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Monday January 7, 2008 - 04:04:10 GMT
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The Case for the Dollar Market Directions Sunday January 6, 2008

Is the long rumored US slowdown is about to become real and verified by statistics? Do we have a case of sell the rumor and buy the fact for the US dollar?

The Dow fell 4.2% in three trading days this week; the dollar lost only a little more than 1% against the euro during the same period. In general there is little direct correlation between day to day trading in the New York equities averages and the currency market valuation of the US dollar. But this week’s Dow collapse was prompted by two dismal US statistics, a sub 50 ISM Manufacturing Index and a very weak Non Farm Payrolls report. Both seem to presage a much slower if not recessionary American economy. The equities reaction was one of disappointed hopes, but no so the dollar traders.

Has the currency market evaluation of US economic prospects been so negative that the arrival of the slowdown becomes the occasion for a classic reversal? To put it another way, has the ‘recession’ already been priced in and if it now may be here—not yet a fact despite the statistics—has the dollar no where to go but up? Questions looking for answers, truly, and one should be careful of making too much of a short term move but the blasé reaction of currency traders to the dismal and unexpected numbers requires explanation.

There is little doubt that an American economic slowdown has long been the operating assumption for the currency markets; it is has been one of the drivers for the ascent of the euro since August. But the logic for a dollar recovery is straightforward. If an American economic slowdown or a recession is priced into the current dollar level, as I believe it is, then the questions become, what happens to the dollar if the US enters recession, what happens if it doesn’t and where does the dollar go when the issue is decided? There is an objective definition of recession, two successive quarters of shrinking GDP, but since traders must operate with imperfect foresight we can use weakening US statistics in lieu of the formal definition. Will more statistics like the ISM and NFP results drag the dollar down?

Let us examine the possibilities.

If the United States is headed for or perhaps has already entered a recession can the Eurozone be far behind? If the Fed and the BOE are reducing rates can the ECB afford to be the sole anti inflation paladin? Judging by the reaction of the currency markets the answer is no. If traders really believed that the ECB would hold the line indefinitely then the recent US numbers, clearly indicative of further Fed rate cuts and a widening gap in base rates for the two currencies, should have driven the US lower. They did not. My view is that US economic weakness and further Fed cuts were anticipated and already factored into the dollar level. The assumption that the US economy will falter may well have as its unstated corollary that where the US leads the Eurozone will soon follow.

And if the US does enter recession what then? The dollar may weaken marginally as the few remaining optimists are converted but very soon the focus will shift to the second half of this year. As the fall in the dollar from August to the end of the year anticipated, for arguments sake, a recession in the first quarters of 2008, so a dollar recovery, in early 2008 could anticipate a US economic resurgence in the last quarters of the year.

At the end of the first quarter it will be six months from the first Fed cut on September 18th. . That is when traders will expect the Fed stimulus to begin its work. It is also when the ECB lack of attention will begin to bite. Despite the ominous tone of much press coverage of the housing and financial sectors, the conditions which have been threatening to derail consumer spending and business activity will not last forever. The housing collapse has been gathering steam for two years; the asset backed mess will be more than six months old at the end of the first quarter. If for no other reason than short market attention spans and traders’ perennial focus on what is over the horizon both crises will be much diminished as sources for dollar weakness by the end of the first quarter.

If on the other hand the US economy does not enter recession, if Non Farm payrolls are revised much higher, as then have been in the past, if consumer spending does not crack, and the economy does not slow to sub 1% GDP growth then the dollar has no place to go but up. Current dollar levels are predicated on serious weakness in the US economy. No economic weakness, no falling dollar.

Either way the economy goes the dollar looks primed for recovery. The dollar is at current levels because it has been struggling under the assumption of a recession. If the recession is here, then it is out of the way and the market will move to the next target. If the recession does not materialize, then the market has been wrong and traders will have to buy back their short dollar positions. Either way the dollar rises. If a US economic slowdown or recession has been priced into the market, then logic dictates the dollar must shortly begin to gain, regardless of whether the recession is or ever will be, real.

Central Banks


Cyprus and Malta joined the European Monetary Union, as of January 1st, becoming the 14th and 15th European Union member nations to give up their national currencies and join the Euro. The Cyprus Pound and the Maltese Lira will soon disappear from circulation, remembered only by historians. 15 out of 27 EU members now belong to the European Monetary Union and use the euro.

Athanasios Orphanides governor of the Cypriot Central Bank said that the ECB stands ready to raise rates if needed. But his comments, much as recent comments by Jurgen Stark and others, must be taken with certain skepticism. With European economic growth set, by the bank’s own projections, to slow to 2% or less, with the euro close to its all time high against the dollar, with the credit and financial turmoil still unwinding and with a US recession becoming more likely, the chance of an ECB rate hike is negligible. A central bank has two major tools to manipulate markets, interest rates and rhetoric. Sometimes rhetoric is a creditable guide to future action, but in this case, the rhetoric is mere words. The ECB will not change its rate policy on Thursday.

Federal Reserve

ISM and NFP have weighed in and futures pricing makes a 25 basis point cut at the January 30th meeting a near certainty. Speculation that the Fed will cut 50 points or be forced to make an interim reduction before the FOMC meeting now is now heavily entertained.

FOMC minutes of the December meeting where the Fed funds rate was cut by 25 basis points reflected a committee unanimous only in its uncertainty. With economic indicators pointing in several directions and with plenty of overhanging if not yet substantive worry in the financial markets, the housing sector and on consumer spending, the varied opinions of the board members mirrored the lack of consensus in the statistics and in the markets generally. But the minutes also depicted a board more concerned about the state of the economy than the rate of inflation. Or to quote from the minutes themselves, some governors anticipate the need for “substantial further easing of policy”. With that mindset on the board and the weak ISM and NFP numbers, expectations for a rate cut at the end of January will not diminish a whit no matter the intervening statistics.

Bank of England

Market opinion is evenly balanced between a 25 basis point cut and a continued hold at the Monetary Policy Committee (MPC) meeting this Thursday. Though last month’s cut surprised the market and inflation is a major concern, it is possible that the MPC members will wait for the February 13th quarterly inflation report before making their decision. The recent softness in manufacturing and purchasing indices are not thought to be weak enough to force the MPC’s hand and they were balanced by a stronger than anticipated PMI services report.

United Arab Emirates

The central bank of the United Arab Emirates, the source of much capital recently for western financial corporations, has decided, after review, to retain their currency peg to the US Dollar. Given the damage that removal of the peg would have done to their own dollar reserves, the decision was not unexpected. However, in the current weak dollar environment the review had generated a good deal of speculation about the negative consequences for the dollar if the peg had been converted to euro or to a basket of currencies. That worry is now removed.

The Week in Review December 31 – January 4

United States

Two major statistics, the ISM Manufacturing Index and the Non Farm Payroll report painted a much grimmer picture of immediate US economic prospects than had been foreseen a week ago. Particularly worrying was the 0.3% jump in the unemployment rate to 5.0%. In October 2006 and again in March 2007 the unemployment rate was 4.4%; it is now 0.6% higher. Since 1949 the unemployment rate has never risen by that much without the economy being in recession. Sudden large additions to the rate typically happen around recessions. The availability of jobs has been one of the secure supports for consumer spending as housing equity has fallen precipitously in many parts of the country.


The ECB kept on a brave face, even recruiting its newest member the Cypriot Central Bank to talk up the possibility of a rate increase to ward off “second round inflation effects”. But this is whistling in a graveyard. The Fed will cut again at the end of the month; the BOE will cut again this coming week or in February. The ECB will not and cannot buck that trend. Other central banks are not reducing rates because they want to make the ECB anti inflation job harder but because the economics of their own countries and the world warrant the easing. If England and the United States are sickening the EMU will not be immune; the ECB will be forced to cut rates, the only question is when?

Economic Releases December 31 – January 4

United States

Monday: Existing Home Sales rose 0.4% in November to 5.0 million units, besting the 4.96 million predicted and ahead of the revised October figure of 4.98 million (up 0.01 million). Existing Homes Sales is a seasonally adjusted number so the traditionally slower end of the year selling season is not a factor. The inventory of unsold homes dropped to 10.3 months from 10.8 in October which had been a 20 year high.

Wednesday: the Institute for Supply Manages Index for December came in well under prediction at 47.7. It was also below the 50.8 November figure. Most importantly it was beneath the 50 demarcation between contraction and expansion in manufacturing; 50.5 had been forecast. It is the lowest reading since April 2003 at the beginning of the Iraq war. ‘New Orders’ fell to 45.7 from 52.6 in November; ’Prices’ rose to 68 from 67.5 and “Employment’ added 0.2 to 48.0. Though it is long since that manufacturing has been the mainstay of American GDP, the sector is used as a barometer for the rest of the economy. With the dollar low and US exports rising the manufacturing sector should be one of the healthiest in the economy. Is this apparent fall into contraction a statistical outlier or a early sign of recession? Construction spending in November was much more robust than expected at +0.1% against predictions of a fall of 0.4%; October was adjusted up to -0.4% from -0.8% and September to +0.3% from +0.2%. Private non residential and public construction gained in the month while private residential building fell 2.5%. It was the 21st straight monthly fall. Construction of single family homes dropped 5.0%.

Thursday: Factory Orders rose 1.5% in November almost tripling the forecast of +0.4%; October’s figure was boosted to +0.7% from +0.5%. However, the increase was due to higher prices for energy products and did not evidence stronger overall activity.

Friday: Non Farm Payrolls added only 18,000 jobs in December, far less than the 70,000 consensus estimate. Adjustments added a net 10,000 to October and November’s results. The unemployment rate jumped 0.3% to 5.0%, a two year high. The Non Manufacturing ISM Index scored 53.9 in December slightly off the November reading of 54.1. ‘Employment’ rose to 52.1 from 50.8. Over 70 percent of the US economy is generated by non manufacturing activity. The economy is thought to need 150,000 new jobs each month to prevent the unemployment rate from rising.


Wednesday: manufacturing PMI for December added 0.1 in the final issuance to 52.6; November was 52.8. M3 Money Supply expanded 12.3% in November and maintained the record high reached in October; growth of 12.1% had been forecast. Growth in loans to the private sector dipped slightly to 11.0% in November; October had been 11.2%. The official ECB target for M3 expansion is 8% monthly but money supply has not met that target since July of 2006. It has been over 10% for one year, since January 2007.

Friday: Flash (1st issue) HICP for December was 3.1%, the same as in November and as forecast. It is the highest rate since May 2001 and has climbed rapidly since the summer. As recently as August the HICP rate was 1.7%. Services PMI for December was finalized at 53.1, 0.1 below the flash estimate.


Thursday: the nationwide unemployment rate in December dropped to 8.4% from 8.6% in November; 8.5% had been expected.

Friday: Services PMI for December was 51.2, well below the median consensus of 52.4 and the weakest since February 2005. This series peaked in August at 58.9 and has a long term average of 53.5.

United Kingdom

Wednesday: manufacturing PMI in December fell short of expectation at 52.9, 53.6 had been forecast. The November figure was revised down to 54.3 from 54.4.

Friday: Services PMI in December rose to 52.4, ahead of the forecast of 51.6 and also better than the November result of 51.9

The Week Ahead January 7 - 11

United States

Tuesday: National Association of Realtors Pending Home Sales for November at 10:00 ET; October 87.2. Investor Business Daily/Technometric Institute of Policy and Politics (IBD/TIPP) Economic Optimism Index for January at 10:00 ET; December 44.4

Friday: International Trade Balance for November at 8:30 ET; October -$57.8 billion.


Monday: EMU Economic Sentiment Index for December at 10:00 GMT; November 104.8. EMU Industry Confidence for December at 10:00 GMT; November +3. EMU Consumer Confidence for December at 10:00 GMT; November -8. EMU Business Climate Indicator for December at 10:00 GMT; November 1.04. Unemployment Rate for November at 10:00 GMT; October 7.2%. Industrial PPI for November at 10:00 GMT; October +0.6% m/m, +3.3% y/y.

Tuesday: Retail Trade for November at 10:00 GMT; October -0.7% m/m, +0.2% y/y.

Wednesday: Q3 GDP (second issue) at 10:00 GMT; first issue +0.7 q/q, +2.6% y/y, Q2 +0.3%q/q, +2.5% y/y.

Thursday: ECB rate announcement at 12:45 ET; current 4.00%.


Tuesday: Total Manufacturing Orders for November at 11:00 GMT; October +4.0% m/m, +10.3% y/y.

Wednesday: Industrial Output for November at 11:00 GMT; October -0.3% m/m, +5.9% y/y. Manufacturing Sector Output for November at 11:00 GMT; October +0.1% m/m, +6.9% y/y.

Friday: Total Retail Sales for November (release time undetermined); October -1.8% m/m, -3.8% y/y.

United Kingdom

Tuesday: British Retail Consortium (BRC) Retail Sales (like for like) for December at 00:01 GMT; November +1.2% y/y.

Wednesday: Nationwide Consumer Confidence for December at 00:01 GMT; November 86.

Thursday: Bank of England rate announcement at 12:00 ET; current 5.50%.


Thursday: Preliminary Leading Index for November at 5:00 GMT; October 18.2. Coincident Index for November at 5:00 GMT; October 70.0.


Release Date Undetermined: Q4 GDP; Q3 +11.5% qtr, +11.5% y/y. PPI for December; November +4.6% ytd, +2.9% y/y. CPI for December; +6.9% ytd, +4.6% y/y. Money Supply for December; November +18.45% y/y.

Joseph Trevisani
FX Solutions
Chief Market Analyst

[email protected]

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