EUR/USD Weekly Outlook - - 8/3 thru 8/8 2008

For the most part you can basically forget about all the events that have occurred in the market the past two weeks because this week the circus comes to town...

Arriving in the clown car is the FOMC with their interest rate decision and monetary policy statement while in the circus sideshow tent we have ringleader Mademoiselle Trichet running the ECB’s interest rate decision followed with a bonus freak show that’s not recommended for children, pregnant women, and those with heart conditions.

This I do know – neither central bank is going to move on rates this week. This I do not know – how hawkish or how dovish the Fed and ECB intend to come across to the markets. Inflation in Europe is running over 200bps higher than the ECB’s target inflation rate. In June the Fed started talking tough on inflation as they finally realized they can no longer lie to the markets about the U.S. inflation issue.

Political pressure forced the Fed to step up their hawkish rhetoric on inflation. In Europe the ECB is facing political pressure to tone their hawkish rhetoric on rates and to soothe the Eurozone with signs and signals of rate cuts to divert the coming economic recession and sharp downturn in growth.

Both banks have painted themselves into a corner and both have few options. The Fed has exhausted it’s arsenal of dovish monetary policy. The ECB’s hands are tied behind their backs now and can no longer raise rates. Bernanke has been abundantly clear about one thing: his first objective is to bring about the smooth functioning of financial markets. Trichet has also been clear on his first mandate: ensuring price stability in the Eurozone.

We’re coming to a crossroads where the Fed and ECB are going to have to change their top priorities. While the ECB was focused on inflation, they will now have to focus on growth, their financial markets, employment, and overall economic stability. As the financial markets do find stability, Bernanke will have to shift his focus on a future cycle of rate hikes to not only cool inflation but to bring down commodities and boost the value of the USD.

Are we there yet? No, not exactly. It’s only August and it’s a bit early for this shift to begin to physically take place, but the time is drawing very near. That being said, we’ve already seen the underlying fundamentals of the market begin to shift in the second half of this year, just as we forecasted they would back in January.

Now one of the main reasons the markets have been behaving wildly the past few weeks is mostly due to the complete lack of liquidity and heightened uncertainties. But, the other issue is simply due to the fact that the markets have not heard much from the Fed and ECB the past 30-days.

The markets are like children. When children are neglected and have no authority figures to keep order in their lives, they are left up to their own devices and the results are often not pretty. This is exactly how it works in our market. The central bankers have neglected the markets and the markets have been left up to their whims and I believe this has a lot to do with the craziness we’ve seen in currencies, commodities, and equities the past few weeks.

The markets need guidance from the central banks… they need to hear the rhetoric, they need to look for the signs and clues about future monetary policy… when this is lacking, the markets run wild… but, this should change as we get to hear from both the Fed and ECB this week, with each bank speaking on the number one key driver of the currency market: interest rates and interest rate policy.

EUR/USD:

The euro’s had the crap kicked out of it after making its last all-time high at 1.6038. In my view I see the risk is clearly on the euro this week. Not only do we get a ton of Eurozone data, which could easily print unexpectedly to the downside, we have the unpredictable factor of Trichet and what he may tell the markets on Thursday.

That being said, the dollar has seen some decent gains the past few weeks but if the FOMC fails to hit the markets with a hawkish stance on inflation, any dollar gains will likely be capped. The Fed is still printing money for the financial markets which tells me credit conditions are tight and not getting any better.

Unemployment is at a 4-year high and we’ve had seven straight months of job losses in the economy. Housing has not bottomed and there’s no real bottom in sight as far as I can see. The equities market is a mess. So, how hawkish can the Fed possibly be when any significant amount of light has yet to be seen at the end of the tunnel?

Another point to consider is this: since the FOMC meeting we’ve seen crude come down from a high at the $148 level to the mid to low $120’s. Gold has dropped significantly. The price of gas at the pump has dropped dramatically in many regions in the U.S. Here in Nashville at my local gas station the price for a gallon of gas has dropped 36 cents in the past two weeks.

So, in my view it’s quite possible the FOMC looks at some of those bright spots with commodities which will diminish their need to manipulate the markets with strong hawkish rhetoric on inflation and keep singing the same tune about ensuring the orderly functioning of financial markets.

My opinion is that the euro bleeding should come to an end at least until we hear what the Fed and ECB have to say. The 1.5500 level has held strong in the face of some serious profit-taking, euro selling, and abysmal fundamental data out of Europe.

Should the euro sell-offs continue, there are a few overall downside levels I’m looking at according to my own numbers:

1.5504
1.5482
1.5464
1.5442
1.5418

The euro will likely continue to struggle to make any significant upside gains. As soon as we hit 1.5700 last week that price level was resoundingly rejected. In order to gain any traction and momentum to climb out of these low levels the market correlated variables will need to work hand-in-hand to give the euro a boost. This is imperative.

Bear in mind the market is not even open yet, but I do have a few key upside levels you will want to be mindful of as we get started this week:

1.5588
1.5614
1.5632
1.5658
1.5684

I’m expecting liquidity to remain terribly low at least until Tuesday’s FOMC events. But keep in mind we have a ton of mega fundamental data on the books all week long in addition to the monetary policy events.

As far as trading goes, I’m not about to make any big moves at this point. I have euro longs that are sitting in drawdown but I’m not overly concerned right now because there’s really no fundamental reason for another extended move down. I believe we do need to see some upside retracement, so I’ll be holding open all longs until market conditions and price action patterns dictate otherwise.

Any move up we do get you can be sure I will take fresh shorts. As I’ve said many times, I will keep shorting every rise we get… I’ll short it all the way to 1.6400 if I have to, I don’t care. I’m shorting everything I can get my hands on.

This could be quite a monumental week because the fundamentals and central bank monetary policy steps to the forefront. The fact that we’re still in the summer session diminishes the probability we break out of this range between 1.5900 and 1.5400, at least that’s my opinion. But once we get back to normal in September, it’s game on…

You know the drill – be smart with your trades, be smart with your open entries, and be a strict risk and money manager this week. Be smart about your entries and be wise with your entry sizes. This means taking 0.5% used margin entries and not allowing your usable margin to get below the 90% level at the most.

If you’re new here or you’re a tech trader, this week will offer you many lessons on what really moves this market and why this market moves… the underlying fundamentals, moves within the market correlated variables, and most of all, all things interest rate related.