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The Dollar's Excellent Week

Mon, Aug 11 2008, 14:30 GMT
by Joseph Trevisani

FX Solutions

When economic fundamentals, central bank rate policy, and technical analysis align the currency market can experience the rare tsunami that struck the euro this past week.

From Monday to Friday the euro lost 4.0% against the US dollar, 2.5% against the yen, and 1.7% against the British Pound. Almost all the losses against the dollar and the pound, (3.3% and 1.5%) and the entire decline versus the yen, occurred after Jean Claude Trichet the President of the European Central Bank (ECB) reordered the market view of the Eurozone economy.

European statistics have been failing for several weeks. But Mr. Trichet moved the euro reconsideration into high gear when he admitted that the Eurozone economies are in for a very rough few quarters immediately ahead. Acknowledgement of economic weakness is a new factor and given Mr. Trichet's history of letting the markets know the bank's thinking and with the second quarter GDP release coming this Thursday, no currency trader was disposed to take him at anything other than his word.

"Much of the immediate prognosis for the euro will depend on Mr. Trichet's answers to questions about the Eurozone economy. Strict inflation talk from Mr. Trichet is expected, but the more he acknowledges pending economic weakness or cooling inflation the more the markets will begin to price a rate cut". That was the analysis I posted on our website on Wednesday evening before the ECB rate announcement. And so it turned out.

Mr. Trichet's commented that "we are identifying downside risk…for a number of months and I would say that the information that we have which are very, very clear for some of them suggest the materialization of those risks." He also suggested that Eurozone growth may experience a trough in the next two quarters. Both statements were a clear warning that the economies of the euro 15 have deteriorated faster than the central bank expected. Although the ECB maintained its current base rate of 4.25%, the implications of the new economic assessment for future rate policy are plain.

The Federal Reserve began its own rate consideration in a gingerly fashion on Tuesday. The FOMC statement said "Although downside risks to growth remain the upside risks to inflation are also of significant concern to the Committee." Though the statement was at pains to delineate the economic problems in the US, those are well known and have long been priced into the dollar outlook. The mention of the concern of the committee was new, at least in phrasing. And it seemed to add a note of urgency to the Fed concerns about inflation.

The Fed has recently been highlighting its view of inflation and intensified the inflation rhetoric in its Tuesday statement. But it cannot yet raise rates. The economy is still weak with worrisome if not unknown risks in the banking, financial and consumer credit and mortgage sectors. High oil prices are crimping American consumer spending, the engine of GDP.

But the economic outlook in Europe and future ECB rate cuts were not the only factors weighing on the united currency. The euro broke three critical technical supports in its week-long descent: the unbroken trend support line at 1.5500-15 which went back to last August and the beginning of the credit crisis; the 38% Fibonacci retracement at 1.5410-20 of the February to July climb; the 23% Fibonacci of the entire August to July move at 1.5380-90.

The currency debate between the euro and the US dollar has shifted topic. It is no longer solely about the rate policy of the ECB and the Federal Reserve. Although central bank policy is the prime determinant in a currency's value both banks are on long term hiatus. It is not primarily about the US economy which though weak has not collapsed and has been a story for many months. The debate is now about the economic health of the Eurozone and it has been brought to the fore courtesy of Jean Claude Trichet the President of the European Central Bank. It is a debate the Eurozone and the euro will lose.

Published on  Mon, Aug 11 2008, 14:32 GMT