Currency Analysis and Updates

Tuesday, December 16, 2008

Still bearish USD

The monetary policy statement from the Fed will be key to watch today for signs that the Fed is planning on launching new, unprecedented measures like quantitative easing and even the extension of credit directly to corporations and consumers. It is clear from current credit spreads that hardly any credit is available on the open market as banks are hoarding reserves to protect their balance sheets. This is guaranteeing that the weakest corporations will default and an unprecedented squeeze on consumers that the Fed chairman no doubt fears would send the US economy staggering into what some have called stag-deflation (highly dangerous for growth as debts become more and more onerous in a deflationary, highly indebted economy). Bernanke has already forewarned the potential for the Fed to monetize debt with the purchase of US treasuries and has even brought up the idea of the Fed issuing its own debt. But how much sway does Mr. Bernanke hold over the FOMC? There are dissident voices... A mushy statement resulting from lack of unity in the FOMC could result in a USD rally if the USD has been selling off over fears of Fed/Treasury balance sheet profligacy - there are signs this is the case, but the disappearing yield in the US has been no bit player either. By the same token, a more clear voice showing intent to move rapidly toward alternative monetary measures would then supposedly be more USD bearish.

There are virtually no signs out there that risk conditions are improving, and we are a bit surprised to see equities trading as high as they have recently. Most risk spreads are getting worse and worse and it feels like something must give soon. Still, it is very difficult to gauge the market's potential for movement as we are reaching the calendar year-end and all of the lousy liquidity and unpredictable action that it entails. Remember the 2004-2005 transition: EURUSD rallied strongly to record highs on the final two days of the year, only to collapse starting on the very first trading day of the year such that it was trading over 800 pips lower by the end of the month of January. We're not saying that we expect a repeat, just that the transition to a new year could provide an important pivot point across markets - especially as we have seen a year of historical market moves.

CAD Review

CAD is looking weak again versus the broader market as the crude oil rally petered out quickly at the $50/barrel level and fell sharply from there all the way below $45 again - this is an especially bearish signal from crude considering the normally slavish reaction to a weaker USD from the energy market (it is also a USD booster generally we might add). If oil tumbles further, we would expect CAD to remain weak. EURCAD is shooting out the lights, but USDCAD needs to work its way back above 1.2500 to help prove that the lows are in for now.


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