has bounced strongly against the US dollar.  Also, you can see euro’s relative strength in the Euro – British pound cross (at an all-time high) and the Euro – Swiss franc cross (wasn’t Swiss supposed to be the safe haven)? 

EURGBP Weekly:
 (chart unavailable.)

EURCHF Weekly:
 (Chart unavailable.)

No doubt, of the central banks, the European Central Bank at the moment is acting most “central bank-like.”  What we mean is that Mr. Trichet, President of the ECB, seems most publicly concerned about stuff like fiscal responsibility and running out of bullets by cutting too aggressively.  Adding to that, an ECB talker was trying to put on a good face about 2009, suggesting the Eurozone would be emerging from all this mess by the second half of the year.  So he is doing come cheerleading too. 

But, we are concerned about the euro safe haven argument for a couple of reasons:

First, despite our general agreement with Mr. Trichet about his monetary and fiscal views, we wonder if his reluctance to ease further and faster may not add to the weight of the problems in Europe.  Consider that member countries are busting their budgets in an effort to drive demand, and ECB stinginess on rates, or lack of monetary stimulus, may only exacerbate the fiscal strains Mr. Trichet is concerned about—and widen already widening member country bond spreads.  Plus, we think the emerging markets of Europe could be the Achilles heel for the euro; they’re starving for liquidity even more than the larger euro members. 

Our second concern is Germany.  Europe’s real engine of growth is still seen as being in relatively decent shape.  But, we don’t think that will last too much longer.  Germany after all is an export powerhouse. We believe the exact same dynamic hitting China—no buyers—will hammer German growth. 

However, all that said, we remain open.  Price action is always the final arbiter no matter how we spin our macro story.

Jack&JR

Key News
• The number of Americans filing first- time claims for unemployment benefits surged more than forecast last week to a 26-year high. (Bloomberg)

Quotable
“I’m not confused, I’m just well mixed.”

  Robert Frost

FX Trading – Turning to the Technicals for Guidance

We’ve told our story as to why the US dollar has possibly entered a multi-year bull market. And depending on where else you dig for investment advice, you may have also heard why the US dollar has not entered such a bull market ... why this is only a correction in the major long-term downtrend.

To us, that’s the OLD story. And it seems that those sticking to the old story are failing to recognize the importance of some key changes to the global financial system and economy. I’m not sure exactly why a potential US dollar bull scares some so much. Maybe it has something to do with gold.

Anyway, with the fundamental drivers out on the table it’s only a matter of time till we find out who is right about what direction the dollar will take over the coming months and years. We’re not 100% confident our story will prove true. And we’re far less confident the old story will prove true.

So as we press on we seek out confirmation as to whether we’re right ... or we’re wrong. Beyond monitoring the latest data on interest rates, GDP, exports, et cetera, it’s in technical analysis of price charts where we search for confirmation.

The extent of technical analysis is mind-boggling. With so many different types of momentum indicators and trend studies it’s easy to get overwhelmed. That said, we try to keep it simple: trendline analysis, basic moving averages, Fibonacci retracement levels ... stuff like that.
About as deep as we get into the realm of technical analysis, so as not to cloud our perspectives, is with Elliot Wave. Elliot Wave theory is very deep, but its basic purpose is to help indentify repetitive, predictive waves. These waves form and repeat themselves as pieces of larger waves, and so on.

From where we stand now, we see this most likely wave scenarios shaping up in the nearer-term ...

Dollar Remains in Wave 4 Corrective Move – More Downside Ahead

As it is now, wave 4 of this move is not set in stone. Elliot defined corrective trends as consisting of three-wave patterns (e.g. a-b-c). So the dollar could continue lower before wave 4 is complete. The following chart shows how this might potentially play out.

That’s where we are now. Around 8310 on the dollar index is the next chart support (trading at 8411 now).  The next key Fib support comes in at 8190 and wave C as an extension of wave A comes in around 8150.  So maybe that’s the first viable target?

What we do find a bit odd is the relative currency move today—the entire pack is rallying against the buck.  Could this be something “wholesale”? 

The correlations we are used to seeing are “out of whack” a bit.  E.G. both the yen and euro are sharply higher against Greenie—not a pattern we’ve seen for some time.  Stocks are bidding lower and bonds are higher—it ain’t helping the buck, yet this pattern has mostly been supportive…hmmm.  Some are saying the move higher in gold means concerns are now becoming US specific.  Given today’s dollar action we have to be wide open to that potential. 

Regards,

Jack&JR

Key News
• U.K. manufacturing contracted almost three times as much as economists forecast in October and housing sales fell to the lowest in three decades, as the country slipped deeper into recession. (Bloomberg)
• The crunch may close a fifth of Guangdong’s factories and leave 6 million migrants without work next year, according to the Institute of Contemporary Observation, a labor rights group in the province. That would further slow the world economy because Guangdong accounts for 12 percent of the nation’s gross domestic product and China is the biggest driver of international growth. (Bloomberg)
• South Africa’s current account deficit widened to 7.9 percent of gross domestic product in the third quarter as a global credit crisis slashed demand for gold and platinum, the country’s biggest exports. (Bloomberg)
• The Bank of Canada lowered its benchmark interest rate by more than anticipated to a half- century low and signaled more action may be needed as economic growth sputters amid a “broader and deeper” global slump. (Bloomberg)

Quotable
“If a man will begin with certainties, he shall end in doubts, but if he will be content to begin with doubts, he shall end in certainties.”

Francis Bacon

FX Trading – Foiled again?  Rambling about trading inside the chop zone!
Ouch!  Another seeming dollar correction is off the rails so far this morning, as it is sharply higher against all comers (yen the exception).  Watching the dollar move sideways since November 21st is like watching an episode of the Twilight Zone—all kinds of game changing global macro events everyday and the world’s major currency just ranges.  Let’s call it the “chop zone,” because that is what it can do to one’s short-term trading account—chop it up into small little pieces: 

Could it be the continued dire economic news from Europe is starting to outweigh the nastiness flowing from the US?  Could it be concern that China may disappoint in a very big way to the downside?  Could it be growing confidence about President Elect Obama’s grasp of the economics?  It could be any, all, or none of those things.  That’s what is so difficult about this market of late.  As soon as you hang your hat on rationales to justify a daily move, it snaps back and whacks you in the face. 

“There are only two types of theories [according to Karl Popper]” taken from Nassim Taleb’s “Fooled by Randomness”:

1. Theories that are known to be wrong, as they were tested and adequately rejected (he calls them falsified).
2. Theories that have not yet been known to be wrong, not falsified yet, but are exposed to be proved wrong.”

Our long-term view, as you know, is predicated on a yes to all the loaded questions we asked above.  But the reality is maybe we are simply finding sweet sounding rationales to support the price trend—it is always a danger thinking one really knows. For just as Karl Popper concluded, it only takes one sample to invalidate a theory; it only takes one wrong rationale—driven by the ephemeral fundamentals—to obliterate a price trend. 

We’ve been receiving a fair amount of comments of late rejecting our dollar view.  These comments have rationales ranging across the board supporting their view and why ours IS wrong.  Feel free to write.  But let me explain something if you don’t already know as a CC reader: 

WE KNOW OUR VIEW MAY PROVE VERY WRONG.  IN FACT, JUST BECAUSE THE TREND IS SUPPORTING OUR LONG-TERM VIEW DOESN’T MEAN ANY OF THE RATIONALES WE ESPOUSE ARE RIGHT!

As we’ve been getting chopped out near-term, based on our “technical theories” that have been consistently falsified while lingering in the “chop zone,” we’ve been thinking about this process we call “trading.”  Our conclusion: It is ultimately all a nice little intellectual game that is consistently based on flawed rationales.  Where theory meets reality is our trading account. 

It is by nature a flawed process because we cannot predict and flawed because the part of the trading game that is supposed to provide some modicum of terra firma—fundamentals—changes so rapidly (which most are now recognizing in this cycle).  Thus, we have theory only at the core.  We have at times boiled it down to saying trading is simple guesswork is all!  And we stand by that. 

Now, you might be saying, what good are you if you admit it’s all guesswork?  Honestly, we don’t have a good answer to that question, but we’ll try. 

We’d like to say it comes back to performance and experience and blah…blah…blah…But as you know, a lot of players with good past performance and lots of grey hairs are being carried out in this market.  Game over!

So what does make a good trader (again even the term good is extremely subjective)?  We will go back to Popper for a good answer, thanks to Taleb’s “Fooled by Randomness”:

Taleb: “The reason I feel he [Popper] is important for us as traders is because to him the matter of knowledge and discovery is not so much in dealing with what we know, as in dealing with what we do not know. His famous quote:

“These are men with bold ideas, but highly critical of their own ideas; they try to find whether their ideas are right by trying to find whether they are not perhaps wrong.  They work with bold conjectures and severe attempts at refuting their own conjectures.”

Thus, all we can do: Examine our rationales both fundamental and technical.  Pull the trigger when confidence appears (something that looks at least 50.1% to 49.9%); define how much risk you will take, using a stop, before price action proves you wrong; and constantly and continuously question yourself: Where am I wrong on this trade?  That is a never-ending process of letting in negative information that may explode your rationales.  It’s a process of not falling in love with one’s story, but being the harshest critic of your own story. 

So, what makes reading Currency Currents worthwhile: It is worthwhile only if we ask questions and not pretend to give correct answers. 

And one of the questions we are fumbling with now is a biggie: 

Does it behoove the global economy—global healing and balancing—for the US to have an implicit AND explicit strong dollar policy? 

We have some reasons why we think that answer to that could be yes.  But let’s save that for another day; maybe another day when some trend clarity arises i.e. a move out of the “chop zone.” 

Jack&JR

Key News
• The euro area has so far defied Milton Friedman’s forecast that it would splinter as soon as the “global economy hits a real bump.” (Bloomberg)
• In the worst year ever for oil, investors can lock in the biggest profits in a decade by storing crude. (Bloomberg)
• Canada's housing sector is entering what RBC Economics calls a “cyclical downtown,” but says the risk of a U.S.-style meltdown is remote. (G&M)
• Record numbers of companies will go bankrupt next year with 200,000 insolvencies in Europe alone and “an explosion” of failed businesses in the US, according to the world’s largest credit insurer. (FT)

Quotable
“A product of the untalented, sold by the unprincipled to the utterly bewildered.

     Al Capp (of abstract art)…think derivatives!

FX Trading – Dollar correction time? Finally?
If we could only forecast the stock market, then we’d be able to forecast the dollar—it seems.  But we can forecast either of them—we can only make probability bets on both.  And those probabilities are all in our head—guesswork at best there too.

But, based on Friday afternoon’s huge reversal in fortunes in both the stock market and dollar, and adding in the carry-though today (stocks higher globally and buck bashing) on seeming euphoria over President-elect Obama’s self-expressed gargantuan stimulus package that will surely get the US job market moving again, it looks like stocks could stage a decent bounce—here and elsewhere.  That would mean a decent correction in the dollar.

US$ Index Daily:  First Fib from the July dollar blast-off point comes in at 8194. 

 

Dow Jones Industrial Average Daily: 28-day moving average has been strong resistance.

Trying to play a dollar correction has been a dangerous and unprofitable game however.  We know that firsthand, as we have called about five of the last zero dollar corrections…that is a disclaimer. 

Stay tuned.

Jack&JR

Key News
• Sweden Cuts Benchmark Rate More Than Forecast as Economy, Inflation Slow (Bloomberg)
• New Zealand Cuts Key Rate to 5% From 6.5% as Recession Curbs Export Demand (Bloomberg)
• US, China headed for possible currency clash (Breitbart)

Quotable
“Wait until it stops rolling and pick it up.”

     Bob Eucker, on how to catch a knuckleball

FX Trading – Interest Rate Decisions Dominate Headlines -- But Is It News?

Well, the trend is certainly there. Central banks are cutting interest rates in a big way. The first two key news headlines above speak to that point. And of course, the Bank of England just announced a 100-basis point rate cut this morning. The European Central Bank cut 75 basis points.

Heading into these two key decisions traders bid down both the pound and the euro. Selling pressure forced the British pound below key daily support but the price popped back up ahead of the announcement.

Reaction after the BOE announced was somewhat pound-positive. The decision was in-line with expectations and it seemed traders were in no hurry to push the British pound lower. But the bounce remained contained as traders waited to see and hear from the ECB.

Well, they’ve seen what the ECB did. Even though the 75-basis point cut was a larger cut than was expected, prices didn’t respond a whole lot. Now we wait to hear a press conference from the main man, Jean-Claude Trichet. The big question for him will likely be: are additional rate cuts necessary? We would say yes.

Looking at the technical picture, the British pound has tested key daily support. While it’s holding back above this level night now, it seems like further declines are not far off on the horizon.

The euro has been disappointingly boring over the last couple weeks. Traders have had little conviction over the need for the euro to backtrack from its declines ... or continue its descent.

On a technical basis, the euro is stuck in a narrowing trading range, refusing to break in either direction. Unfortunately, the immediate reaction to the ECB news hasn’t given us any peak at which way the euro might be itching to run.

What we can take from this chart is the important fact that, with narrowing ranges such as this, prices typically exit the range heading in the same direction they entered. In the case of the euro, the direction is down.

Plus, we are also keeping in mind some of the fundamental drivers that will impact the intermediate-term trends for these currencies. Jack touched on one important point on Tuesday in Currency Currents:

Banks in the United Kingdom and the Euro Zone are loaded up past their eyeballs in liabilities. As a percentage of GDP, they’re exceptionally more exposed than, say, US banks. And let’s not forget the exposure each of these European regions has in the form of loans to emerging markets. Major deleveraging is yanking money out of emerging market economies fast. Major defaults have become a huge risk. This over-exposure to emerging market economies is another major burden on European and UK banks that the US doesn’t have.

Keep that in mind as we make our way to week’s end. Perhaps Trichet will have a lot to say next hour. And perhaps traders would prefer waiting until tomorrow when the November US jobs report is released.

Regards,

Jack&JR

Key News
• Britain's services sector contracted at its fastest rate in at least 12 years, a closely-watched survey showed Wednesday, ratcheting up expectations that the Bank of England will cut interest rates by a full percentage point on Thursday. (AP)
• The Australian economy grew at its slowest pace in eight years last quarter. (IHT)
Key Reports Due (WSJ):
7:00a.m. MBA Mortgage Application Survey for Nov 28: Previous: -2.1%.
8:30a.m. 3Q Productivity&Labor Costs, revised: Expected: +3.1%. Previous: +4.3%.
10:00a.m. Nov ISM Non-Mfg Index: Previous: 44.4.
10:35p.m. API Oil Industry Report for Nov 28
10:35p.m. US Energy Dept Oil Inventories for Nov 28
2:00p.m. Federal Reserve Beige Book

Tomorrow (Time GMT):

12/4/2008 12:00  UK  BOE ANNOUNCES RATES 2.50%  3.00%
12/4/2008 12:45  EU  ECB Announces Interest Rates 3.00%  3.25%

Quotable
"The world has run out of willing and creditworthy private borrowers. The spectacular collapse of the western financial system is a symptom of this big fact. In the short run, governments will replace private sectors as borrowers. But that cannot last for ever. In the long run, the global economy will have to rebalance. If the surplus countries do not expand domestic demand relative to potential output, the open world economy may even break down. As in the 1930s, this is now a real danger.”

   Martin Wolf

FX Trading – Oh Canada in a little trouble of late… 
Oh the Canadian dollar!  John Ross and I usually say: “They don’t call it the Loonie for nothing!”  And at times, after playing a setup in the Loonie where we felt some degree of confidence, and got crushed still, we add another moniker—Currency Assured Destruction.  I share this with you as a type of disclaimer, so to speak. 

The Canadian dollar is getting hit, and looks as though it will test its old high.  Politics seem one factor to blame, beside the fact that commodities aren’t helping.

Our Wave Count Guess….Daily USDCAD:
 

And to the politics in Canada we reprint a note from a very smart Canadian friend of ours who has been on top of the global macro scene for many years:

“Jack - a coalition of three opposition parties, (*The Liberals under Stephan Dion who was about to be dumped as Liberal leader......a communist party, the NDP, headed by a power hungry dolt named Jack Layton....and also to include the Bloc Quebecois - whose sole mission is the breakup of Canada) want to bring down Harper at next no-confidence vote and they can........so maybe you and JR might want to keep an eye on the Loonie....we are in deep [do-do]....”

So, keep an eye on the Loonie!
--------------------------------
Another View: Are Stocks Due for Big Move Higher?

Another friend of ours from Canada, Yves Lamoureux, Investment Advisor for Blackmount Capital Inc., sent us this note and the corresponding chart below.  We thought you might be interested. 

From Panic buying to Manic selling

We had been very nervous back in 2007 about margin buying showing a great acceleration. We called the ballistic move up in borrowing to buy stocks a panic buying.

It became clear in 2000 that the start of unwinding of the margin would have great repercussion. So it is with this past experience that I approached 2007 with great prudence.  Knowing that the margin was even higher than the previous peak.  One would have to expect big carnage.

So it is today that we are  faced with a negative loop feedback.  Stocks are offering one of the best entry in the last 15 years and who is courageous enough to buy.
When all told that we are going into depression.

Once unwinding is done, I believe that the supply and velocity of money will overwhelm the system. I am looking at strong inflation that will again inflate bubbles vigourously. The secret is to find new ones rather than look at the past bubbles.

Equities still offer a better store of value in an inflationary environment.  Often 60% of the total return is derived by inflation. 

We face the best prospect in stocks in a while and few will answer the call.
I believe, as shown from the dot.com era, that a 50% take down of the total debt margin results in creating a bottom. We are therefore getting real close to this event.

 Bulls unite !

Disclaimer: opinions and projections contained are of the guestblog author and may not represent the views of , Blackmont Capital (BCI) or any other organization. The information contained herein is for information purposes only and this report is not to be construed as an offer to buy or sell any securities. Neither , BCI nor the author accepts any liability whatsoever for any loss arising from use of this report or its content. The comments and opinions expressed in this letter are the result of work done by Yves Lamoureux. They may differ from the opinion of Blackmont Capital Inc. ("BCI") and should not be considered as representative of BCI, belief, opinion, or recommendations. The statements and statistics contained herein have been prepared by sources we believe to be reliable but we cannot represent that they are complete and accurate. This material is published for general information only. BCI assumes no liability for financial decisions based on this information. Readers should obtain professional advice before applying any ideas mentioned to their own personal situation to ensure their individual circumstances have been properly considered.  BCI is an independently owned subsidiary of CI Financial Income Fund. CI Financial is a Canadian owned diversified wealth management firm
 

Have a great trading day!

 Jack & JR

Key News
• Russia’s central bank probably doubled spending of foreign reserves to defend the ruble from its biggest weekly plunge against the euro in more than four years. (Bloomberg)

 
• The Canadian dollar recovered some ground versus the U.S. dollar on Tuesday but remained range-bound and at risk of pressure from falling oil prices and political uncertainty in Canada. (Reuters)

Quotable
"The great question is whether the government will succeed in reinstilling the inflationary spirit of reckless abandon in American lenders and borrowers.  Debasement is what the authorities are driving toward.  It’s why they keep inventing new [lending] facilities.”
Jim Grant

FX Trading – Can you say 1% Treasury Bond Yield? 
The Fed’s announcement that it will start buying Treasury bonds, along with everyone else in the world it seems, pushes the Fed into official Quantitative Easing (QE) territory. 

A recent article, dated October 10th, carried in the Financial Times by Graham Turner, from GFC Economics, helps explain why this was needed [our emphasis]:

“But, as we saw in Japan, that may well not be enough. The recapitalisation of banks in 1998 is often cited as a successful intervention that turned the corner for Japan. That is not true. The stock market did not hit its lows until April 2003.

“The tide only turned when long term interest rates were pegged down at low levels too, with the Bank of Japan buying government debt. This is the essence of quantitative easing. The Ministry of Finance was also allowed by the US administration to intervene in the currency markets and drive the yen down.

Clearly the latter is not an option for the world economy. But driving down both short and long term rates is a far better policy weapon than the current stream of government initiatives, which will wreak havoc with the public sector finances.

Today’s partial recapitalisations of banks are not the answer because they will accelerate the slide into a debt trap. In the absence of radical monetary easing, the increased government borrowing to fund quasi nationalisations will ensure bond yields remain elevated. We are repeating many of the mistakes made by successive Japanese governments during the 1990s. They allowed the JGB curve to steepen and that delayed the much needed decline in borrowing costs. It would be better if governments in the West simply nationalised struggling banks outright. But even this still has to be funded through quantitative easing, otherwise, there will be classic crowding out as idenitified by Keynes.

“Indeed, Japan saw its public sector debt burden soar from 65% to 175% of GDP between 1990 and 2005. This increase in public spending was not Keynesian. For much of this period before the BoJ started buying government debt aggressively, it caused bond yields to remain elevated relative to short rates. Lending rates did not fall quickly enough, and Japan became embedded in a cycle of debt deflation.”

So maybe there is a plan behind Helicopter Ben’s seemingly ongoing debasement. 

We get asked often why this weight of dollars thrown onto the market won’t push the dollar down the proverbial rat hole.  And our answer, right or wrong, is that this is a relative game.  And because the US banking system, as bad as it is, still lacks the exposure of the dollar’s main competitors. 

“Notwithstanding all the problems in the US banking system, the size of banks’ balance sheet is much smaller in the US than in many other countries.  For example, total bank liabilities are around 650% of GDP for Switzerland, 430% for the UK, 320% for the Euroland, 150% for Japan and 85% for the US.  Investors should keep this fact in mind,” writes Morgan’s Stephen Jen.  [Our emphasis]

But what about the return of inflation, won’t that be bad for the dollar?  Well it might!  But given the increased potential for major debt default to come, i.e. high yield corporate bonds and EM countries, the major deleveraging phase seems far from over.  And as we know, consumers are finally getting scarred enough to start saving and the banks are still too damaged (or frightened) to lend.  Thus the money multiplier is plunging.  This should keep inflation at bay for a while—deflation is the real concern now.  And news global guru favorite China is in trouble only adds to this concern.  After all, China was supposed to be the White Knight to ride in on its massive reserve horse to save the rest of us heathens. That ain’t going to happen is our bet!

Again from Mr. Jen at Morgan [our emphasis]:

“We looked at the trajectories for M2 of Japan and the US.  During Japan’s QE period, its M2 expanded from around 125% of GDP to more than 140%.  In the US, M2 has expanded from 53% to 57% of GDP since September. While the latter is a sharp surge, M2/GDP is not substantially higher than it was during 2003, when the Fed drove the FFR towards 1.00%.  Indeed, most of the surge in the figure comes from the anticipated sharp drop in 4Q nominal GDP. To summarise, while base money has increased dramatically (by 34% since August), M2 has grown by only 2.7%.

“The reason for this, of course, is that the ‘money multiplier’ (MM) has collapsed, reflecting a severe breakdown in the ability and the willingness of the bank and non-bank entities in the US to intermediate capital to the extent they had done prior to the crisis.  The collapse in the US MM is significantly more severe than in the case of Japan, during which time Japan’s MM fell from around 10 times the size of the BoJ’s balance sheet to around 6.5 times (a fall of 35%).  In the US in the last two months, we have seen the US MM falling from more than 9 to around 7 (down 22%).” 

So, the US money multiplier collapsing faster than Japan’s did…hmmm.  Maybe that explains why Helicopter Ben is breaking out all the tools in his box. 

Reader Q&A:

Q: Quick thoughts on the implications of the Chinese yuan shift that is showing up on the charts? Bullish/bearish for what? Bonds? Stocks?

A: We think it is bullish for bonds (not corporate) and bearish for stocks.  It portends big problems for China.  Hot money is likely running out for cover; a bit of “Chinese capitulation,” so to speak.  We think that is what sparked yesterday’s moves higher in bonds and stocks.  We think it will be ongoing as China spirals downward beyond expectations. 

Jack&JR

Key News
• The World Bank on Tuesday cut its growth forecast for China next year to 7.5 per cent, the slowest rate of expansion since 1990, and said the impact of the global financial crisis was likely to “intensify”. (FT)
• [UK] Prime Minister Gordon Brown swept aside three decades of economic orthodoxy with tax increases on the rich and plans that will double Britain’s national debt.

Key Reports Due (WSJ):
7:45a.m. ICSC Chain Store Sales Index For Nov 22: Previous: +0.3%.
8:30a.m. 3Q Preliminary GDP: Previous: -0.3%.
8:30a.m. 3Q Preliminary Corporate Profits: Previous: -0.4%.
8:55a.m. Redbook Retail Sales Index For Nov 22: Previous: -1.1%.
9:00a.m. Sep S&P/Case Shiller Home Price Index: Previous: -17.7%.
10:00a.m. Nov Conference Board Consumer Confidence: Expected: 38.5. Previous: 38.0
10:00a.m. Nov Richmond Fed Mfg Survey: Previous: -26.
10:30a.m. Nov Dallas Fed Mfg Production Index: Previous: -13.7.
5:00p.m. ABC/Wash Post Consumer Conf For Nov 22: Previous: -52.
 

Quotable
"The government is unresponsive to the needs of the little man. Under 5'7", it is impossible to get your congressman on the phone.”
 
Woody Allen 

FX Trading – Can we muster a 2-day stock rally?

Yesterday looked like another day foreshadowing a decent dollar correction on the bounce higher in stocks.  This morning we wake to a stronger dollar again….hmmm…and of course “new” concerns about stocks, one story we saw read.  We bit on the dollar move yesterday, expecting at least a 2-day ebb in risk aversion, playing for a short-term correction.  That view isn’t looking as good today as it was yesterday

It all keeps coming back to the stock market—the key risk asset class; currencies are joined at its hip.

(Chart unav

S&P 500 Index vs. EURUSD 240-min (Nov 3-25):
 

When I played baseball and was in a batting slump (which was often), I would consider a foul ball and hit-by-pitch (taking one for the team) a hitting streak; but to qualify in my mind as a streak, the sequence had to come after two consecutive plate appearances.  If the stock market could muster two-days higher in a row I’m sure traders would consider that a streak.  I know Tout TV would.  Yikes!

Every seeming glimmer of perceived good news is quickly dashed by more and more bad of late.  But, the question is, and always is, how much of the bad is discounted into the price?  The collective thing we call the market is the arbiter of news and reflects that in price action.  And if Mr. Market perceives bad news as “a little less bad,” that’s all he needs sometime to stage a rally.

Stay tuned.  A streak is on the line. 

Reader Q&A:

Dear Mr. Crooks,

Q: I’ve read all of your articles ...But, I can’t get my arms around your fundamental bullish view of the dollar.

Am I missing something?

There have been 2 real cases of DEFLATION in our lifetimes: 1) US Great Depression.  2) Japan 1990s.  In both instances they were CREDITOR nations.  No MASSIVE interest bill on debt (with declining income to pay).  They had reserves and surplus cash on hand which led to hoarding and deflation.  You can’t hoard (deflate) when you have no savings.

Gold and Silver: This comes down to the inflation/deflation argument.  I do not equate short term liquidation/deleveraging with deflation.  Debtors will always have to print money to pay debt and (sooner or later) increase interest rates and attract purchasers of their debt respectively.  If they don’t print money (inflationary), then they can’t pay the interest on their treasuries.  If the US defaults on its bonds, Gold will go to $3,000/oz+.  Since it is unlikely the US Treasury will default, it simply means they will keep issuing debt (treasuries) to pay the bills and raising interest rates to continue to attract capital (after the ‘flight to safety’ panic mitigates).  With a declining GDP, no matter how much they tax us, they will not raise enough cash to pay interest on the debt.  They will print more money to pay their creditors.  They is hugely inflationary.  In the short term, dollar strengthens only because as people liquidate assets they convert to dollars and treasuries for safety.

Second, as a fed chairman, if people will not spend, how do you get them to in order to stimulate the economy?  You devalue what they are hoarding.  It is very hard to hold onto something that is dropping in value weekly – as we are finding with housing.  Same will hold true for the dollar. 

The fact that the dollar has artificially strengthened dramatically and gold/silver have relatively held their ground (i.e. the dollar has gained more than gold/silver has dropped – percentage wise) means it’s a net move up for gold/silver.  For example:

If two months ago, $2.00 bought 1 British Pound and now $1.50 buys 1 British Pound, this means the dollar has gained 25%.

If GLD and SLV dropped from $85 to $75 and $12 to $10, they have dropped between 12-20%.  This means you gained a relative purchasing power of at least 5%.  i.e. The $75 you would gain today by selling one share of GLD will purchase more than the $85 of two months ago.

Here’s what is interesting.  In the last few days, the dollar has strengthened AND Gold and Silver have moved up.  This is doubly bullish for metals.

Could GLD and SLV go to $60 and $8 per share before increasing to $100+ and $15+ respectively?  Yes.  Do I think they will?  No.

Your comments are appreciated.  I am open to the possibility that I have a big blind spot in my argument…

A: Dear Mr. Reader...

First let me say that no doubt this is an extremely ugly and precarious situation facing the US.  We have no allusion about the danger here, or pretend the US is good shape.  But because our analysis is of the currency, and how to try to profit from it; the economic analysis that we do always has to be a “relative” game.  And we think, despite the problems, the US is relatively better off than its key competitors in the major and emerging currency sphere.  Ultimately the currency game is about trying to determine the underlying flow of global capital.  And in this environment, because of risk and because the US plays the role of reserve currency, it wins in this environment…a deflationary environment.

We don’t quite know why a creditor vs. debtor country matters in a global deflationary environment?  The amount of once “productive capital” in the world that stimulated demand for goods was a big driver in bidding up inflation.  The supply of real stuff lagged as China demand surged. This, coupled with massive dollar-based liquidity thanks to 1% interest rates at the Fed and ECB in 2002 and 0.25% from the BOJ, ensured “free” money and was the key driver of trillions in derivatives, i.e. dollar-based credit. 

We have a situation where this once seemingly “productive” capital, which was really malinvestment (in the Austrian School terminology), is being destroyed—that is deflationary as demand is sagging.  In addition, because this capital (granted—derivative credit) is disappearing around the globe, it reduces the supply of dollars in the system (one can see that by the improvement of the US current account deficit).  And yet the demand for these dollar-based credits is rising a la the emerging economies that have no domestic source of capital funding and were reliant primarily on international banks and foreign direct investment.  We think this great unwind could last years, not months.  If so, that should be a major deflationary event.

We have always looked at gold as another asset class, and do not attribute a great role to gold in a world driven primarily by credit.  We see it as the reflection of the world’s money—the US dollar.  If the dollar weakens, gold must maintain its purchasing power against a real international basket of goods ... as gold does play that role as maintaining its purchasing power against real stuff.  Gold has rallied in this cycle very tightly with the other asset classes that were dollar-based credit driven, i.e. a liquidity move.  So, if we are right on the dollar, we think gold enters a bear market.

As you astutely observe, the correlation between gold and the dollar isn’t always tight; it can decouple.  And gold may start to play the fear role; we are not sure and are very open to that possibility.  If it does finally start playing that role, it will likely go a lot higher.  But it was definitely not the place to be during this near financial Armageddon.  The gold bugs got everything they wanted and yet their strategy of buying gold and selling the dollar has backfired so far.  We think this proves the role the reserve currency plays at times like these, and suggest to us the gold market is a liquidity animal and not very important to the major players around the globe, i.e. those that have to hide big pools of capital. 

We think the dollar strength will surprise, not just because of this fear move. Here are just a couple of reasons. 

1) US is still more flexible in labor.
2) US is still more flexible in monetary and fiscal matters.
3) US will likely emerge from this faster, i.e. Europe is behind on the business cycle standpoint. (This is why the dollar usually does better than the other major currencies during recession -- 4 of the last 5 recessions the dollar has outperformed.)
4) European banking has massive exposure that has not yet “hit the fan” so to speak.  If the emerging markets breakdown in a big way, it could mean players begin to question the European Monetary System.  That would be very bad for the euro, the key dollar competitor.
5) US dollar world reserve currency status has not been challenged in this cycle; that is solidly intact.

We disagree this dollar move is “artificial” in any way.  It is driven by global macro factors and we think the ongoing sea change in the global economy marks the dollar bottom in this cycle. 

Now, all that said is our story.  If risk appetite returns and industrial production ticks higher and China grows rapidly again and emerging economies start exporting again, etc ... then our view will be proven wrong and liquidity returns and liquidity-driven asset classes go higher as dollar-based credit flows again. 

We know WE are missing something. There is much going on under the surface of the economy that we don’t see, i.e. our standard analysis can’t pickup.  So, we are always open to be very wrong no matter how confident we might be about the fundamentals.  Price is the final arbiter that will tell us we are wrong.  So, we watch and constantly ask ourselves that question as we do our homework: Where are we wrong? 

Thank you for your excellent question and hope our response makes some sense.

Regards,

Jack&JR

Key News
• S&P 500's Worst-Ever Year Leaves 64 Industries, 483 Companies With Losses (Bloomberg)
• Putin Sparks Parlor Game on Whether He'll Oust Medvedev, Retake Presidency (Bloomberg)
• Volcker Tells Baseball Owners He Foresees Extended Economic Slump in U.S. (Bloomberg)

Quotable
"The natural reaction to market breakdown is to add layers of protection and regulation. But trying to regulate a market entangled by complexity can lead to unintended consequences, compounding crisis rather than extinguishing them because safeguards add even more complexity, which in turn feeds more failure. Trying harder means sinking deeper into the quicksand.”

     Richard Bookstaber

FX Trading – Dollars Bulls Now Owe It to Tight Coupling

I received an email from a reader that contained an interesting fact:

Seven separate assets currently maintain an 85% correlation (or better) with the S&P 500 over the last six months.

Included in that group is Reuters/Jefferies CRB Index, emerging-market bond spreads, and not surprisingly, the euro. I’ve been consistently discussing the tight correlation between the currencies and stocks. The reason I’ve cited has been simple: as risk ebbs and flows, buying of US dollars ebbs and flows ... in an opposite direction.

So that means, as witnessed earlier in the week, when the S&P 500 tested new lows and bounced sharply, the US dollar did the opposite -- tested new highs and fell back sharply. Then on Thursday stocks collapsed again. They tumbled to new lows not seen since 2003, and dragged down the euro right alongside. Of course, the US dollar index broke out to a new high.

These tight correlations often are simply risk ebbing and flowing. But maybe we should look deeper to understand the true driving forces behind recent trends, and ultimately, why these correlations are more dollar-bullish than you might think.

Tight Coupling – Not Just a Two-Person Strategy to Prevent Hypothermia

I’ve talked about the market process plenty of times before. Specifically how it’s able to consistently, over time, produce extremely efficient interaction among human beings in the marketplace, in the business place and in life.

I try to make it sound simple. I try to boil it down to the big ideas. But really the entire process and all that goes into it is extremely complex.

I’m in the middle of a book by Richard Bookstaber titled Demon of Our Own Design. He’s devoted an entire chapter to an idea known as “tight coupling”. And that idea alone explains the correlations I spoke about earlier ... it explains why the financial system crumbled, why the global economy is sinking, and why the US dollar is back in vogue.

Tight coupling is the design and labor that goes into the construction of a house. Tight coupling is an expedition of rock climbers scaling a mountain-side. Tight coupling is an idea that helps to explain the detailed processes that go into complex, everyday functions; and why disruptions of these detailed processes often occur.

As we concern ourselves, tight coupling exists throughout the financial markets that we stress over nearly every single day. A good example would be the recent subprime mortgage backed securities fiasco. Before the entire credit system went boom, there were quite a few things strung together tightly that kept supported the trend of issuing subprime mortgages, bundling them up with other assets and selling them to investors.

But then home prices started falling. Then borrowers became unable to afford loans. Then bundled loans became less attractive. The market for this newly-created product froze up. Then losses started piling up for investors in these bundled assets. And then investors isolated from these assets began experiencing losses as the tightly coupled financial industry became unwound and asset values of good assets and bad began deteriorating together.

Propagate is a good word here – whereas it means to cause to spread out and affect a greater number –  and is used by Bookstaber on occasion to explain how the complexity added to the financial system by its participants can lead to accidents that in turn trigger a vicious downward spiral of asset prices.

And that’s all well and good. Even if you’ve not yet grasped the idea of tight coupling yet, you understand what’s happened with the subprime market by now and understand that relatively solid assets have been impacted once subprime derivative participants, and the market, were no longer able to handle the complexity of what they created.

Decoupling Loses Out to Tight Coupling

I’m trying to think back to when the consensus believed the global economy would be fine without the United States economy, should the US fall into a nasty recession or something. Maybe it was as recent as the middle or the end of 2007 that global bulls still clung to this hope that things had changed.

In hindsight we realize that’s all it was: hope No change, despite what was talked about. The global economy did not decouple from the US. Now many are suffering for running hastily in search of greener pastures without understanding what and where they were consuming ...

Emerging markets became the investment story. The growth potential was huge. And besides, everyone sought to get away from dreary US investments and put their money into more lucrative investments. Of course, more lucrative implies more risky.

But why not? The global economy was chugging along. The developed world was more than willing to buy China’s cheap stuff, and China was happy to produce it. China was demanding raw materials, and small resource-focused economies were thrilled to meet China’s appetite.

The diagram above is pretty clear: emerging market economies provide the stuff to make things, China makes the things to sell to the developed world, and the developed world supplies the global capital necessary to keep the circuit unbroken.

As it was, emerging economies invested more heavily into their export-centric model. China invested heavily into their export-centric, cheap labor model. This gravy train was paying off before a wrench got thrown into the mix.

United States Loses the Ability to Absorb Surpluses

As just mentioned, emerging markets (and China) invested primarily in their export-centric growth model. Can you blame them? But they neglected to invest in their domestic sectors. And instead, they took their left-over capital – the capital not already put towards building exports – and shoveled it into the US in exchange for safe investment returns.

The problem arose when the US could no longer find places to channel these trade surpluses that overseas economies were pumping into US capital markets. As mentioned earlier, all sorts of new derivative products were created ... all sorts of new investment avenues became accessible ... in hopes of allowing liquidity to flow efficiently. But of course, as is the case with tight coupling, the complexity of new initiatives (and even routine processes) opened the door for error.

Asset bubbles inflated and popped ... investors realized they had little understanding of new financial instruments ... consumers have watched their stock market and housing wealth evaporate ... spending across developed nations is retreating ... export-centric growth models are suffering as global liquidity vanishes ...

And this is a process that cannot be stopped effectively. Naturally the cycle will find its end. And unnaturally “officials of last-resort” will try to come in and stem the unraveling. But that just makes things more complex and increases the likelihood of unintended consequences.

It is for all these reasons that so many markets – dependent upon the continued flow of liquidity – have become so extremely correlated now that global capital flow has morphed. What this has done is create a trend primarily away from risk-taking and towards risk-aversion.

It is my feeling that risk-aversion is here to stay, as this cleansing cycle runs its course. And I’m of the opinion that US capital markets remain the deepest and most efficient in the world. The United States maintains the largest capacity to produce wealth. Risk-aversion will continue to steer capital back to the US. And this supports the beginnings of a long-term dollar bull market in the making.
 

Regards,

Jack&JR

Key News
• Oil prices fell below $53 to almost a two-year low . (AP)
• The yield on two-year US Treasury bonds hit a record low of 1.06 per cent, responding both to the fresh flight to safety and the prospect of lower interest rates. Eurozone government bond futures hit their highest level since March 2006. (FT)

• World stock markets tumbled Thursday, with benchmarks in Tokyo and Seoul losing almost 7 percent each. (AP)
• Five years after Federal Reserve Chairman Ben S. Bernanke helped stamp out the risk of deflation, the threat is returning as the financial crisis and a worsening economic slump pull inflation lower. (Bloomberg)
• The RBA said in a monthly bulletin today that it bought A$3.15 billion ($2 billion) of its own currency last month, the biggest net purchase on record, as the local dollar posted a record monthly decline.

• U.S. options trading slowed this month from a record pace after hedge funds collapsed and the biggest market swings since 1929 made equity derivatives too expensive to be used as insurance against stock losses. (Bloomberg)
Key Reports (WSJ):
8:30a.m. Initial Jobless Claims For Nov 18 Week: Expected: -11K. Previous: +32K.
10:00a.m. Oct Conference Board Leading Indicators: Expected: -0.6%. Previous: -0.3%
10:00a.m. Nov Philadelphia Fed Business Index: Expected: -38. Previous: -37.5.
10:00a.m. DJ-BTMU Business Barometer For Nov 8: Previous: -0.7%.

Quotable
“Early in life I had noticed that no event is ever correctly reported in a newspaper.”

  George Orwell

Best of CC: Below is a reprint of our 9 July 2008 Currency Currents where we examined the break down in the correlation between oil and the dollar—it was telling us something as we suspected.  It’s another example of why we pay close attention to intermarket correlations; it can be a very powerful tool for currency traders. 

FX Trading – $ vs. Crude…Hmmm! (9 July 2008 Issue)
Can we continue to hang our hat on the view that much of the bad news is already in the price of the dollar?  Well, based on the dismal views about the US economy, which we don’t dispute, which we seem to find everywhere we look, the short answer is yes.  But it’s not just that belief.  Something seems to have changed—though even this is a thin reed of reasoning we grant you.

Back in mid-April the US dollar index made its closing low (and its all-time low in mid-March, the day the Fed saved Bear Stearns).  At the time, crude oil was trading at $116 per barrel (heck, downright cheap in retrospect…LOL).  By now of course, everyone had caught on to the crude-$ connection that says the dollar goes lower when oil goes higher.  But, the problem with this new theory is that crude oil has rallied about $29 since mid-April, or a cool 25%!  However, the US $ index has rallied too—up 2%! 

Based on the crude-$ connection, that wasn’t supposed to happen. 

Chronology of key players’ recent trips to the Middle East (read Saudi Arabia):

• Vice President Dick Cheney – Mid-March
• President George Bush – Mid-May
• Treasury Secretary Hank Paulson – Late-May and Early-June

And on June 1, 2008 this from Reuters:

ABU DHABI (Reuters) - Treasury Secretary Henry Paulson said on Sunday leaders of Gulf oil producing states had told him that abandoning their currency pegs to the dollar will not solve their inflation problems.
Paulson, two-thirds of the way through a four-day trip to Saudi Arabia, Qatar and the United Arab Emirates, said leaders in the region have "quite an awareness that the peg does not influence inflation to a significant degree.
"They recognize that inflation is the overriding issue ... Ending the peg is not the solution to the inflation problem."

Hmmm…

Is it possible the Gulf States were treated to a litany of promises that the dollar was nearing a bottom and now is not the time to abandon said dollar pegs?  Again, we have no clue. But, it would be a nice fit with the ongoing lack of correlation between all-time highs in crude and the $ index cautiously trending higher.

Stranger things have happened.  Stay tuned. 

Regards,
Jack&JR

Key News
• Russia Spent $57.5 Billion Backing Ruble in September, October, Bank Says (Bloomberg)
• Ireland Planning `Huge' Bank Rescue Plan: Irish Independent Link
• S&P 500 Failure to Rebound From `Retest' Points to New Lows, Charts Show (Bloomberg)

Key Reports Due (WSJ):
8:30a.m. Sep Consumer Price Index: Expected: -0.6%. Previous: 0%.
8:30a.m. Sep CPI, Ex-Food&Energy: Expected: +0.2%. Previous: +0.1%.
8:30a.m. Sep Housing Starts: Expected: -2.7%. Previous: -6.3%.
10:35a.m. Nov 14 US Energy Dept Oil Inventories
11:00a.m. Nov 14 API Oil Industry Report
2:00p.m. Oct FOMC Minutes

Quotable
“The fact that an opinion has been widely held is no evidence whatever that it is not utterly absurd; indeed, in view of the silliness of the majority of mankind, a wide-spread belief is more likely to be foolish than sensible.”

     Bertrand Russel

FX Trading – Uninspired Moves in a Meandering Market 

Last week I touched on the potential end to the sideways US dollar correction. Then all of a sudden some unidentified reckless group came in to buy stocks and keep them from finishing at lows not seen since 2003. As I also mentioned, that effort gave traders enough reason to flood money into the euro and stop the buck’s breakout effort dead in its tracks.

But common to the market of the last couple weeks, no one’s really wanted to follow through on any of the bigger moves mixed in to relatively morose markets. The euro faded after its big day last Thursday – perhaps because there wasn’t much substance behind the move.

Then yesterday, an abysmal report on the US housing market by the National Association of Home Builders gave reason to expect that crisis will last still longer. The US dollar, seemingly perversely on negative US data, woke up and went into rally mode. Of course we know it was because stocks got knocked back down for a retest of recent lows. But that didn’t last either.

Now, overnight, minutes came out on the Bank of England’s most recent monetary policy meeting. Recall that they surprised the market and lopped off 150 basis points from their benchmark lending rate. Turns out, they talked about going a full 200 basis points. That means further rate cuts are surely in the pipeline for the BOE. And that should mean the British pound suffers versus the buck as the BOE converges on Federal Reserve interest rate levels.

But I guess nobody told the British pound the news. It’s now finding a way to rally sharply against the dollar. Of course, when I say sharply I don’t mean the several hundred-PIP moves we’ve become accustomed to on a daily basis. The currencies seem to have calmed down from that recent phase. The British pound is, however, currently leading the pack and holding on to roughly 100 PIPs of upside this morning.

If the British pound finds a way to break above current levels, it could carry that move quite a ways.

And the pound isn’t the only currency with pent-up momentum. The euro is showing a narrowing sideways pattern (similar to the US dollar chart I showed you last week) that could lead to a big breakout move.

Of course we’re going to need some conviction if these currencies go anywhere from here. At a time where the data continues to be poor from all corners of the globe, maybe technical levels become even more crucial than the fundamental morsels that typically excite this market.

Still ... it’ll probably make sense to keep an eye on stocks after economic data comes out in the US this morning!

Regards,

Jack & JR

Key News
• The Japanese economy entered its first recession in seven years, as growth declined for the second quarter running by a wider margin than expected, raising fears the situation could deteriorate amid the global downturn. (FT)
• Mining companies -- which couldn't dig minerals out of the earth fast enough just a few months ago -- now are struggling to climb out of a very deep hole. On Friday, the world's biggest miner, BHP Billiton, said major Chinese customers are trying to delay purchases of iron ore as China's building boom slows sharply. (WSJ)
• Australian retail sales rose in the third quarter by less than economists forecast. (Bloomberg)
• Key Reports (WSJ):
8:30a.m. Nov NY Fed Manufacturing Index: Expected: -27. Previous: -24.6.
9:15a.m. Sep Industrial Production: Expected: +0.4%. Previous: -2.8%.
9:15a.m. Sep Capacity Utilization: Expected: 76.7. Previous: 76.4.

Quotable
“It is fascinating to watch politicians come up with ‘solutions’ to problems that are a direct result of their previous solutions. In many cases, the most efficient thing to do would be to repeal their previous solutions and stop being so gung-ho for creating new solutions in the future.  But, politically, that is the last thing they will do.”
   
Thomas Sowell

FX Trading – G-20: No new structures—maybe a reality bite!

No major new global frameworks were hashed out by the G-20.  Dollar is giving back some gains from that late blow-off move very late in the day on Friday.  The pound is staging a nice-sized bounce. 

Crude oil, the global growth thermometer, continues to move lower and lower.  We would have expected a bounce in crude if the market expected anything said by the G-20 would help.  There seems a sinking realization that global recession will continue to get worse before better.  And maybe the simple goal of G-20 at this stage is to avert global depression, instead of the run of the mill recession, now that there is growing panic about Chinese growth.  Or maybe too soon to say panic, but growing concern China isn’t going to be the market white knight riding to the rescue with its FX reserves. 

And if you consider the haircut oil producers have taken on the price of their product, not to mention their Sovereign Wealth Fund equity investments, one wonders where all their extra funds will flow from, those that are supposed to be lumped together with China’s to save the world economy. 

Maybe those oil traders rumored to be buying $30 put options know something.  Next chart support, on a weekly basis, comes in at $49.90.

Maybe the G-20 got a wakeup call this weekend.  There are no white knights left out there.  And now is no time to rejigger the global financial system to create a one-off quick fix and return of risk taking.  Maybe it’s time to get out of the way and let the market decide who swims upstream and who doesn’t.

With news of Ecuador may default, with the fall in oil prices playing a big part, we think Mr. Market may start to really kick it into gear in the emerging world.  Emerging market contagion takes a direct route into the European banking system.  This might keep Mr. Sarkozy busy instead of allowing him time to dream up new global financial structures with more government control over everything related to money—a dream near and dear to hearts of progressives everywhere. 

Regards,
Jack&JR

Key News
• Europe Falls Into First Recession in 15 Years as Financial Crisis Deepens (Bloomberg)
• G-20 Leaders May Agree on Stimulus, Little Else as Bush Prepares His Exit (Bloomberg)

Key Reports Due (WSJ):
8:30a.m. Oct Import Prices: Expected: -4.0%. Previous: -3.0%.
8:30a.m. Oct Retail Sales: Expected: -2.4%. Previous: -1.2%.
8:30a.m. Oct Retail Sales, Ex-Autos: Expected: -1.6%. Previous: -0.6%.
10:00a.m. Sep Business Inventories: Expected: -0.1%. Previous: +0.3%.
10:00a.m. Mid-Nov Reut/U Mich Sentiment Index: Expected: 55. Previous: 57.5.
10:35a.m. Nov 7 Natural Gas Inventories (in billion cubic feet)

Quotable
“Progress is precisely that which rules and regulation did not foresee.”

  Ludwig von Mises

FX Trading – Our Euro Comments: A Nasty Head-Fake 

On Tuesday, in Currency Currents, I got into some Elliot Wave Principle in order to discuss why the US dollar correction might have been over, opening the door for sharp appreciation.

Until yesterday afternoon my forecast was right on the money. The US dollar had rallied and even touched a new intra-day high – 88.14 on the US dollar index – a point where the buck hasn’t traded in more than two and a half years.

Then we watched the euro, which had held up rather well this week compared to the rest of the majors, surge and reverse its losses from earlier in the week. The move was sharp and relatively large. And it led the majors in what was very much a widespread rally against the buck.

When I say nasty head-fake, I’m talking about the chart I showed you on Tuesday with the US dollar index making its way out of a contracting triangle correction pattern. Sure enough yesterday’s move brought the dollar right back.

 

Tuesday’s Chart in Currency Currents Updated to Show the Week’s Price Action

We had some calls and emails right off the bat asking “What the heck is going on with the euro?”

We didn’t have much of an answer except to say we’d been watching a major reversal among US stock indices play out. After the S&P 500 a new intra-day low and the Dow nearly did the same, some curiously strong buying interest arose and sent stocks higher. And with the tight inverse correlation between the US dollar and stocks, it followed that the euro would find buyers.

 

A Dramatic Inverse Correlation Between the US Dollar and Stocks

As the session came to a close yesterday it became clear that the rally against the dollar wasn’t anything to be taken lightly. It was out of the ordinary and could prove to mark an interim bottom for currencies in a similar position to the euro.

With that said, however, it’d be refreshing to see a follow-through move take the euro up through a key level. I’m talking about some short-term trendline resistance standing in its way.

Until that happens we’ll honor the potential for a major US dollar correction. Yesterday’s rally faded overnight, but there’s no doubt the momentum could resume rather quickly. But as of right now we can’t guarantee yesterday’s move was anything more than fast-paced backing and filling.

So what’s it going to be? Can the stock market wiggle together two consecutive days of gains? Can the euro fight-off the fundamentals (and technicals) that are calling for it to go lower? It’s Friday – so we’ll probably see a big-time move ... or nothing much at all.

Have a nice weekend!

Regards,

Jack&JR