FX Weekly 07.11-07.17.08 - Can the Greenback Gets Its Groove Back?

July 12, 2008

bkpicsmall FX Market Outlook
Dollar: No Mercy For the Buck
Euro: Rallies As Oil Rises
Yen: Rangebound
Pound: 5% Stays in Place
Commdollars: Aussie Rules Caddie Drools

Top 5 Stories in FX This Week

The Markets Two Biggest Fears
No More Dollar Anchor
Was the Collapse of the Bear a Crime?
Five Themes for 2008 - Scorecard
Are Confindence Surveys Signaling a Market Rally?

—————–Trading Thoughts-Follow The Model—————-
“First, let me say thank you for helping me make a little more money today.” the email began. “I’d like to preface this email by saying that I am asking these questions so I can learn, not to second guess you.

My question for you is, what is it you were looking at to determine your exit? Just a couple of hours later the pair was 30 pips higher. Were you looking at indicators and oscillators? Are you looking at price action only? Again, I’m looking to learn.”

————–FX Market Outlook————–

Collapse of the system or just a bunch of nervous Nellies panicking for no good reason? That’s going to be the question next week as a confluence of macro stories will continue to drive the market. Are Fanie Mae and Freddie Mac really insolvent? If so the cost of rescuing them may be more that the budget of the entire US government. They sit on 5 Trillion dollars of US debt and that’s no chump change even by today’s standards.

Both companies came out on Friday denying the rumors.with Fannie Mae stating that it has ample sources of liquidity and has issued more than $24 bln in debt this week with a higher capital surplus than any time in its history. Freddie Mac said it has no mandate to raise capital and could free up as much as $3 bln in new capital. If the markets don’t believe them however and continue to destroy their stocks, those capital sources may dry up quikly. No one wants another Bear Stearns disaster but can they really avoid it?

The other question this week that will preoccupy the market - is Mahmoud Ahmadinejad crazy or just bluffing? According to the best geopolitical analyst I know - my mom - he truly harbors messianic feelings. If so the depressing conclusion is that the conflict in the Middle East is inevitable and that means crude goes higher. So forget micro economics for the time being. Its a macro market and the themes of higher crude (thus higher inflation and higher euro) and the euro safe haven bid ( as US financial assets seem to have become spontaneously combustible) will be the twin pillars of trade next week.

Cable got its bounce from the anti-dollar flows and the fact that BoE kept rates at 5%. The unit is once again flirting with the 2.0000 handle, but the UK economy is clearly coming apart at the seams and rates will have to be lowered sooner rather than later. One factor that the market is overlooking for now is the weakness in global equities. If DJIA drops to 10K taking the rest of indicies with it, the hedge fund economy of UK will implode.

USDJPY held up surprisingly well given the doomsday scenario that swirled through the markets on Friday. One possible reason is the small uptick in US economic data as jobless claims, weekly retail sales and consumer confidence all beat expectations. Could US really avoid a recession despite $4.5 gallon gasoline? If so, the greenback could stage a surprisingly strong bounce once the macro fears subside.

Meanwhile on the commdollar front the familiar Aussie/Caddie split continued this week as Australian employment data blew out the estimates to the upside while Canadian data disappointed. We noted that chance of an RBA rate cut before the year end are practically nil given the strength in labor, but if crude continues to $150 or above the balance of power will shift to the loonie, especially if China has a post Olympic hangover and chooses to curb its demand for commodities. As we’ve been saying forever, Aussie has a chance to go to parity, but not much more.

But as we noted in out commentary at the end of the week, “The data from US leaves little to cheer about, The NFP report was hardly encouraging showing a sixth consecutive monthly loss of jobs with the forward indicators suggesting that the economic data may only get worse. Under those conditions the Fed may have a very difficult time raising rates in September and once the market reaches that conclusion the EURUSD may resume its rally as interest rate differentials take center stage once again.”

Cable in the meantime hit a brick wall as the economic data destroyed any notion that UK economy continues to perform well. Construction, manufacturing and service sectors are all in a recession with PMI gauges missing their market forecasts by a mile. How long can the BoE keep rates steady in this clearly contractionary environment? The MPC meets this week to set rates and while no one expects a rate cut from Mr. King and Company, UK monetary authorities may not be able to hold out much longer if the data (most importantly the labor reports) shows further deterioration.

Last week we wrote, “If the news continues to drive stocks lower USDJPY could slice through 105 by the end of next week.” The low print last week? 105.14. Alas it occurred at the start rather than the end of the week, as stock rallied on the misguided notion that the NFPs “were not so bad”. Nevertheless, the central tenet of US equities is that they are in a bear market and that fact means generally lower USDJPY prices ahead.

Aussie was the center of attention in the commdollar universe last week as it reached all time highs after blow out Retail Sales numbers. This week the focus falls on the employment report. The market will want to see if last months horrendous miss was an aberration or the start of decidedly dour downward trend. That data therefore could determine if the Aussie makes the run for parity or slumps back below 9500.

————–Top 5 Stories in FX This Week—————-

The Markets Two Biggest Fears
No More Dollar Anchor
Was the Collapse of the Bear a Crime?
Five Themes for 2008 - Scorecard
Are Confidence Surveys Signaling a Market Rally?

To which I replied that the only thing that I was looking at was looking like an idiot after EURGBP continued to go higher after we closed out the second lot. The truth of the matter is that I got too cute. Over the past few trades we’ve had many breakeven stop outs on the second half of the position and I just didn’t want to give up the pips. Its a perfect example of how a few bad bounces could subtly sabotage your long term trading plan by having you alter it just a bit.

Our model is well thought out. We trade trend. We bank some profits early and we try to let the rest run. Over the past two months makes have been rangebound so continuation has been rare. However that’s no reason to deviate from the plan. In July we got back to trading trend with very positive results profiting on every trade so far. Now is the time for us to follow the rest of the model.

Now on to this week’s trades.