Forex Investment and Currency Trading

1 - 3 Month Outlook:

USD suffered staggering body blows in July with the collapse of IndyMac, the third largest banking failure in US history, and a near-death experience by mortgage giants Fannie Mae and Freddie Mac. USD wobbled and net USD shorts did increase, but USD did not test the March 17 low of 70.7. Its resiliency lends support to the view that USD bottomed in Q1. With confidence unstable, USD might struggle to show steady gains over the next 1-3 months, but it is poised to advance.

The response by Congress and the Administration to the Fannie Mae and Freddie Mac crisis suggests that concerns about systemic stability have peaked. Even so, more bank failures are likely, as the struggle of the US housing sector will continue to weigh on the financial sector, and household balance sheets. Signs of tentative stability in housing are just that, tentative. Delinquencies are still rising, an inventory overhang lingers that will weigh on house prices, mortgage rates have increased and credit standards have tightened sharply. These factors, along with still elevated energy prices, are key elements of the Fed’s concerns about growth over the next few quarters, and might blunt a USD recovery in the months ahead. They will also feature prominently in the Presidential election campaign.

There was one dissenter to the Fed’s August 5 decision to leave rates unchanged, Dallas’ Fisher. Philly’s Plosser, who had argued the need to hike rates “sooner rather than later” to fight inflation and defend Fed credibility voted with the majority suggesting there is little appetite to hike rates anytime soon. Oil’s retreat from US$147.3/b in mid-July to below US$120/b has helped boost US equity markets, and USD and might have helped ease some of the Fed’s “significant concern” about high inflation.

6 - 12 Month Outlook:

In the medium term also, market expects EUR/USD to trend steadily lower, with a mid-2009 target of 1.34. Although this is primarily driven by view that the USD recovery will be well underway in 2009, EUR-specific factors are also negative. In particular, when ECB does finally signal that rates have peaked (Q1 2009), it will also implicitly signal diminishing tolerance of a highly overvalued exchange rate. Market estimates currency suggest EUR/GBP is more than 30% above PPP, a larger misalignment than for any other G10 currency. Technically, prices must pierce 1.4586 in order to present strong evidence that a top is forming.