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GVI Forex-Week ahead Outlook and End of Week Post-mortem October 25, 2009

Week ahead Outlook and End of Week Post-Mortem
The focus of all markets last week remained on the weakness of the USD. Strength in many of the carry trades is being blamed on USD weakness, but that strength is more a result of an over-abundance of USD liquidity than USD weakness. This is the classic carry trade with a cheap (interest rates) USD the funding currency. On the other hand, the U.S. administration is pursuing a weak dollar policy as it hopes to see demand from the export sector spur economic growth.

The problem with this strategy is that holders of USD are being “punished” by official policy. To compensate for this risk, holders of the currency will demand higher interest rates to compensate for this risk in time. In the interim, many central banks that are holding large portions of their official reserves in the U.S. currency now are steadily unloading excess USD reserves on strength in the currency. That means periodic rebounds in the currency have been met with selling. The preferred alternative to the U.S. currency is primarily the EUR, but to a lesser extent have been the other majors (JPY, GBP, CHF, Gold). China is also been purchasing physical commodities.

Traders have closely followed the current round of quarterly earnings reports. They have generally have been much better than expected. They haven’t helped the dollar. By now, we have to wonder what already has been priced in. On balance, the USD is likely to remain on the defensive. Odds are its going to take a lot to reverse it downward momentum and we might have to wait until the Fed starts to take unambiguous and aggressive steps to reduce the excessive supply of the unit.

Post-Mortem follows…

from... GVI Forex Discussion Points Thursday PM
We indicated early Thursday that equities seemed to be back in a corrective frame of mind. Once again the market tested the downside in stocks, but selling did not follow through. Wednesday saw a late day break in shares reportedly fueled by Galleon Fund liquidations a WFC downgrade and worry about the Wal-Mart report. This all matters because of the equity to forex correlation. We indicated today that “equity correlations should be followed.”

From GVI Discussion Points... Thursday AM

"Equities back in a corrective frame of mind today. Wonder if the Galleon Fund liquidation is having an impact? Nevertheless shares have been behaving like they are overbought in the last two days. WFC downgrade yesterday was said to be a catalyst, but was that enough? Equity correlations should be followed today. Odds are liquidity (positions) more than economic indicators will drive trade into the weekend through tomorrow. China +8.9% GDP. Amazing that reportedly only 8 people can compute national GDP in just 22 days. Nobody else can do the job that fast and most have much larger bureaus on this job. In short, take the data with a pinch of salt. Some say the data is geared to meet political expectations..."

GVI Forex Discussion Points... Wednesday Evening
"We cited the inevitability of a run at EURUSD 1.50 earlier today simply because that’s where the stops were resting. It was not obvious that today was the day, but it turned out it was. There was also talk again that the Eastern European names led the charge. Their motivation was unclear. It could have been for reserve diversification or other reasons. The GBP got a boost from BOE minutes saying the MPC voted 9-0 not to increase quantitative ease in early October. The U.S. remains in the thick of earnings season. Some apparently were set up for a correction today and were caught short. Now stocks are slumping..."

from...GVI Forex Discussion Points Wednesday AM
"Forex markets seem to be biding their time until option barriers at EURUSD 1.50 and above run off. Tuesday saw a modest correction in the pair, but that correction lacked power. Equities saw similar price behavior. We will have to see how they behave in the sessions ahead. The GBP got a boost a short while ago following BOE minutes that showed the MPC had voted 9-0 not to increase quantitative ease early this month. The U.S. remains in the thick of earnings season. When equity prices ease on good news, it can mean that the market is already long. It does not necessarily mean that a major correction is underway..."

GVI Forex Discussion Points... Tuesday PM
"Trading volume seemed to tail off early in NYC on Tuesday. One problem is that the market appears to be set up for a run through the EUR/USD 1.50 line, but it failed to trade through that line when equity prices failed. It was not due to a bad earnings report that stock prices slumped. In fact earnings were strong. When equity prices ease on good news, it can mean that the market was already long. It does NOT necessarily mean that a major correction is underway. "
GVI Forex Discussion Points... Tuesday AM
"The USD remains soft, but the speed of its decline remains surprisingly orderly. The EcoFin meeting yesterday ended with European Finance Ministers not intimidating USD sellers, as feared they might. Also, U.S. earnings reports for 3Q09 have been surprisingly positive in terms of earnings and future guidance. This is good for equities and bad for the USD on the equity correlation trade. Lastly, the USD has become the preferred carry trade financing currency with JPY policy in flux..."

from... GVI Forex Discussion Points.. Monday PM
"There was talk of a rather odd reaction of the markets to a round of “test” Fed reverse repos in the money markets Monday. A reverse repo drains liquidity from the system, and the fact that there were going to be a test was pre-announced in the last Fed statement. The odd item was for the market to react to a “test” when no action was taken. The reaction was said to be to the fact that the Fed did NOTHING. Go Figure!..."

from... GVI Forex Discussion Points...Monday AM
"Lots of chatter about Barrons headline article about need for Fed to increase interest rates. Barrons does not set policy and wont change Fed thinking about keeping rates low for a long time, especially with inflation subdued. EcoFin to follow G7 line on forex. Junker is the person to listen to, and the peripheral countries are not. USD generally soft"

John M. Bland is an author and co-founder of Prior that, he was a senior forex dealer in a subsidiary of the Continental Grain Company in NYC. Previously, he was a member of the Chemical Bank corporate advisory service in NYC. He also worked in international liability management. John holds an MBA from the Hass School at the University of California at Berkeley and a BA in Economics from Berkeley.


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