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The Case For Dollar Strength
©TheLFB Data [B]Analysis By NewsTraderFX[/B] [B]The Dollar[/B] appears to be gaining some traction. Although it is far too early to say that the ‘worm has turned’ at this point, here are a number of things we are looking at that could support the case for an eventual dollar rebound. The exact timing of the moves and the time that they take to get absorbed into the markets is hard to call, but we may be looking at holding Long Dollar trades for more than just the Bounce Days that we have got so used to if this does manage to follow through. [B]Fed Funds Implied Probabilities-[/B]There have been some remarkable changes recently in how the market sees the FOMC members making policy changes at the April 29-30 meeting and beyond. Four weeks ago, traders saw a 72% chance for a 50 basis point move in April and a 28% chance for 25 basis points. Last week, traders began seeing [I]no chance[/I] for a 50 basis point cut and now see an 18% chance the Fed will make no move at all (the rest of the bets are for a 25 basis point cut, which is the outcome that is most likely). What’s more, the chances of the Fed going below 2.0% on the overnight rate are decreasing rapidly-there currently is a 69% chance that the Fed will make no move at all at the June meeting. This doesn't mean the Fed is necessarily finished adjusting policy, but rather that a period to pause in order to assess the effectiveness of the policy changes that have already been made seems to be in order. [B]Martin Feldstein-[/B]According the the head of the NBER, who presented at Jackson Hole last summer and said the Fed needed to make a rapid series of rate reductions totaling at least 100 basis points, "it’s time for the Federal Reserve to stop reducing the federal funds rate, because the likely benefit is small compared to the potential damage," and there’s a danger that "lower interest rates could raise the already high prices of energy and food." According to Dr. Feldstein, lowering the overnight rate won’t do much good because "economic recovery will require resolving the difficult problems of the credit markets, dealing with the millions of homeowners who may now be tempted to default on mortgages that exceed the value of their homes, and reducing the risk that the ongoing decline in house prices will push millions of additional homeowners into a vulnerable, negative equity condition. A lower fed funds rate will not solve any of those problems." [B]Equity Markets-[/B]The Fed remains adamant that policy is not adjusted as a response to falling asset values in equity markets, however, the FOMC has seen what happens when policy is not adjusted to the degree the market is looking for. There’s no question that stock markets fell in October and December in part because the Fed did not move to the degree that the market saw as being necessary. What's happened over the last two weeks is that equities have gained [I]even as expectations for rate cuts have diminished[/I], a clear sign the market is becoming more comfortable with having the Fed on hold for the time being. [B]The FOMC-[/B]There’s evidence that policy makers may want to pause now in order to give the actions they have already taken time to work their way into the system. Fed Governor Kevin Warsh said last week that as credit markets begin to operate more smoothly, more of the Fed’s interest-rate cuts will filter through to the economy. "The problems afflicting our financial markets are indeed long-in-the-making," he said. "Time is an essential tool of our policy response." [B]The Dollar Index-[/B]The index lost 14.2% from May 14 2007 to April 22, 2008 however, starting on March 20 the chart began to show a bullish divergence on the MACD, a technical sign that indicates the long descent may be coming to an end (at least for the time being). The Dollar has already been in a strengthening trend against some of the components that make up the index. The Pound (11.9% of the Index) has been losing ground since the middle of March and the same thing has been happening against the Yen (13.6% of the Index). The Canadian Dollar (9.1% of the Index) has been in a 400 pip trading range since mid December and has been in a downtrend since the early part of March. The Swiss Franc (3.6% of the Index) couldn’t hold parity and has been losing ground in April while another bullish MACD divergence builds against the Swedish Krona (4.2% of the Index). [IMG]http://www.thelfb.com/wp-content/uploads/03-28-08/TheLFB-SP-.JPG[/IMG] This matches up very well with what’s happening on EUR/USD, as the Euro comprises 57.6% of the basket of currencies that make up the Dollar Index. [IMG]http://www.thelfb.com/wp-content/uploads/03-28-08/TheLFB-Bullish-Divergance.JPG[/IMG] [B]Going Forward-[/B]While the case for the Dollar strengthening can certainly be made, it may be that the Dollar is not ready to make a really strong run up against the Euro just yet. A technical sign that we are looking for is to see the Euro make one more rise against the Dollar to a price that closes on a Daily candle with the stochastic indicator showing overbought, but at a price that’s [I]lower[/I] than the closing price on April 16 at 1.5946. That will place EUR/USD in a ‘Double Stochastic Over-Bought’ (DS OB) formation, which may signal that the Dollar is ready to make an initial run against the Euro. And while we can't promise this will show up on the charts (and certainly the Dollar can gain without this occurring) we have found this to be a very reliable technical indicator. [B]To hold the moves,[/B] and cement a trend that looks realistically capable of maintaining itself for good Dollar appreciation over a sustained period of time requires that a number of economic factors fall into place. [B]The Fed:[/B] We've spoken about a likely pause in the easing cycle. We did not say the easing cycle has necessarily ended. Obviously, the Dollar cannot maintain momentum if it becomes apparent the Fed needs to reduce interest rates further. [B]Jobs:[/B] The economy lost nearly a quarter of a million jobs in Q1 2008, so a positive NFP number in Q2 will need to be seen. [B]Energy Inflation/Consumer Spending:[/B] With Consumer Confidence currently at 26 year lows due in large part to rising energy costs, the price of oil may need to be heading towards $90 a barrel in order to stimulate consumer spending on discretionary items. Overall confidence in stable prices is also reflected in the price of Gold; Gold heading towards $750 an ounce indicates that investors see less need for an inflation hedge. [B]Housing:[/B] If you are of the belief in the old adage that says housing leads the economy into and out of recession, you'll want to see the overhang on US Housing Inventories working down to six months. No economist will even begin to talk about a housing bottom without at least one quarter of inventory reduction. The Technical set-up will need more than a little help from the Fundamentals and that may take a little while in coming outside of the initial moves lower that may come. [B]TheLFB[/B] have spent the last nine months looking at buying the dips on the Euro, and as recently as late January signaled a Blow-Out Bottom on the major pairs that went on to move the Euro from 1.4650 to 1.5950. Those were Fundamentally and Technically backed. It could be that the Fundamentals may be starting to signal that the USD may have based, and if so this may be one of the last Buy The Dips that we get a chance to follow for a little while on Eur/Usd if this comes to pass. A Big If? We'll soon see; we have not turned into rampaging Dollar Bulls, after all one sunny day does not make a Summer, but our radar is running. [B]NewsTraderFX[/B]
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