FED's DILEMMA IN REVERSE; Unlike in 2007 when Fed funds futures were forcing the inflation-centric Bernanke to cut interest rate, markets today are demanding the Fed to raise interest rates. But Bernanke is TOO CAREFUL NOT to allow markets to force the Fed into a premature tightening of credit conditions. Separately, theres talk in the central bank arena that the Federal Reserve is under pressure to halt (or slow) the USD-based carry trades, which have been responsible for prompting excessive strengthening in the currencies of Eurozone, Canada, Australia and New Zealand. But with the USD Index entering its 3rd weekly gain (longest winning streak since March), the Fed may be under less pressure to talk up the currency or/and issue hawkish statement. We expect the FOMC statement to issue a brigther economic outlook (in the 1st paragraph of the FOMC statement) but to leave the inflation language unchanged. This may prompt some further knee-jerk selling in USD, followed by retracement later in the US session. The escalating credit/banking issues of the Eurozone and their sudden concentration in less than 10 days are too great to be ignored by FX traders.
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Recently the markets have rallied on the day of the FOMC announcement. The market knows the Federal Reserve Bank is not going to say anything to spoil the apple cart. They have been more than accommodative by keeping the Fed funds rate (overnight rate from the FRB to the large major banks) at virtually zero percent. Some would argue that these efforts have saved the financial system. This comes even as banks are still not lending. Well who is really qualified to get a loan anyway with unemployment at 10 percent? While the U.S. Dollar is near all time lows it is important to remember that this helps to boost U.S. exports. The question is what exports? The U.S. manufacturing sector has shrunk by 80 percent over the past 20 years. It is still surprising that with all the mathematicians, statisticians, Ph D's, MBA's, and every other title that no single person is seeing this explosive government spending and money printing as a problem in the U.S.Today the highly read Time Magazine announced that Federal Reserve Bank Chairman Ben Bernanke is the man of the year. He is being honored as the man that prevented the second "Great Depression." It's amazing that the world thinks things are back to normal. Well at least the media who reports the news thinks so. People seem to forget that Ben Bernanke was around when Alan Greenspan lowered rates down to 1 percent in the early 2000's causing the greatest bubble (credit and housing bubble) in 70 years. Now Ben Bernanke is following the same recipe with low rates. One can only wonder what kind of bubble comes out of this one.Here is some irony for us all. The President was given the Nobel Peace Prize despite being in two separate wars. Some would find this rather disturbing considering it is a peace award not a killing or death award. Then Time magazine gives their "Man of the Year" award to Ben Bernanke who helped cause the huge financial crisis along with former Federal Reserve Board Chairman Alan Greenspan. Goldman Sachs is also giving out nearly $20 billion dollars in bonuses this year despite being bailed out by the U.S. government one year ago. One can only wonder if Charles Manson is due to receive the Congressional Medal of Honor, or tiger woods receiving the Husband of the year award.The markets are all positive, trading higher as the dollar is lower. Technology stocks such as Apple Computer (NasdaqGS: AAPL), Google (NasdaqGS: GOOG), and Research in Motion (NasdaqGS: RIMM), are leading the NASDAQ. Other market leaders such as Goldman Sachs (NYSE: GS), and Exxon Mobile (NYSE: XOM) are also trading higher on the day giving the markets a broad based rally ahead of the FOMC announcement.Nicholas SantiagoChief Market Strategistwww.InTheMoneyStocks.comRead more…
Despite a heavy dose of U.S. economic reports this morning, the lack surprises left the control of the market in the hands of dollar bulls. The greenback held onto its gains ahead of this afternoon's Federal Reserve monetary policy announcement on the expectation that the Fed will be more upbeat and announce plans to shut down additional emergency programs.
Yesterday we learned that producer prices increased significantly in November but the strong price pressures on the wholesale level failed to translate into strong price pressures on the consumer level. This was partially due to discounting by apparel and electronic retailers as well as the fact that gasoline prices gradually declined last month even though oil prices held steady. Producers are having a tough time passing higher costs to consumers because demand is weak. On a headline basis, CPI rose 0.4 percent but if we exclude food and energy prices, consumer prices were unchanged last month, leaving the annualized CPI rate at 1.8 percent and 1.7 percent ex food and energy. Meanwhile the current account deficit widened in the third quarter from -$98B to -$108B, reminding everyone that the twin deficits are here to stay. The one area of continued strength is housing. Despite a drop in builder confidence, housing starts increased 8.9 percent while building permits rose 6.0 percent to the highest level in 12 months.
Counting Down to FOMC
For more on the FOMC Rate decision, read our FOMC Preview
We expect the dollar to remain firm ahead of the FOMC announcement. Based upon the price action in the forex, equity and bond markets, traders across different asset classes are all positioning for a hawkish outcome from the Fed. The 3 things that investors will be looking for will be the tone of the FOMC statement, changes to the discount rate and any plans to end emergency programs. The sharp moderation in job losses and improvement in consumer spending will encourage the Federal Reserve to grow more comfortable with the outlook for the U.S. economy. However there are still plenty of reasons why the Fed may not want to appear overly hawkish and therefore quite a bit of uncertainty rests with tomorrow’s FOMC statement. We only expect the bare minimum from the Fed because they realize that at this critical juncture in the U.S. recovery, there are more consequences than benefits to being overly hawkish. Although we believe that the Fed will underwhelm, dollar bulls may not need much to be satisfied and therefore any subtle changes to the language of the FOMC statement could affect how the dollar trades. A more upbeat tone by the Fed would be positive for the dollar while skepticism about the sustainability of the improvements in the labor market or consumer spending could reverse the greenback’s recent gains. The tone of FOMC decision should determine how the dollar trades for the remainder of the year.
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One of the best and most simple patterns to find is the double top. While most intraday double tops will be a good resistance level and a possible intraday scalp area they are not all created equal. As traders all we look to do is put the odds in our favor. Therefore, technically we want to take advantage and read the best support/resistance levels possible.
When trading the double top pattern intraday we want to spot a top that occurred several days ago. In fact the longer back the better the odds. For example, look at the COST 15 minute chart the last time COST made a significant pivot high was on December 7th around the 59.75 level. Then today at the open COST trades up to that same level and then sells off. Always keep a 10 day chart up on the smaller time frames as this will help you identify prior major resistance levels.
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U.S. DOLLAR: POSITIONING AHEAD FOMC
The U.S. dollar rose to a 2 month high against the euro ahead of the Federal Reserve’s monetary policy announcement on Wednesday. Based upon the price action in the forex, equity and bond markets, traders across different asset classes are all positioning for a hawkish outcome from the Fed. This suggests that if there was a disappointment, it would come in the form of an unchanged rather than hawkish monetary policy statement. However this does not mean that a hawkish statement would elicit a weaker reaction in the forex market than a dovish statement because currency traders are not over weighted U.S. dollars. Instead, the tone of FOMC decision should determine how the dollar trades for the remainder of the year.
What to Expect from the Fed
The 3 things that investors will be looking for tomorrow will be the tone of the FOMC statement, changes to the discount rate and any plans to end emergency programs. The sharp moderation in job losses and improvement in consumer spending will encourage the Federal Reserve to grow more comfortable with the outlook for the U.S. economy. However there are still plenty of reasons why the Fed may not want to appear overly hawkish and therefore quite a bit of uncertainty rests with tomorrow’s FOMC statement. We only expect the bare minimum from the Fed because they realize that at this critical juncture in the U.S. recovery, there are more consequences than benefits to being overly hawkish. Although we believe that the Fed will underwhelm, dollar bulls may not need much to be satisfied and therefore any subtle changes to the language of the FOMC statement could affect how the dollar trades. A more upbeat tone by the Fed would be positive for the dollar while skepticism about the sustainability of the improvements in the labor market or consumer spending could reverse the greenback’s recent gains. For more on these 3 items that the market wants the Fed to address, read our FOMC Preview.
Economic Data: Good News and Bad News
Meanwhile a round of mixed U.S. economic data has not stopped the dollar from rising. Producer prices which measures wholesale level inflation increased 1.8 percent in November with core prices rising 0.5 percent. On an annualized basis, PPI rose by the strongest pace since October 2008. Unsurprisingly, the weakness of the U.S. dollar, rise in gasoline and other energy prices played a big role in pushing PPI higher but aside from a drop in the price of passenger cars and computers, stronger price pressures was seen everywhere. However unlike oil prices, gas prices fell gradually last month which means that even though we also expect consumer prices which are due for release tomorrow to rise, the pace of growth may not be as strong as PPI. Stronger inflationary pressures, a pickup in consumer spending and a dramatic improvement in the labor market should encourage the Fed to adopt a more hawkish tone on Wednesday. Unfortunately the sharp drop in the Empire State Manufacturing survey will make it difficult for the Fed to be anything more than cautiously optimistic. The index fell from 23.51 to a five month low of 2.55 which indicates that manufacturing activity slowed significantly last month. The only saving grace is the rise in industrial production in November and the increase in capacity utilization which suggests that the slowdown in the NY region may be unique to the Empire State. The Treasury International Capital flow report was conflicting with demand for long term securities increasing but demand for short term securities falling. However the key takeaway is that foreign officials which include central banks boosted their holdings of U.S. dollars by $14.6B, the largest increase in 4 months. Aside from CPI, the current account balance for the third quarter, housing starts and building permits are also due for release. The decline in the NAHB housing market index which measures builder confidence suggests that that like the manufacturing sector, the pace of activity in the housing market may have slowed.
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Is the bond market talking to us? The yield on the 10 year Treasury note is now at 3.61%. The 10 year Treasury note is by far the most important bond. Most of the mortgages are based off the 10 year note. The housing market is one area in the economy that is still facing major headwinds. Foreclosures and delinquent mortgages continue to rise. This fact remains even with the U.S. government offering an $8,000 tax credit for first time home buyers and the $6500 tax credit to anyone that buys a house. One can only think that the government and the Federal Reserve Bank do not want to see a rise on the 10 year Treasury note.Yields have been exceptionally low for quite some a while. However, there was something interesting that we noticed. The last time the 10- year yield hit 4.00% was in early June. This happened to coincide with a one month stock market pullback into July 10th 2009. This was the longest pullback in the stock market since the March lows. Did the 4.00% yield really affect the stock market in this negative way?There is an old saying on Wall Street that says 'the bond market knows best'. This could certainly be the case. The 10 year bond could be hinting that rates need to go up. What would happen to this stock rally if rates go higher? What is going to happen to the housing market if foreclosures and delinquencies continue to rise? Eventually the Federal Reserve bank will be forced to raise rates on would think. Remember the bubble that Alan Greenspan caused by lowering the Fed funds rate (overnight rate from the Federal Reserve Bank to large banks) to 1.00%. The current Fed Chairman Ben Bernanke has lowered rates to 0-0.25%.What happens from here? Is there another bubble in the making? These and many other questions remain to be seen. We shall all find out soon enough.
How the U.S. dollar trades for the remainder of the year will be largely dependent upon the outcome of Wednesday’s Federal Reserve monetary policy announcement. Over the past 2 weeks, the dollar has strengthened significantly and the central bank’s degree of hawkishness will determine whether the dollar will break its 3 month high against the euro. The sharp moderation in job losses and improvement in consumer spending will cause the Federal Reserve to grow more comfortable with the outlook for the U.S. economy. However there are still plenty of reasons why the Fed may not want to appear overly hawkish and therefore quite a bit of uncertainty rests with tomorrow’s FOMC statement. Although we believe that the Fed will underwhelm, dollar bulls may not need much to be satisfied and therefore any subtle changes to the language of the FOMC statement could affect how the dollar trades. A more upbeat tone by the Fed would be positive for the dollar while skepticism about the sustainability of the improvements in the labor market or consumer spending could reverse the greenback’s recent gains.
The 3 things that investors will be looking for tomorrow will be the tone of the FOMC statement, changes to the discount rate and any plans to end emergency programs. We only expect the bare minimum from the Fed because they realize that at this critical juncture in the U.S. recovery, there are more consequences than benefits to being overly hawkish. Now let’s take a look at these 3 questions in further detail:
1) What will be the Tone of the FOMC Statement?
The Federal Reserve provided very little optimism and very little action when they met on November 4th. At that time, the central bank was weary of a jobless recovery and losses in the commercial real estate sector. They were also mindful of the risks associated with a weak dollar and low interest rates. Since that meeting, the U.S. economy has improved. According to the table at the end of this article, the labor market has taken a turn for the better along with consumer spending and confidence. Inflationary pressures also accelerated, while asset prices increased. However the latest non-manufacturing ISM report indicated that activity contracted last month. Given that the service sector represents more than 70 percent of the U.S. economy, the slowdown is certainly worrisome. The manufacturing sector, which previously led the recovery, is also slowing. Furthermore, less than 36 hours after the non-farm payrolls report was released, Fed Chairman Ben Bernanke gave a speech warning about the risks facing the economy which suggests he is not convinced the improvements are here to stay. Therefore we expect a slightly more hawkish but still very cautious tone from the Fed which should help the dollar extend its gains. However the reaction in the dollar should be tempered by the strong likelihood of the Fed repeating the well worn statement that interest rates will remain “at exceptionally low levels” for an “extend period.”
2) Will the Fed Raise the Discount Rate?
Spurred by an article today’s Financial Times about the upcoming FOMC rate decision, there is now speculation that the central bank could raise the discount rate. In our view this is extremely unlikely because we expect the Fed to first announce plans to unwind some of their emergency measures before taking this relatively bold move. Raising the discount rate, which is the rate that regional Federal Reserve banks lend to commercial banks would carry with it hawkish monetary policy connotations. It also would be at odds with the Fed’s commitment to keep interest rates low and plans to taper off asset purchases. However the fact that the Financial Times has raised this option reflects the growing division within the FOMC. Certain Fed officials are more hawkish than others and we expect the division on monetary policy to increase as the economy continues to improve.
3) Will the Fed Announce Plans to Unwind Emergency Measures?
Given the Federal Reserve’s commitment to slow their pace of asset purchases over the next few months and to complete their program by the end of the first quarter, we expect the central bank to step up their plans to unwind emergency measures. There is a good chance that they will also end other emergency programs and any specifics on this front should also be positive for the U.S. dollar.
What to Expect for the EUR/USD
Although 1.45 is a significant support psychological support level for the EUR/USD, 1.44 is the true technical support as it represents the former breakout point in the EUR/USD back in September. If the Federal Reserve is hawkish enough to satisfy dollar bulls, expect this level to be tested. However if they fall short of market expectations and remains cautious, the EUR/USD could rebound back above the 100-day SMA at 1.4650.
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As the USD builds further strength, Wednesday's FOMC statement is deemed as the only major negative for the US currency in the event it reiterates the usual indication of: low interest rates for a considerable period; low resource utilization; and benign inflation. Any sign of an upgrade in the Fed's view or FRB's growth forecasts, credit markets would favour the USD's yield differential on the interpretation that the Fed intends to withdraw liquidity earlier than foreseen. USDX 55-day MA now becoming a key support after having served as a resistance over the last 8 months.
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