For How Long, Fed and ECB Will Hold Rates Steady?

The U.S. Congress has finally approved the economic recovery plan, but more time is needed to have the economy moving again in the United States. In effect, consumes are fading, while the number of unemployed is increasing. In Europe, at the same time, the financial crisis is just worsening, as banks rely on ECB's lending facility to raise cash against eventual bailouts. The U.S. dollar is testing key resistance lines, although the long term scenario remains negative for the greenback.

Government's job almost done, then the Fed's again

At end, there were light. Following a few days of tight debate, the USD 700 billion bill plan has been finally approved by both the Senate and the House of Representatives. The bill includes many items such as few tax offerings and an increase of the FDIC insurance limits to USD 250,000 for each account from USD 100,000. Would it calm investor fear and give some vitality to the battered markets? Time will tell. However, the current financial meltdown has hit strongly the U.S. economy and more time is needed to have things moving again. Foreign investors remain skeptical about the safety of U.S. assets. So, the inflow of money into the U.S. could be very slow and the U.S. taxpayers will have to take charge of the financial burden, once the current turmoil will subside. Under these conditions, financing the still enormous current account deficit will be very challenging. The Federal Reserve might cut rates again this year, or at the beginning of next year, to bring fresh liquidity to the markets. In effect, housing is still in a steep downtrend, the Case/Shiller house price index fell 16.3% year on year in July, and the number of unemployed is increasing.

Capital spending falling in the U.S.

In September, there were 159,000 new persons without work (107,000 expected) on the top of the decline of 73,000 registered in August. The unemployment rate is now at 6.1%, unchanged from August, but above the 5.7% registered in July. Most of the sectors showed a loss, including the service industries, and the average workweek is now at 33.6 hours from 33.7 hours. Along with the economic slowdown, consumes are softening. In August, the personal consumer expenditure (PCE) was unchanged (+0.2% expected), after rising 0.1% in July, despite income moving up 0.5%. In reality, capital spending has been declining since the beginning of the year and the trend might continue in the future as well. In September, the ISM manufacturing index slumped to 43.5 (49.6 expected) from 49.9 in August. All the index components are in recession. New order slid to 38.8 from 48.3, production moved down to 40.8 from 52.1 and employment fell to 41.8 from 49.7. The ISM services, at the contrary, stayed practically unchanged at 50.2 from 50. Nevertheless, the employment index confirmed the negative trend and fell to 44.2 from 45.4.

ECB holding, but not for too long

Despite the world falling into a recession, the European Central Bank (ECB) left once again rates unchanged at 4.25% last Thursday. The decision was widely expected, albeit still counter trending to current economic conditions. The governments of Belgium, Netherlands and Luxembourg, as an example, injected Euro 11.2 billion of capital into Fortis, while Hypo Real Estate received a loan guarantees from the German government. Finally, during the week-end, few European banks borrowed almost Euro 600 billion from the ECB marginal lending facility as an insurance against an hypothetical banking sell-off. In effect, Mr. Trichet acknowledged that the economic activity could deteriorate further, although German unemployment rate declined to 7.4% from 7.6% in September. Consequently, inflation containment is still the target, but opportunities to cut rates are increasing, as oil is receding from the highs. In August, the Euro zone Producer Price Index (PPI) moved down to 8.5% year on year from 9.2% in July.

In September, the Bloomberg Euro zone Retail Purchasing Manager's Index (PMI), which is based on a survey done in the middle of the month to more than 1000 retail executives, declined for the fourth consecutive month to 46.2 from 47.7. Losses were registered in Germany and Italy, while France showed only minor changes. Recent data is only confirming the final reading of the Purchasing Manager's Index for services which was 48.4 in September, slightly below August numbers of 48.5. The PMI manufacturing declined instead to 45.0 from 47.6. So, the Euro zone economic confidence fell to the lowest level of the past seven years and it is near where it was in 2001. Construction, industry and services were among the worst beaten by the crisis. In France, housing starts declined 13.1% (-10% expected) year on year in the three months to August, faster than the 11.8% seen during the previous period, and housing permits fell almost 20.0% (-17% expected).

EURO/USD: at key support lines

EUR/USD moved below the important support line at 1.3850 and declined to the key level at 1.3550. The market appears to be oversold. In fact, there is a strong divergence between the Rsi indicator the current chart pattern. A move above 1.3890 would take the price to 1.41, eventually 1.43. On the downside, the next target could eventually be 1.3250.

GBP/USD quickly reached the important support lines at 1.74/1.75. They correspond to two long term trendlines. As a result, a bold move below 1.7330 is necessary for 1.7050. A breakout failure would complete the double bottom formation and take the price back to 1.82, 1.84.

USD/JPY is consolidating within 1.0350 and 1.0750. A decline below 1.0280 would target 1.020, 1.0150. A move above 1.0835 would bring the price to 1.09, eventually 110.50.

USD/CAD moved above the important resistance at 1.0450 and is targeting 1.0850, 1.0950. These levels are in conjunction of various trendlines. A move above 1.0990 is necessary to target 110.50, 111.20.

Angelo Airaghi
MG Financial Group
http://www.mgforex.com

Angelo Airaghi is a Commodity Trading Advisor, registered with the National Futures Association and the Commodity Futures Trading Commission. He has been an active professional since 1990 working for major international financial companies. In the past 10 years, Angelo Airaghi has been an analyst and commentator for national and international media.

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