Trade Team Update

Overall we had a rather choppy day in the market... during early Frankfurt session I took some euro shorts, but that was about it as far as trading went.

The euro didn't like being below the 1.5600 level and has creeped back up to the 1.5660 level. It seems for now we may be temporarily stuck in about a 120 pip range and we could see this persist through most of today's Asian session.

German CPI came in below market expectations and this is something to note... I'll talk more about that in my commentary below...

Tomorrow we get the S&P/Case-Shiller Home Price Index which should be pretty crappy, I don't see much relief or bottom to falling house prices. Consumer Confidence should print USD- as well. The consumer has continued to pullback and I've not found any credible evidence to prove otherwise.

I can't really be bullish on either currency at this point. As you'll read below, I make my case for why the euro can depreciate. Fundamentally, the dollar is still worthless and there's no complete signs of a full recovery.

There are two events this week that will give my trading more clarity -- FOMC and NFP. Until then, I'll play it tight and smart and minimize my risk exposure. I cannot stress risk management enough. Don't force trades... don't trade for the sake of being in a trade. Follow your gameplan and trade rules and be smart about how you trade the next 4 days...

EUR/USD, Fed, and ECB:

The farther we get away from 1.6018, I see the probabilities decreasing that we go back and break that level. As we’re correcting the past few days I see the rhetoric coming from Trichet and the ECB changing and shifting in a way that is more EUR-. I’m also seeing some of the Eurozone data showing patterns of weakness.

The ECB is no longer talking the euro back up like they used just a few weeks ago. They are not talking hawkish about inflation and are now saying that rates will not need to go up to fight price instability. I take all this as a signal we may see a shift in monetary policy soon.

Based on patterns I’ve observed with Fed and ECB central bankers, it’s rarer to see central bank rhetoric and fundamental data totally contradict each other. While it’s true central bankers will either lie, sugarcoat, or gloss over certain fundamentals, in the end, monetary policy will almost always fall in line with rhetoric and with the data. Central bankers might be liars and thieves, but they still have some pride and will try to avoid looking like idiots as much as possible which is just normal human behavior.

When it comes to any statements made by the Fed and ECB I’m always reading between the lines. I need to cut through the crap and focus on the “signals” that the Fed and ECB give the markets. Dumb money will usually miss those signals. The Fed and ECB do not give signals to dumb money, they give signals to smart money because smart money will take those signals to respond the way the central bankers want the market to evolve. The Fed and ECB know the banks are at their bidding and vice versa. It’s a very profitable relationship for both parties.

If the ECB has had enough of the strong EUR, they will first signal this through rhetoric and commentary, which I believe they started doing about two weeks ago (which is why I was shorting above the 1.5850 level). Next, the action will come directly through monetary policy, specifically interest rate policy.

The Fed’s monetary policy over the past year is a prime example of how this process works. When the Fed disregarded the need for a strong dollar and shifted their focus on growth, credit, and housing, their tones on inflation first shifted through their rhetoric and then it physically shifted through their monetary policy over the past 8-months.

Could the Fed admit we have inflation yet go into a rate cut cycle? Of course not, it would be 100% contradictory to their rhetoric, their signals, and their focus. In this market often times perception is reality. You cannot have $120 oil and not have inflation. You can’t have off-the-charts PPI in China and not have inflation in the U.S. You can’t have soft commodities flying through the roof and not have inflation. As you know, Fed inflation data says there’s no price instability, which falls directly in-line with Fed rate policy as the focus is not on inflation but on credit and growth.

In the coming weeks and months it’s my opinion that we will see the Fed shift rhetoric to focus on inflation. It will take the economy about another 6-month’s before the effects of the rate cuts are felt in the broader economic system. Once those cuts finally cycle through the economy and the economic stimulus checks start boosting the consumer sector, I think we’ll see a more concerted effort by the Fed to change the tune they’ve had since last March.

These are just my opinions of how I see things in this market and how it makes sense to me… so, take all this for what it’s worth.

Anyway, fundamental data patterns and central bank patterns will often correlate closely. When the ECB was over-the-top hawkish on inflation, and rightfully so, they were in a rate hike cycle. Now we see Trichet backing away from those hawkish tones and the ECB is saying inflation will subside in the coming months. It’s true, if the USD finally bottoms out, finds support, and finds a way to rebound, it will actually fight back global inflation because commodities should weaken, which would be a very positive inflation fighter, especially against energy-induced inflation.

I believe Trichet is giving the markets signals of a coming rate cut later this year. I firmly believe we will see an ECB cut in the second half of this year, before the end of the year. Just this morning we saw German CPI come in below expectations… are we in the beginning stages of a EUR- data trend in the price stability department? Could be…

And then there’s the Fed. The FOMC will deliver their rate decision in less than two days. Will we get a cut? Yes, I believe we do. It’s almost a foregone conclusion that we’ll get a cut. The size of the cut is something I cannot try to predict, but the verdict will largely dictate the market’s reaction.

The accompanying statement from the FOMC will be absolutely critical. The market is looking for “signals” that Bernanke has either reached the end of the rate cut cycle or is just one more FOMC away from reaching the end.

The patterns in the interest rate cycles between the Fed and ECB allow me to believe the two central banks play a game of see-saw. Can the USD and EUR both be heavyweight champs? No, there is only one heavyweight champ. I’m not saying the dollar is about to rise from the ashes and totally resurrect itself, but if the Fed and ECB are truly playing a game of see-saw, we may be getting close to a period of dollar recovery against the euro.

If the ECB is orchestrating a period of EUR weakness and possibly more than one rate cut, the patterns within the Eurozone data will show weakness in these sectors:

CPI & PPI
GDP
Industrial and Manufacturing Production
ZEW & IFO
Retail Sales & Consumer Confidence

I don’t have a crystal ball that tells me the future of the market. The best thing I can get to a crystal ball is for me to dissect every little comment and speech by the Fed and ECB. They tell the markets what they want the markets to do and the smart money reacts accordingly.

The Fed’s monetary policy since at least October of 2006 told the markets it was OK to sell-off dollars and the ECB’s monetary policy told the markets it was OK to buy up euros. I don’t see that those same signals are there anymore.

Just some food for thought… and again, these are just my opinions and how I see things in the market. You have to come to your own conclusions and trade accordingly. But this is why I’ve stopped taking euro longs and have been shorting the rises for the past few weeks. I prefer to stay ahead of the game and ahead of the curve and not get on the wrong side of the market.

Ultimately, the market will decide. It always does. I'm not ready to declare myself a EUR bear, but I'm certainly not going crazy with adding new euro longs up here at these levels.