EUR/USD Weekly Outlook 10/12 thur 10/17 2008

Once again we start the week with more questions than answers, more unknowns, more speculation, and more save-the-world rhetoric from the world’s top central bankers, finance ministers and politicians.

One thing I will not do in today’s update is regale you with numbers, facts, and figures. There’s an art and science to analyzing and trading markets. As I’ve said in the past, I am not the “science” of the market, I’m more the “art” of the market. If you want the “science” part (facts, figures, and technical views) I suggest you read John Mauldin’s latest commentaries. Mauldin is the only market analyst I trust these days and the only market participant I will endorse.

Overall, here’s what the markets will be dealing with this week… reaction to the G7, reaction to rhetoric and moves made by the central banks, reactions to moves made on the global equities and commodities market, and yes, we will see a return of the fundamentals this week. The fundamentals have largely taken a back to the other issues market participants have been responding to but this week we have key inflation, growth, retail, consumer, and foreign investment data. I am certain the fundamentals will play a bigger role this week as compared to weeks past.

G7:

Over the weekend central bankers and finance ministers were led by the IMF in a series of meetings designed to give the global markets a decisive plan to not only calm all world markets but also to instill confidence in the banking system, to unfreeze the credit markets and to stabilize the rapidly declining asset values of investors.

I’m thrilled to report the G7 accomplished none of this. The G7 communiqué is a joke. In the midst of the worst financial crisis since the Great Depression of the 1930s the best the G7 could come up with is a plan filled with more empty rhetoric. There is no exact and definitive plan of attack given in the communiqué. There is no step-by-step course of action. I wouldn’t even line the bottom of a birdcage with that piece of trash.

Reading the communiqué made me dumber, I think. At the risk of making you dumber, I’m going to cut and paste a few gems from the communiqué just so you can get an understanding of how this G7 plan offers absolutely nothing to the global markets:

Take decisive action and use all available tools to support systemically important financial institutions and prevent their failure.

Take all necessary steps to unfreeze credit and money markets and ensure that banks and other financial institutions have broad access to liquidity and funding.

Ensure that our banks and other major financial intermediaries, as needed, can raise capital from public as well as private sources, in sufficient amounts to re-establish confidence and permit them to continue lending to households and businesses.

Ensure that our respective national deposit insurance and guarantee programs are robust and consistent so that our retail depositors will continue to have confidence in the safety of their deposits.

Take action, where appropriate, to restart the secondary markets for mortgages and other securitized assets. Accurate valuation and transparent disclosure of assets and consistent implementation of high quality accounting standards are necessary.

That’s it… those five points right there is how the G7 intends to fix the markets. In there we read rhetoric that says “take action” and “take steps” and “programs”. Gee that’s great but what are these programs and what are these actions? When do they begin? What will they cost? What segment of the market will be tackled first? Will the US get the G7’s help first or will Europe? Why are the Asian market participants so quiet?

Those were just a few questions I thought of within the first 30-seconds of reading that garbage. The central banks of the world are playing a game with the markets and I do not believe this game will work. These central banks are using monetary action and monetary policy as a form of psychotherapy on the markets.

But what these brilliant men do not understand is that the markets are using psychotherapy on the central banks. It’s what you call getting the tables turned on you. All participants involved know it’s nothing but a lose-lose situation… during this painful and violent re-pricing and re-valuing process the majority loses and a small minority of smart players come out unharmed.

The central bankers think they are in control but they are not. The markets have the central bankers by the throat and they won’t let go until they’re ready. The markets wanted lower rates and they got lower rates. Of course this didn’t fix anything, but hey, at least money is cheaper now. The central bankers of the world are getting played by the numbers they see on Bloomberg and read in the Financial Times. They are being pressured by the publically-traded and privately-owned banks they have undisclosed relationships with.

Bernanke, Trichet, and Paulson are behaving like children in their responses to this financial crisis. These are grown adult men who are clearly powerless to stop the runaway freight train of the re-pricing process. When I read between the lines of this communiqué I read nothing but disagreements and uncertainty between the world’s financial leaders.

I shouldn’t even call these men leaders because they are followers. They are leading nothing and I think it’s painfully obvious these men do not even believe the G7 plan will work or that any plan will work. Central bank monetary policy is the catalyst for financial booms and busts. Surely these educated men of economics understand these events happen at their hand.

I’ve watched a few clips of the central bankers and finance ministers at the G7 meeting. I was observing how they were interacting with each other. After studying the G7 communiqué, watching images from their meetings, and then reading their comments it struck me that these men have no common plan of attack and it would likely take weeks or months for this group to get on the same page for how to solve the issues faced by the global markets.

I grew up in the Southern Baptist church. That won’t mean much to our friends here from other countries, but when I was growing up we had a lot of preachers talking about the New World Order – a one-world government, the rise of the anti-Christ, war with Russia… all kinds of doom and gloom they could conjure up out of the book of Revelation.

I’ve sat through a few old timey Southern Baptist tent meetings hearing how the governments of the world would band together to form a single government entity with the goal of controlling all peoples of the world so the anti-Christ could rule. Now I’m not saying that won’t happen but the point is, after what I observed with this G7 meeting in regards to the utter lack of agreement, I can’t imagine how the governments of the world are going to be able to unify in a way to solve the issues facing the financial markets let alone create a one-world government.

My opinion – the G7 accomplishes only one thing – adding more confusion and volatility in the markets.

Fundamentals:

Unlike the past few weeks, some of the fundamental data we get this week will weigh on the market in my opinion. Of course all speeches by Trichet, Bernanke, and officials from the Fed and ECB can and will move the market this week. But in addition to that we get extremely key inflation data out of Europe and the US. CPI and PPI are critical right now.

If Eurozone CPI prints at or below expected you can be sure this will put downside pressure on the euro because it will cause the markets to believe the ECB has room to cut rates even lower. Trichet has clearly backed away from his over-the-top hawkishness on inflation. The same may also be true for the US if Core CPI comes in cooler than expected. Many believe Bernanke is willing to take rates down to 1%.

Retail Sales is another key piece of data we get this week. I am forecasting a USD- print on this data. My preliminary research shows a very sharp pullback from the consumer in the month of September. The US consumer is basically non-existent at the moment and will likely remain as such throughout the rest of 2008.

We also get the Treasury International data this week. TIC data is two months behind but last month’s print showed a dramatic pullback in foreign investment. My forecast is for more USD- TIC data. The print may come in as expected. Reason being is because we have seen heavy money-flows into Treasuries the past two months and this may help the print but overall it’s still going to be very bad for the US deficit.

In addition we also get manufacturing, production, and consumer sentiment data. I have to remain extremely bearish on both the US and European economies and I believe their fundamentals reflect the weakness these nations are suffering from. Many regions in Europe are a flat out mess. I don’t know any other way to put it.

EUR/USD:

As of the writing of this update the euro was at 1.3518 during weekend trading but it may open lower than that. I am certainly not ruling out another test of the 1.3320 to 1.3280 level sometime this week. I am still very bearish on the euro and will use more caution buying the dips. That being said I’m not at all bullish on the dollar either.

In my opinion the EUR/USD will remain correlated with equities this week in addition to more of a correlation with commodities. Some of those key fundamentals will come back into play this week. LIBOR will also be a factor in this week’s trading. If dollar LIBOR rates manage to come down this may take some pressure off of the euro.

Crude is a disaster. Crude closed down 17% last week and while I do not believe we’ll see another massive loss like that, I do think crude can go lower which would put more downside pressure on the euro. If crude goes much lower I expect OPEC to start stepping up the rhetoric. A break of the $70 level on crude could cause an emergency OPEC meeting and a large supply cut. There’s only so much of a hit OPEC is willing to take before they decide to manipulate the crude market.

Rate cuts will continue to be speculated on this week. Over the weekend ECB Almunia basically said there’s more room to cut rates. He says:

“Supported by the easing of commodity prices, the presently high inflation is on a downward trend and long-term inflation expectations are stabilizing at a lower level consistent with price stability, if confirmed, these new developments could justify some monetary easing in the near-term”.

That is a very cut-n-dry statement right there. There is also speculation that the Fed will cut rates again on October 29th. I think rate cuts are possible for both banks if the financial crisis drags on because rate cuts are what these bankers think will help solve the problems.

The rate cuts will supply the markets with cheap money. The central banks want market participants to start buying equities with cheap money. This isn’t happening. So, what the central banks do next is cut rates lower and then they print more money in addition to keeping loose monetary policy. There’s all this cheap money and quite an abundance of it in the monetary base. This is inflation.

The cheap money, the abundance of money, and the inflation are the exact three things needed to re-inflate equities. Equities thrive when there’s tons of cheap money and high prices (inflation). The central bankers answer is to pump up the equities markets therefore restoring confidence to investors and all market players.

As far as trading goes, expect more chaos, more volatility, more price swings, more choppy and confusing price action and no real slowdown in the crisis-conditions. The markets will remain extremely ill-liquid this week. These are purely speculative markets. The risks of trading this market are astronomical. Whatever you decide to risk in the market this week you should be prepared to lose because violent price swings could happen at any moment.

Don’t forget US banks are closed on Monday which means the liquidity will be almost nothing and that can give certain market players who might be slightly more liquid than the rest the ability to move the market whichever direction they desire. I’m just bearish, bearish on anything and everything. I think I could make money shorting anything right now. The worst has not been seen in my opinion.

After the market is open for a few hours I hope to see some signs of direction and to get a better idea of how the market may want to respond after London opens. The Frankfurt and London openings will be key. The euro typically benefits from G7 meetings, so I will be looking for signs of possible euro strength.

Be smart with your trades and do not take any unnecessary risks. We could see some very violent moves this week that you do not want to be caught on the wrong side of. Risk and money management is imperative under these extreme conditions.