Trade Team Update

This is a very rare thing, but I'm mostly at a loss for words... obviously the big news is the nuclear bomb the central banks of the world dropped on the markets this morning... this move is certainly a game-changer here going forward...

Clearly the big question on the mind's of traders is how the ECB cut will affect the euro and how the Fed cut will affect the dollar. That's what we're going to look at first tonight. For those looking for a definitive, "should I go long or should I go short" analysis let me save you the time and say that I don't have an answer to that question at this point.

This is not the first time that the major central banks of the world banded together to do a joint rate cut. Apparently it was rather popular in the 1980's and according to the historians these types of moves have mostly worked to bring order to the markets.

Just because it worked in the past doesn't give me any comfort that today's coordinated rate cut will do the trick. I was skeptical of the idea and I'm skeptical now that it's a reality. The markets were all over the shop today... equities went from red to green to red and back to green... the euro went up, then down, then up, then back down.

This is the kind of price action I'm expecting to see in the markets at least the rest of this week. I do believe the rate cuts will bring overnight LIBOR rates down and that would be a good thing for the euro. The ECB's rate cut should also lift some of the doom and gloom off of Europe.

Trichet was under tremendous pressure to cut rates and yet he would not relent from the hawkish price stability stance. In my opinion this whole thing was the Fed's idea and they pushed it on Trichet. Trichet was surely the hardest one to convince to go along with it but the ECB's cut may have the most impact out of all the banks who cut rates.

Most market participants were looking for a 25bps cut and Trichet gave them 50bps in one shot. This should raise investor confidence and hopefully take some pressure out of the European money markets. This rate cut does not solve the issues facing European banks and the fact they are highly overleveraged and many are facing insolvency issues.

The rate cut may change Europe's growth fundamentals in the next few months, so that is an area we need to keep a close watch on. As far as the rate differential between the US and Europe is concerned, it's a wash. The Fed is at 1.50% and the ECB is at 3.75%. But the fact that the European rate of return is 50bps lower than yesterday is certainly cause to consider other sources that pay better rates.

At this early stage in the game it cannot be realized how this joint rate reduction will affect the EUR/USD. If it was just the Fed that cut rates the trade would be a no-brainer. If the ECB had cut 50bps and the Fed had held rates steady, again, it would be an easy call to make.

I think it will be required to give market participants some time to consider the implications of a European rate reduction and then to begin speculating on Trichet's next move. With Fed Funds a 1.50% and the ECB still at 3.75% it's possible market participants will look at the ECB has having more room to drop rates further. Trichet did make a comment today about not expecting more rate cuts but don't forget two months ago he told the markets that the ECB would hold rates steady through 2009.

Back in January we forecasted the first ECB rate cut to happen during the second half of 2008 and while that was expected, I certainly did not expect it to go down this way. As far as trading goes it's imperative that all traders realize that there is no known pattern behavior based on this joint rate cut event.

Let me explain... since the euro was introduced and allowed to float on the open market at no time has the Fed and ECB cut rates on the same day, or during the same quarter, or the same exact amount. So when I say there is no known pattern behavior based on this event it means that the market will be trading in unchartered waters at least for the short-term while market participants reposition and align themselves based on the euro and dollar interest rate differentials.

The billions of dollars worth of liquidty the banks provide to the market has been absent ever since we started the summer session and that liquidity has yet to return as the summer session turned into the worst financial crisis in modern history.

If these coordinated rate cuts serve to bring some order to the markets we may see some of that liquidity come back. And it may take that liquidity, which provides order, to get a feel for how the market is going to punish either the dollar or the euro for their respective rate cuts.

Both the euro and dollar fundamentals are both abysmal. I'm expecting both Eurozone and US GDP to show negative prints for Q4. I'm expecting more uncertainty about future monetary policy, and I'm still expecting much stress within Europe's banking system.

It never seems to get less complicated does it? I know traders will be anxious to know whether the trade is euro long or short but it will be important to keep in mind that the this coordinated rate cut effort is less than 24-hours old and the markets will need time to digest and position themselves. As always we will do our best here to keep reading the market's behavioral patterns and trying to give the most accurate forecasts as possible.

EUR/USD:

Tomorrow's big fundamental even will be Initial Claims. Focus and attention will be on other matters of course... equities, commodities, and the market's response to today's actions will likely dictate where the EUR/USD goes from here.

The euro was very correlated with the Dow today... as the Dow went up the euro went up and vice versa. Gold and crude seem to just have a mind of their own right now. They are moving for totally different reasons right now, so we have a quite a mixup on our correlations. But, there's always a correlation that can be used a great trade indicator and today the Dow was one of those great indicators.

The 1.3730-50 resistance level is still holding solid so far. There is some support at 1.3620 and 1.3580 levels currently. Overall my bias is still bearish on the euro but I'm now opening my mind to the possibilities of buying the euro again should the market cooperate. I will be more cautious with adding shorts at these levels. I'm not yet ruling out another possible downside test below the 1.3500 level. And I'm also not ruling out a test of the 1.3800 level before the market closes on Friday.

Tokyo was closed when the rate cut announcement hit the wires so we will need to see how they respond in Asia. My guess would be that the Nikkei enjoys the news. If the Dow shows strength tomorrow is possible the euro moves up right alongside.

I am expecting a test of the 1.3600 level during Asia and possibly lower. Current price action is more to the downside right now but we could find some buyers on a 1.3580 level break.

Just be extremely smart with your risk and money. Allow this to develop and allow yourself the time to read these new patterns of behavior we're about to see in the short-term. If you're not feeling the market and you don't see your trade, just wait it out. The market will always be here and you don't have to be in every second.