Tuesday March 29, 2005 - 11:30:31 GMT
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Black Swan Capital - www.blackswantrading.com
1.40 euro fading fast
“The real, or inflation-adjusted federal funds rate currently stands at just 0.35% if the nominal funds rate (2.75%) is “deflated” by the year-over-year increase in the core CPI (2.4%); it is still slightly in negative territory if the headline CPI (3.0%) is used. An average of the two readings works out to a “zero” real federal funds rate -- underscoring the persistence of extraordinary monetary accommodation.”
Andy Xie, Morgan Stanley
Those bank analyst forecasts of 1.40+ in the euro, prescribed with the usual dose of hubris, predicated of course on the “deficit,” seem to be fading fast. The euro has fallen against the lowly greenback in nine out of 11 consecutive days of trading, based on the close yesterday. A test of the Feb ’04 lows near 1.2730 and then a breach seems in order, but maybe a little bounce will come first (B).
euro daily chart
Here is that (B) part on a 60-minute chart provided to Black Swan clients’ yesterday evening…
euro 60-min chart
Despite the decline in the euro, and corresponding rocket-like move in the dollar, there are still plenty of dollar skeptics in the market. Why wouldn’t there be? People have been pounded by the deficit argument relentlessly. Dollar bears still hold out hope that the Double D’s of Doom will eventually bail them out. Dollar bulls on the other hand, see this as potential fuel for the next leg up in the dollar i.e. capitulation to the trend.
Here’s a very brief synopsis/scenario that shows why the deficit is likely to improve marginally:
1) The dollar is rising—this alone will help reduce import costs more than it hurts exports.
2) Rising interest rates force savings—the complaint has been the US consumer doesn’t save enough, and because of the dearth of domestic savings the deficit must be funded overseas. If the Fed is as far behind the curve as many suggest, the message sent by rising rates will force consumer time preferences to shift from near-term consumption to savings.
3) A slowdown in Chinese exports—if consumers shift to relatively move savings, then fewer of the Chinese goods stocked at China’s outlet—WalMart—will fly off the shelves.
I told you this would be a simple analysis. The complicated part I will leave to the experts. Of course there could be many risks related to an improving deficit in terms of consumer liquidity, asset bubbles, and global growth. So maybe the market should be careful about what it wishes for. It could come true.
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