Forex Investment and Currency Trading

One can almost hear the late-night TV monologue now – “I want to spend my tax rebate check, but it costs too much to drive to the mall!” While it might make good humor, it is getting uncomfortably close to reality.

The surge in energy prices shows most visibly at the gasoline pumps, with rough estimates suggesting each 10 cent rise in the price of gasoline drains about $10bn annually from consumer discretionary spending. The surge past $3.50 for the average price of regular gasoline, versus an average $3.04 during 4Q 2007, would suggest a potential drain of over $40bn (annual rate) during 2Q versus the holiday selling period of 2007.
While the CBO estimates that tax rebates will amount to $65-70bn, and those rebates are concentrated in the current quarter, the foresighted fiscal boost enacted earlier this year is being muted by the rise in gasoline prices. Adding in other energy costs (heating/cooling, airfares, etc) and the rise in food costs, the one-time tax rebates now appear unlikely to provide much of a boost to consumer demand during the months ahead. In fact, based on the consumer response in recent years, the tax rebates are likely only to prevent a significant consumer slowdown during the quarters ahead, with the deterioration of consumer sentiment
to new lows for the cycle suggesting a sluggish summer for US consumer spending (although tourists visits may help support spending gains).

In this context, the recent surge in US interest rate expectations appears tenuous. Based on Fed funds futures, the yearend Fed funds rate is now likely to reach 2.15%, almost 75bp above the low reached on March 17. To be sure, financial markets conditions are much more stable than in mid-March, with aggressive Fed initiatives reducing the most severe downside risks for the financial system. However, stabilizing financial sector risks does not necessarily imply stability in economic risks, and the surge in energy and food prices in recent weeks is probably, on balance, more damaging for the broad economy. While
heightened inflation fears continue to garner the attention of Fed policymakers, the prevailing view appears to anticipate restraint on sustainable inflation as the US output gap widens. In summary, as economic risks appear to be rising, suggesting the recent back-up in US interest rate expectations is unlikely to be sustained. In this context, new record lows for the USD versus major currencies remain likely during the weeks ahead.

Moreover, despite the steady rise in EUR/USD this month, speculative positioning has remained remarkably subdued, particularly versus core European currencies. In fact, speculative traders on the CFTC (April 15 data) had the largest long USD position versus the GBP since February 2006, and the aggregate USD position versus core European currencies (EUR+CHF+GBP) was a modest -$2.7bn, only just over 20% of the average such position since the beginning of 2006. And with the position only about 1/10th of the record net short last July, there appears to be significant further USD downside potential.

Accordingly, the break of EUR/USD through 1.60 today is European currencies. It is difficult to establish clear targets, with the USD moving into uncharted territory versus both the CHF and DEM and little clear support
before another 20% decline for the USD. While such a drop is very unlikely, it remains premature to position for what is likely to be a meaningful USD rebound during 2H 2008, particularly before key FOMC meetings on April 30, June 25 and August 5.