EUR/USD Weekly Outlook 10/19 thru 10/24 2008

Guess what? This weekend I did something I almost never do. I was stuck at home with a bad cold and as I was going stir crazy I decided to do some research to see how other analysts, gurus, and traders are viewing the markets presently. I was mostly interested on their views for this week. Fundamentally there’s just not much on the books. The only big fundamentals out of Europe this week are manufacturing and those should be terrible. The only big events out of the US this week are a speech by Bernanke, Existing Home Sales, and Initial Claims.

The vibe I’m getting from the analysts is that this week will be orderly, the credit markets will flow nicely, and these issues we’ve been dealing with for the past few weeks will miraculously disappear. I’m going to take the contrarian view as I approach this week’s trading with an understanding the risks will be enormous and the volatility will be chaotic at times.

The fundamentals will absolutely come into play this week but not the “textbook” definition of fundamentals. First, Wall St. will get earnings reports this week from major US corporations like Caterpillar, Google, Intel, 3M, Microsoft, Boeing, McDonalds, and Amazon just to name a few. Why does any of that matter to EUR/USD traders? Reason being is because Wall St. money-flows are a major determining factor in the daily trends of the EUR/USD and I do not see this correlation going away this week.

If poor earnings or shocks on Wall St. lead equities lower and Treasuries higher the dollar will be the likely beneficiary of this move and the euro will be punished. That has been the clear correlation and I see no reason why this correlation evaporates this week. This week I will be watching the S&P 500 more closely to give me direction indication for the euro.

The reason I’ll be focusing more on the S&P 500 is because of the issue we still have within the credit markets. As a value weighted index, the S&P 500 has more connection to the credit market and to credit flows as compared to the Dow. While the Dow is a great overall indicator, right now I’m seeing more of an important correlation with the S&P 500. The thing you have to remember about correlations is that they should not be considered as constants. Real-time market conditions dictate the relative overall strength or weakness of a market correlated variable’s pull on the EUR/USD.

Interest rates will absolutely factor into this week’s trading. Towards the end of last week we finally saw overnight dollar LIBOR rates ease. While this didn’t send the euro rocketing back up I believe the easing of dollar LIBOR rates helped keep the euro from sustaining a break of the 1.3400 level as we closed out the week. While it’s encouraging to see LIBOR cooperating with the EUR/USD, I do not think we’ve been given a guarantee the credit markets have to operate in an orderly fashion this week just because they did last Thursday and Friday.

Its true Wall St. made a nice comeback at the end of the week which brought more talk of a bottom in equities. I do not subscribe to this kind of thinking. The fundamentals of the US economy will keep deteriorating. Our forecast on this has been clear and has been proven to be a reality. I do not see how it’s possible for equities to truly bottom when some of the worst is yet to come, especially in housing. I find it hard to believe market participants cured themselves of their panic, knee-jerk behaviors.

How this all ties into trading is quite clear in my view… should Wall St. find stability this week and equities make consistent gains I believe this will take downside pressure off the euro and will give the euro a fighting chance. But the same must hold true for interest rates. If we have a bank failure situation in Europe or more troubles on Wall St. this could send dollar LIBOR rates back up which would benefit the dollar against the euro.

Consumers and Global Economies:

For the past month I’ve been focusing a lot of commentary on the US consumer because I believe the consumer sector is a fundamental area putting an extreme amount of downside pressure on the economy and on growth. I stand by the forecast that the consumer will bring the economy to its knees during Q4 and Q1 of 2009.

Over the weekend I asked a friend who is very observant and detail-oriented to do some field research for me. I asked her to go to the top two upscale, high-end malls in Nashville and then to hit the two lowest-end malls. The task was to observe traffic, get an idea of how many bags were in shopper’s hands, what stores they were from, and which mall was “performing” the best.

Green Hills Mall, the most upscale in Nashville had the least amount of shopper traffic, the highest amount of “window shoppers” and the lowest amount of purchases per shopper as compared to the other three malls. The lowest-end mall had the most traffic and the most purchases per shopper. When classifying a mall as “low-end” I’m specifically referring to retailers who offer products that are priced for middle-class and poorer consumers… it’s like the difference of spending $58 for a shirt at Abercrombie compared to $14.99 at Old Navy.

Nashville serves as a great consumer indicator because our region has been largely unaffected by the recession. Nashville is the financial center of the South and is a major player in the healthcare and entertainment industries. When I see a mostly recession-proof economy like that of Nashville getting hit I can only come to the conclusion that areas of the country nailed by foreclosures, plunging home prices, job losses, and recession are suffering terribly.

In the US we have these things called food stamps. Food stamps are subsidized by the government and are available to individuals and families that are below a certain poverty level. According to government statistics, the number of individuals receiving food stamps has jumped by over 2 million between May and October of this year. Those are staggering numbers and further prove the state of the US consumer is abysmal and families are in serious financial jeopardy.

In any welfare state you will have a certain segment milking the system, this is what lazy and dishonest people do but I believe a good number of those 2 million new individuals receiving government subsidized food assistance did so out of dire necessity. The US consumer can no longer use their home as an ATM machine, the credit cards are maxed out, the easy access to lines of credit are all gone, and the entire mindset of the average US consumer will have to change, it simply cannot be any other way.

Under normal circumstances this situation with the US consumer would absolutely hammer the dollar into the ground. While I do believe at some point the dollar will have to pay for the dramatic decline of the consumer, the affects of this intense consumer/retail slowdown will be felt by the global economies as a whole. Under normal circumstances the euro would obviously benefit from a weaker dollar caused by a weaker consumer but the fundamental situation in Europe does not necessarily make this a possibility.

The US consumer will lead economies in Asia, South America, Latin America, and the Middle East to even lower points. I have not heard much talk at all about the stronger dollar’s negative affect on US exports, on the Trade Balance, and on big players like Caterpillar, John Deere, Boeing, etc. And what about all those savvy European and Asian carmakers who pulled up stakes in their own countries and set up shop in America to benefit from the weaker dollar and high consumer demand?

The lure of the worthless dollar brought giants like BMW, VW, Nissan, and Toyota to set up manufacturing plants in the US, mostly here in the South where taxes are low, land is cheap, and economic conditions are favorable (were favorable). That’s just one of many examples of how wide-ranging an affect the beaten-down US consumer is going to have on global economies.

Crude:

Crude has been a mess and the unwinding of crude has no doubt benefited the dollar. Now I see a new potential factor arising if crude is allowed to stay to the downside. I’m talking civil unrest in oil producing nations. Oil producing nations budget a barrel of crude at a specific level and they use this targeted price to determine how much to budget towards three things specifically:

1. Infrastructure and expansion
2. Sovereign wealth fund capital
3. Government subsidies (human control)

Based on my limited understanding of how crude plays a roll in the budgets of OPEC nations and other oil producing nations, I’m seeing that if crude sustains a break of between the $68 and $65 levels and stays below there for even a brief period of time that this will dramatically alter the spending plans of oil producing nations. They basically cannot have oil stay at or below $65 a barrel for the foreseeable future.

The first areas that will get hit are subsidies and expansion projects. This is where the civil unrest part can play a role. Again, I am not an expert on precisely how oil-producing nations handle their politics but I do know they use oil money as a way to subsidize the citizenry in order to wield a certain level of control and power. In nations such as India and China and certain parts of the Middle East the poorer classes have risen into a middle-class lifestyle almost overnight. This global economic slowdown put those folks in jeopardy of returning back to where they came from. They may not want to get downgraded without putting up a fight. I wouldn’t.

Add to that the taking away of government subsidies and programs funded with oil money and you have a decent recipe for a good civil uprising. This type of geo-political event would absolutely cause a tremendous amount of chaos and volatility in not only the crude market but also for the EUR/USD. This type of event won’t happen in the blink of an eye but it’s an issue we need to keep monitoring so long as crude stays at these lower levels.

EUR/USD:

As I said I expect trading conditions to remain frustrating, chaotic, volatile, and erratic this week. I see no reason for this to change. As far as trading goes I would like to offer a suggestion for traders who are serious about risk and money management… do yourself a favor and consider staying out of the market this evening and wait for the overnight dollar LIBOR rates to come out between 0630 EST and 0700 EST on Monday morning.

If you can be patient enough to wait for this fundamental interest rate data from LIBOR it may serve to give some clearer direction for the trade day. If we see a drop in overnight dollar LIBOR rates this will be a good indicator the euro at least has a fighting chance on Monday. The next indicator will be how equities are responding.

At this point on Sunday afternoon I have absolutely no bias for the dollar or the euro. I don’t even really need a bias because my trade plan will mostly depend on what the market correlated variables are showing me and what the euro price action is showing me. These conditions call for taking quick hits on the market, banking the profits, and getting out while you wait for the next trade opportunity to emerge.

Lets be real here… trying to pick a perfect bottom on the EUR/USD is just a complete waste of time and energy under present market conditions. It must not be forgotten that Europe’s banking system is as much a mess as the US banking system, if not more.

At least at the start of the week some important levels to keep an eye on are 1.3382, 1.3317, and 1.3263 on the downside. Topside levels to be aware of are 1.3584, 1.3648, and 1.3737. After the market opens and we get a few hours under our belt it may provide a clearer view of how market conditions may go.

Overall I’m going to say the euro does have a fighting chance to make some gains this week. This means I will be much more cautious with adding euro shorts unless I see the market give me the clear green light to keep shorting the euro, otherwise I will take risks buying the euro this week.

Risk and money management is imperative for all traders this week. I cannot stress this enough. Be smart with your trades and do not be greedy this week. Greed is an enemy that only the most disciplined and focused trader can beat. Please practice strict risk management!