Wednesday August 27, 2008 - 19:36:22 GMT
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Forex Blog - Market In Front of ECB on Easing Expectations
We are used to Fed officials
using the power of verbal intervention to reshape market expectations between
FOMC meetings, though more often than not via surrogates in the financial press
like Ip, Reddy and Guha. What is less obvious is when the ECB engages in
expectations management between monthly governing council meetings.
Indeed it is less obvious because it is so obvious that markets often ignore
the message. Well in the last 24 hours ECBâ€™s Stark. Weber and Bini Smaghi
all seemed to be singing from the same hymn sheetâ€¦hey markets we are not in the
lest bit considering rate cuts ahead (markets are priced for Q1) and
furthermore we may have to hike moreâ€¦second round price effects are
materializing (from rise in commodity prices). And growth naysayers in
the Euro Zone be damnedâ€¦the ECB is not nearly as pessimistic on growth as the
EZ rates and the currency
responded accordingly to the shotgun warning from the ECB. These are not
rogue ECB council members like the Fedâ€™s Fisher riffing on a song he canâ€™t get
off his mind.
No this is no call to return
to the recent days of long euro/dollar â€“ I conceded that one two weeks ago and
in the height of the position liquidation.
However. I am skeptical
that the steepest rally in the dollar arguably since the Plaza Accord in 1985
has Plaza Accord-like legs. Yes the world needed to come to terms with
weakening growth in the rest of the world ex-US. It has done that.
It is now the time to ask can the dollar run to 1.40 on this US economy and
that weakening ROW economy? I just canâ€™t buy into it. A more
logical response is that the bear cycle for the dollar was broken, but a bull
cycle was not bornâ€¦range trading is my best guess ahead and not ever higher
highs for the dollar.
Moreover the borrowing
requirements of the US public and private sector are expected to soar ahead
demanding more foreign capital. And with the dollar rally to date US
exports have lost something of an edge on competitiveness compared to just a
few weeks ago (yes FX impacts exports with long lags, but it impact corporate
And if the US needs ever
more foreign savings to cover current investment and consumption then US rates
have to rise â€“ very likely market rates as they have for private-sector debt
and in time as they will for public debt. This will put more stress on
credit and economic growth, even if it helps stabilize the dollar.
I have heard the argument
made that interest rate futures are pricing in 75bps of Fed tightening 12
months out and 75bps of ECB easing 12 months out and this will drive the dollar
to 1.40 versus the euro. But since when are 12-month official interest
rate expectations an accurate predictor of future official rates in 12 months?
If you like dollars then you
have to be counting on lower oil prices (lower commodity prices) which will be
driven by demand destruction. How does the US economy hold up in a global
slowdown with a broken banking system, falling home prices, elevated consumer
indebtedness and declining corporate earnings. So I am of the view that
in time the correlation between the dollar and oil will break down.
My range for euro/dlr?
1.45-1.50 seems reasonable through Q4.
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