Saturday, August 18, 2007

Euro reverts to bouncing around deep within its trading range - dollar strengthens

For all of the turmoil in the mortgage securities markets and the minor financial crisis it caused these past two weeks and even despite the heightened expectation that the Fed would be cutting interest rates multiple times over the coming year, the dollar strengthened against the euro. Even with market expectations of a Fed rate cut no later than next month and a discount rate cut already in hand, the euro still wasn't able to convincingly break out of the $1.37 to $1.38 upper end of its $1.33 to $1.38 trading range, and in fact slumped back into the middle of the range. The euro is no longer poised as if it might break out, but could still recover over the next few weeks. September futures for the euro closed at $1.3488 on Friday, 2.28 cents below the prior Friday close of $1.3716.

There are plenty of traders and speculators who would like to see the euro break $1.40, but whether there is really a net demand for the euro at these levels remains to be seen. I would give the euro bulls and dollar bears a couple of more weeks to see if the euro really wants to stay up at or above $1.37 and $1.38 before concluding that the euro is likely to weaken for the rest of the year.

Euro futures out at December 2008 were only at $1.3559 on Friday (compared to $1.3795 the previous Friday), so there isn't exactly a lot of "slam dunk" enthusiasm for betting on a $1.40 euro, so far.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, and a hint of a Fed rate hike in the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news or even mere anxiety to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."] It is certainly fun to chatter about how expensive things are for tourists in Europe, but there are other factors that are more significant as far as keeping prices high in Europe than the minor impact of foreign exchange rates.

-- Jack Krupansky


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