A Forex View From Afar

A Fud Funds Futures Story

Written by A Forex View From Afar on Wednesday, July 30, 2008

Fed Funds Futures contracts are pricing a hold on overnight interest rates for the next meeting outcome, scheduled for 5th August.

If the Fed do hold, as the market expects, it will be the second FOMC meeting at which rates are kept at 2%. This after the Fed cut at the April meeting by 25 basis points. According to the Cleveland rate probability the market sees a 90% chance of a hold on Fed Funds next Tuesday.



Regarding future expectations, Fed Funds Futures are pricing a rate increase for the December settlement date. This outlook has the potential to influence the dollar’s valuation, especially if we add the data from the latest period, which suggest the US economy had found a bottom. The old greenback may be further empowered by the fact that the Eonia future contracts in Europe are starting slowly to move up, reflecting the market view that the ECB will likely hold rather than raise.

As such, the dollar bulls may overcome the market for the time being. However, these futures expectations may alter quickly once one of the central banks steps again in the market to do some more jawboning, keep your eye on the calendar; they tend to sneak these speeches in under the radar. Outside of hot air it does look as though the euro has some work to do to hold current valuations, and that makes 1.5550 a very pivotal area to work up or down from.

Are Banks A Good Bet? Part II

Written by A Forex View From Afar on Tuesday, July 29, 2008

After what we saw in the last day, a big No would be the answer. This article comes on top of the first part (although we didn't expected yesterday to happen so soon!).

Merrill Lynch had just announced it will sell $8.5 billion of stock and liquidate $30.6 billion of bonds in order to maintain its credit rating. The selling would go like this: $30.6bn CDOs sold to Lone Star for $6.7bn. That is the equivalent of 22 cents for every dollar (the word cheap is not enough to describe this transactions). In order for Lone Star fund to buy the Super Senior CDO, this is true, Merrill lent them $5bn. Again, Merrill lent $5bn to a fund so that the fund could buy assets worth of $6.7. Practically, Merrill gave away $30.6bn of paper for $1.7bn.

Within all of this we see that Merrill has quite a interesting background. This is Merrill's sixth write-down, after they said repeatedly there is no need to for additional capital, and that there would not be any other write-downs. Bank write-downs have reached $40bn at this stage. Last week, Merrill announced earnings, giving no signs as they would want to sell stocks or bonds. Usually the decision to sell assets would have been announced last week, with the earnings. The apparent reason was Merrill had only just taken the decision this week. Now we only have to find someone who could actually believe that a $6b loan on $30b of paper was thrown together over the weekend.

Anyway, Merrill is off by 55% this year. If they continue this way, the road is open for more losses, but at least they gave a sorely needed boost to the glass half full equity traders, and that fed itself nicely into Usd strength.

Are Banks A Good Bet?

Written by A Forex View From Afar on Monday, July 28, 2008

How much confidence do the financial markets have in banks? None, Zero, Nada – No matter how you say it, the result remains the same

TheLFB Jul 28 XLFThe XLF index, which tracks financial companies in the U.S. markets, has dropped more than 50% since the high that was made last summer and now the index is looking ready to push the price action under the 20 points area. This certainly shows investors’ trust is limited and that they do not want to be caught near any financial shares.

Then we have the bond yields of financial companies. Bonds are usually a form of loans used by financial companies to finance their asset acquisitions. A higher yield means investors do not value the bond and see it as a risky one (due to the reverse correlation between the bonds’ price and yield). Yields for financial companies are now at the highest point since 2000, but back then, the Fed Funds were at 6.5%. Right now, the Fed Funds are at 2%, making the spread between Treasuries, (considered a safe haven) and financial bonds, very steep. This shows investors require a higher premium for holding those bonds. For example, Lehman Brothers borrowing costs for its five-year bonds rose to 7.7%, while 5 year Treasuries are now trading at 3.26%, making the spread 4.44%


Even if the spread does not seem huge, we are speaking about losses reaching millions of dollars. Over time, higher premiums can translate into balance sheet losses since banks will have to pay back more to their lenders. If yields remain so high, and they probably will, the financials will have to carry a big weight over the coming quarters, longer than previously estimated.

Euro-zone Sentiment on the Slide

Written by A Forex View From Afar on Thursday, July 24, 2008

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Recently the Euro-zone has developed a new trend on the calendar by missing virtually every possible release that gauges investor sentiment and future expectations. From the simplest releases to the most complex, the Europeans have missed them all, and that in itself is very unusual, and bucks the trend.

On Thursday the Euro-area has three scheduled releases that can be used very well to gauge expectations: the German PMI (Purchase Managers Index), Euro-area PMI and the IFO release. The PMI release has shown clearly that the service and manufacturing side of the economy in the fifteen member states are in a contraction phase, and that analysts expect a further deterioration from last month. At the same time, the IFO surveys show the Business Climate index is barely holding onto positive ground and that future expectations are in a falling trend, and have been since September last year, reaching the lowest read of 94.7 last month.

If the analyst estimations are missed again on Thursday the euro may continue to tumble below the 1.5700 area, where it seems the pair may find a support for the time being. At this time the market is looking at long dollar positions and if the above works through, the market will have another reason to buy the dollar and sell the euro. In doing so it can really test the resolve of whoever has parked protective orders at 1.5650, because they are there, and at the same time test oil speculators resolve. A stronger dollar equates to weaker crude oil prices, and that may create a euro slide as inflation expectations and growth forecasts decline.

A day with a Wall Street Banker

Written by A Forex View From Afar on Wednesday, July 23, 2008

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08:00 Wake Up. Thank goodness for the 'mobile office'. Check that the web cam is switched off
09:00 Still in bed, reading WSJ/FT and criticizing the sub-prime mess
09:15 Check for any employees that may be late. They will get a penalty for that
09:35 Get the courage to come down from bed
10:30 Reach the office and the first coffee. 7/11, not Starbucks
11:00 Meet the parties that were scheduled at 09:00
11:15 Field the Treasury guy's calls saying that we are in deep trouble. The dollar is depreciating, because of smart-guys lending to clients with no income. The dollar has got dangerously low, and is affecting the asset/liabilities ratio
11:16 Call back the Treasury staff and tell them to relax, we take care of our own books. The accounting office will sort this out
11:25 Enjoy the in-house spa treatment
11:45 Field the accounting office calls saying that we are in bankruptcy. Oh no, No worries here. Tell him the treasury guys will sort it out. Note to self- Didn't he hear of the strong dollar gains lately that the treasury guys were looking for
12:05 Some newbie from the Fed calls me for some stress testing. Do we need that??? Stress is something that comes from too much coffee and our corporate policy restricts employees to a maximum of one coffee per day, 7/11, we are controlling expenses. So no stress here
12:06 Remember the old time when Ally was in charge. The only stress test back then was who sends the Fed Funds lower, us or the Fed
12:30 Lunch, followed closely by daily Midday sleep
15:15 The lending officers calls to approve some loans. Somebod with a minimal income wants a $3m house. Sure, no problem, approve them. They look like honest people, they'll pay it back, they did before
15:20 Call the Treasury to package the new $3m loan as AAA, and sell it. Instead of the risk that Mr 3m defaults we are going to buy some high quality bonds from Citi and UBS. We sell them brown paper, they give us quality paper back. Thank goodness that the rating agencies are behind the curve.
Note to self- Add the rating agencies to night-time prayers
15:21 The Treasury guys complain again about some ratios, but who cares about them? They said something about the dollar posting some gains? Or was it losses? Can't remember correctly, but who really cares
15:25 Switch to Bloomberg TV for the afternoon wrap. They said the dollar index lost 2 points today. Is that good or bad?
Note to self- Call the Treasury to confirm which way is good for the dollar
15:26 The same Bloomberg presenter said it was because of irresponsible lending and some bonds with a wrong ratings? This is good, right?
Note to self- Ensure that Mr 3m's docs do not contain my name
16:03 Find out that those bonds are ours.This is good, we are on TV with free positive publicity
16:10 Head home. Thinking the bonus this year. Our lending officers can't keep the pace with the requests, we buy quality paper from other banks and plus we get free publicity. The council will love me
16:12 Just found out our bank's share are down 15% this year. Good news indead.
Note to self- contact broker to buy more of our discounted shares.

The Fed and the Inflationary Dragon

Written by A Forex View From Afar on Wednesday, July 16, 2008

Inflation; this is what happens when the Fed listens to the market and cuts 75 basis points in inter-meetings, only days before the actual FOMC get-together. Cutting rates garners inflation and we are seeing it fan the dragon’s flames right now. Inflation year-over-year reached an astonishing 5% in the U.S. and is now at the highest inflation level reached since 1992. The CPI release showed the biggest monthly gain since 1991 and the second second-largest rise since 1982.

Loose monetary policy is to blame for the current inflation levels. That, added to the fact that many of the rate cuts still haven’t reached the real economy, increase the chances that those rate cuts that we have not yet felt in the economy will further strengthen the inflationary pressures. Usually a rate decision requires anywhere from 6 to 18 months to create an impact.

Having no real growth, as the Fed Chairman reiterated in his recent speeches, leaves no open door for a rate increase any time soon and thus, inflation may still have room to rise. Second round effects appear to be very near, since the high degree of inflation experienced within the transport index right now will soon reach the other CPI sectors, like food and apparel (which are currently experiencing deflation).

Weak growth coupled with an inflationary economy does not leave any other option now for the FOMC members but to jawbone their way through the summer. That is something we have got quite used to hearing from the Fed. Fed funds futures are already pricing in a hold for the next two meeting’s outcomes; it’s now time to see if the currency market will price in the dollar’s inflation. Starting from a base of huge support at 71.50 is a great place to start.

Meet the Super Fed

Written by A Forex View From Afar on Tuesday, July 15, 2008

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There are some people who like to focus only on one thing, and they usually
they have a highly effective way to reach their goals. At the same time,
there are others who like to focus on a lot of things all at the same time,
and due to resource scarcity, and not having enough time, money or simply
not having enough grey material, ( brain or intelligence), to focus on that
impressive number of details at once, they fail to achieve anything at all.

Usually, a Central Bank has two main focus points: fighting inflation and
assuring the stability of the financial sector. This is not the Federal
Reserve’s case, and they are assuring growth, low unemployment, fighting
inflation, financial stability, bailing out banks/realtors, regulating every
possible industry that has any connection with the financial sector,
assuring the investors buy the treasury yields and so on.

A little too many tasks for the Fed, some would say. We have to wonder how
exactly the bank will reach any of this targets since inflation is sky-high,
there is no growth, there is no financial stability (just watch the XLF, the
exchange traded fund for the financial sector), who would want to buy a
treasury now that pays 2% annually when the dollar looses that much in a
month?

The dollar index has bounced off support, the market has not been able to
find sellers down there, and that may be due to the fact that Central banks
around the world need a stronger dollar so that their regional currency does
not suffer dollar inflation. A stronger dollar also then eliminates the
speculative part of the oil bubble. We’ll see it in the Swiss franc. Watch
that daily chart; it is forming a possible swing point long that could get
confirmed this week. (No laughing, the technical oversold reversal may be
coming).

$/Equity and €/Oil Link. Chicken or the Egg

Written by A Forex View From Afar on Monday, July 14, 2008

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Today two major events happened, the first was the bail-out of the GSE companies, (Freddie Mac and Fannie Mae), and the second was the plan to once again allow offshore drilling in the U.S.

In big-picture terms, both are ‘dollar positive’ news items;

Equities. If the bail-out creates a new bottom in equities, the same as it did the last time a bank was helped by the Fed (the Bear Stearns case), it will equate to no more flights to safety, the treasury yields will actually start once again to rise, and they in turn will start to instigate dollar buying, but only once the confidence to commit to stocks returns. If that sounds like a big ask all we have to think back to is March 16th, the day before the Bear Stearns bailout, and recall just how depressing the environment looked then. Has it got worse since?

The answer in reality is no, it has not got any worse, but neither has it got any better. That conundrum is right now creating the guessing game on the dollar valuations. Both Fundamental and Technical traders have the same issue to deal with here in trying to assess where the breaks will come from, and whether they will hold, on the major pairs.

Oil.The euro has a very strong correlation with oil; at over 93% in the last year, according to Bloomberg, it eclipses the historical Usd/Cad link. If the plan to allow offshore drilling in the U.S. is approved then over time we will see more oil contracts hitting the market, thereby restricting the speculative interest in the overly-inflated crude oil prices. This will automatically empower the dollar, and de-value the euro.

So, how low can the dollar go? If the above moves take place, not too low it seems. The real test will be the dollar index reaction to a test of 71.50. We will see it in the 4 hour charts, the ones that right now are looking a little strained under dollar selling pressure.

Euro and Pound analysis

Written by A Forex View From Afar on Sunday, July 13, 2008

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A heavy calendar awaits the euro, and in general most currency pair next week as a lot of red-noted releases are scheduled almost every day, but the core will be on Tuesday and Wednesday; Retail sales, Mr. Bernanke testimony, and soon after that the CPI and PPI releases from both areas, then we have the FOMC minutes - every one of this releases has the potential to completely shift the market sentiment, especially as they will be released one after the other.

The euro had a very strong week (well a strong friday actually), gaining nearly 250 pips as the whole market was dumping dollar, especially in that last days when the market remembered that the credit crunch isn’t over and that the financial institutions are close to crawling on their knees. In this climate, the euro managed to break above the 1.58 resistance that had held down the pair for some time, and close the week in the 1.59 area. If all of this would have happened on Wednesday and not Friday, we would probably be speaking about a new all times high on the euro, and about the ECB preparing some jawboning so that we could all jump on the short side of things.

The question that arises now is how long the euro can keep this valuation. On one side, we have the US economy which it seemed had bottomed, with the worst behind it (although the future isn’t exactly too bright, or too clear, either). On the other side we have the Euro-zone, a 15 strong group of countries whos economies seem to be slowing. The major distress is that a euro zone slow-down is not yet in the pair’s valuation, although trade desks should slowly start to price it in.

The chart shows that the euro is trading in a regression channel and we just hit the middle line of it. It can clearly be seen how strong the support trend-line is, since the pair never wasted too much time near it, or had ever the strength to break it. Also, it can be clearly be seen that the euro likes to trend until it hits a”.00” resistance area. First it was 1.5000 when the pair needed a lot of momentum to break higher. Now it’s 1.6000




The pound’s long term outlook certainly remains on the downside as the UK economy seems to follow very closely the US, and it has not yet gone through what the U.S. looks to be coming out of. That is the main difference between the two economies, the US is near the bottom phase, while the UK is one step away from the contraction cycle.

The pound has a very heavy calendar this week, especially in the first three days of the new trading session. There will be the CPI and PPI reports, which would probably show inflation is building up undisturbed, and the housing numbers which will bring back to reality any pound bull.

House prices fell the most since 1993, consumer confidence hit an 18-year low, while the service, manufacturing and especially the construction parts of the economy are contracting at an increasing speed. The only indicator that is holding tight is retail sales, which easily beat estimates, but now everyone expects a major revision from those numbers as well. All of this points to the UK central bank probably following the Fed’s footsteps in the next months. A cut may be on the table and will probably start to be seen soon in the pound’s market valuation. Some analysts even say that another financial UK company will need a bail-out pretty soon if the credit market keeps deteriorating.

In the last trading days the pound was dragged higher by the whole market, all week gaining only 40 pips, and closing just underneath the 90 moving average. The pair has traded in a wide channel for almost half of year, but we will follow the “sell” side of this pair in the following weeks, but hopefully after one surge higher that fails at 2.0050.

It’s not the end of the world

Written by A Forex View From Afar on Friday, July 11, 2008

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It’s not the end of the world as we know it and it’s not the end of the financial world. More likely, it’s close to zilch with what is happening right now. The market had already received the antidote for both bankruptcies and high oil prices.

Fannie Mae and Freddie Mac may collapse, but so what? The government/Fed will soon jump to rescue the company to prevent a financial meltdown. Those two companies that did nothing more then fuel the housing boom are now feeling the effects of their own actions.

We must think that behind the companies’ portfolio lies thousands if not millions of families that need to have a roof above their heads. Behind those families and their house contract lies hundreds of investments banks, that won’t be let down by politicians that happily accept donations in their campaigns.

We already had one bailout, and things started to look much better soon after that. It was Bear Stearns back when the Fed first opened the door to their merger and investments office. The same department is probably rubbing their hands for another “acquisition” right now.

Apart from the shareholders, not too many people should worry about the outcome. Bear Stearns was the cause that confirmed the “too big to fail” is really too big to fail, there are no exceptions are made here. If things get worse, it’s very likely the same thing will happen, a bail-out will be signed in a matter of hours of the news that insolvency is here.

The two realtors companies triggered a chain reaction: euro at 1.59, aussie a new top, even the old and tired pound advanced, and of course oil was allowed to get close reaching the $150 barrier.

The question now arises of how long the euro can actually hold this valuation, since the Euro-area is slowing? There are already some voices saying that Q2 GDP will be close to nothing in the euro region. A weaker euro will drag oil lower too, that is of course if nothing further happens again in Nigeria or Iran.

So it’s not the end of the world. Things will resume the normal trend in the following weeks as the muddy water gets clearer. I’m really getting the impression this is the final push for the euro and aussie, keep an eye on the 4 hour charts for a little failure sometime this week.

Currency Trends for the second half of 2008

Written by A Forex View From Afar on Thursday, July 10, 2008

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For the second part of the year, I see foremost a slowdown for the major economies. The GDP numbers will be much lower than seen in Q1, for most economies, including Europe, Japan and UK. I do see a slightly bigger quarterly read for the US economy, and that may be bullish for the dollar.

In my view the feeble economies will be reflected in the currency pair valuations, which will mostly trade in wide ranges. There will be a race between which between the Euro-Zone and the US as to which shows the first signs of recovery, thus for the euro, I see a prologue period ranging between the 1.53 and 1.58 levels, maybe finally managing to break somewhere lower. For the year end, 1.50 will be my target. The main reason being that we have not yet begun the real pull-back in the European Union releases, but have heard that most member states are struggling for growth in H2 2008.

The Housing sector will find a bottom somewhere between the end of the third quarter and the start of the first in 2009, which will be seen in the GDP read. I do not expect the US GDP, in Q4 to be over 0.5% (or 2% annualized), while the European GDP can be expected somewhere around the 0.7% area.

The Pound will be dragged lower by an economy that is moving at a stalling speed. The UK housing market will not find a bottom anywhere near year-end 2008, and will continue to drag the real economy lower. Just what the U.S. is coming out of in 2009 the U.K. will be going into the heart of. The $2 parity will be a forgotten dream in just a few months, but I do expect the pair to slowly move lower, rather than tanking, and do see it having some fights on its way down as fair value is found day-to-day. I do expect the pair to reach the 1.9200 area, but not to hold down there for too long. For the year-end, the 1.9300-1.9500 area could be a good target.

What I do expect to see is to see the yen-equities correlation further separate in the coming months. Thus, I see the S&P falling, and in the worst case to somewhere around the 1150. I do see it soon recovering from that drop and slowly move up. My read for the year end is somewhere in the 1400-1500 area. For the UsdYen, I can’t see it going lower than the 103.00. Once it reaches that area (and maybe 105.00 will hold it up and stop the rot), it will slowly move up toward the 108.00 area and stay there for a long period. At the beginning of 2009, the Yen will trade somewhere in the 112.00 area.

I do expect the swissy to move up for the rest of this year, battling the treasury note market, and tracking the yields that the Fed really need to keep inflated to attract overseas investment that funds the Current account imbalance. My target is somewhere around the 1.110 area for the year end.

For the aussie I expect to move lower, but to have a big fight on it’s way down. A slowing economy coupled with falling commodities, (in my view metals will drop in H2 2008), will be a drag on this pair, despite the huge swap interest that it pays. The 0.9000 area looks like a nice target for the year end.

As I said, I do expect commodities to move lower, they seem to be in a bubble, although I can’t see them poping, as usually happens in a bubbly enviroment. I expect commodities to move lower slowly over time, especially for oil that I see stairstepping lower as the global economy pulls back a little. My target is $90 per barrel for oil, which considering the oil prices just a few years ago I still see it very expensive

U.K Economy Going Lower

Written by A Forex View From Afar on Thursday, July 10, 2008

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The Bank of England faces a pretty hard situation: a stalling economy and a high degree of inflation. More and more economic releases point out a major slowdown, if not contraction, is coming.

House prices fell the most since 1993, consumer confidence hit an 18-year low, while the service, manufacturing and especially the construction parts of the economy are contracting at an increasing speed. The only indicator that is holding tight is retail sales, which easily beat estimates, but now everyone expects a major revision from it. All of this points to the UK central bank iprobably following the Fed’s footsteps in the next months.

A cut may be on the table and will probably start to be seen soon in the pound’s market valuation. Who knows, maybe the BoE will even open its own “mergers and acquisitions” department, as the Fed did. This may be the ultimate sell the rumor, and buy the news, of a U.K. rate cut.

The credit crunch's effects over the real economy

Written by A Forex View From Afar on Wednesday, July 09, 2008

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The credit crunch is here and despite most analyst estimates, including Fed economist, the credit crunch has not been contained and it did spill over the real economy.

Excluding the credit crunch’s effects we see on a daily basis, like a weak dollar, high gas and oil prices, and a bear stock market shaking at the smallest sound of trouble ahead, the credit crunch is starting to reach were it hurts the most: in the money supply side.

A chart provided by Bloomberg, tracking the Fed’s loan officer surveys, shows that credit is harder to get and especially more expensive then ever. That is quite strange to have the highest borrowing cost in the last few years at the same time that the Fed Funds are at 2%, near their historical lows; this is the crude reality, interest rate cuts do not impress a credit decimated market it seems. Banks are crippled by the credit crunch and this is reflected in the credit cost.



The easing in Fed Funds was used to promote a cheap money policy (flooding the financial arteries with money) but it seems that these lower rate funds never reached the end-user, the consumer, and will not reach them in the coming period either.

Cutting the consumer’s safety net- their credit line- especially in a country like the U.S. where the saving rate is negative, does nothing more then fuel even more the economic slowdown. An large part of the economy relies on consumer spending, about 70% and that GDP component will soon have a surprise; a consumer with no money in their pockets complaining about the high prices. Add to that, gas running near $4 per barrel.

Putting this all together reveals that the slowdown will continue far into 2008 and maybe in 2009 despite all of the 2-4% GDP in Q4 headlines that we are seeing. The U.S. is not alone, the same credit crunch is happening in Europe and in the UK, so the dollar won’t get too much weaker than it is right now. My long term view remains stable at this point in time; a prolonged range on the euro, having two economies in a visible slowdown, but one of them ahead of the Credit Crunch curve, the U.S.

Source:
Bloomberg: U.S. Credit Crunch Is Worsening, Nomura Says: Chart of the Day

Even the Fed’s members are gloomy

Written by A Forex View From Afar on Monday, July 07, 2008

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Today, the Federal Reserve Bank of San Francisco President Janet Yellen laid a gloomy outlook for the coming months in a speech at the University of California San Diego’s Economics Roundtable.

Mr. Janet Yellen said credit conditions are still tight, despite the Fed’s more than 300 basis points cut. Inflation expectations are still anchored, despite the fact that she expects inflationary pressures to persist as a problem in the coming months.
Speaking about the housing market, the current problems will continue throughout 2009 as residences in some areas can still be considered too expensive in the current lending climate.

Well, until now she didn’t say anything new, I just do not know from where she took the “inflation expectations as reasonably well anchored” part, when you have the CPI running at over 4%. Probably because she is the one who will have to keep inflation expectations tight and at the same time assure us that the CPI will not get too high. It seems that the Fed partially failed in fulfilling its mandate.

What I really liked in her speech is she admitted that “a few months of data don’t make a trend, particularly because we can’t be sure how large the effects of the roughly $100 billion temporary tax rebate program have been.” Now, if even a Fed member is not sure how much of an impact the free $600 had, than who should. Those analysts who modify their forecast every few months? To me, it’s quite strange to hear something like this from a person who sets the monetary policy.

Furthermore, having the Fed not sure what are the rebate’s effects over the real economy, we could have a plausible explanation why there was such a drastic change in monetary policy lately; from cutting rates inter-meeting, straight away then going to a 'wait and see policy'.

These put together, reassures me that the Fed will stay on hold for the time being, not moving the Fed Funds anywhere and only jawboning about inflation, which in turn should empower the dollar. So, compared to the currency on the other side of that trade you are just about to take, does the dollar look that weak any more? Unlike most regions right now, there is no chance of a cut coming from the Fed it seems, the euro, pound, aussie and yen may want to keep an eye on the market's feel of their fair value.

The Big Mac Index

Written by A Forex View From Afar on Sunday, July 06, 2008

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Classic financial theory states that any given asset should have the same price anywhere in the world.

But things don't work this way it seems, identical assets have different prices from country to country. Economists like to put these different values on the currency shoulders, considering expensive assets are backed by over-valued currencies.

This analysis is called Purchasing Power Parity (PPP) and is used to measure the influence of the exchange rate over the same asset in two different countries.

Editors from the Economist found a unique way of measuring the PPP by using a matchless asset, the Big Mac. The hamburger was chosen due to world-wide spread and availability. The Big Mac index was started in 1986 and is measured annually, showing which currencies are over/under valued.



The swings in the Big Mac index takes years to happen, if ever, so this is why the index is often avoided by currency traders, who focus more on short term trades. Using this for real world trades, the 2007 Big Mac Index showed that the most overvalued currency was the Icelandic kroner, by 123%, against the dollar. This is quite interesting, since recently the kroner was hit by a currency crisis, depreciating at a very fast pace.

The most undervalued currency in 2007 was the Chinese yuan, by 55%. No wonder the Chinese government was accused of manipulating its currency to help exporters.

The Big Mac Index has its own limitations too. The price of a McDonald's meal depends on a lot of variables. Just to name a few: taxes, competition, import functions.

The Big Mac can be a good long time indicator for the currency trends, but these imbalances take years to correct and most importantly, the price of eating out at the local Mac doesn't represent the whole economy.

Press Conference: Prepare to assure price stability

Written by A Forex View From Afar on Thursday, July 03, 2008

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• Weak real GDP growth in the second quarter of 2008
• Expectation of moderate ongoing growth
• Domestic and foreign demand are expected to support real GDP growth, albeit to a lesser extent than during 2007
• Growth in the world economy is expected to remain resilient, benefiting from growth in emerging economies
• Fundamentals of the euro area economy remain sound
• Euro area does not suffer from major imbalances
• Employment rates and labor force participation have increased significantly in recent years
• Unemployment rates have fallen to levels not seen for 25 years
• Uncertainty surrounding the outlook for economic activity remains high
• Risks stem from the dampening impact on consumption and investment of further unanticipated increases in energy and food prices
• Risks continue for the ongoing financial market tensions to affect the real economy more than anticipated
• Annual HICP inflation has remained well above the level consistent with price stability
• On the basis of current futures prices for these commodities, the HICP is likely to remain well above 2% for quite some time, moderating only gradually in 2009
• Experiencing a protracted period of high annual rates of inflation, which is likely to be more persistent than anticipated some months ago
• Risks to price stability for the medium-term horizon remain on the upside and have increased further over the past few months
• Strong concern that price and wage-setting behavior could add to inflationary pressures via broadly based second-round effects
• Imperative to ensure that medium to longer-term inflation expectations remain firmly anchored
• Upside risks to price stability at medium to longer-term horizons
• Sustained underlying strength of monetary and credit expansion has created upside risks to price stability
• Annual M3 growth has remained very vigorous in recent months, supported by the continued strong growth of MFI loans to the private sector
• Monetary analysis clearly confirms the assessment of increasing upside risks to price stability over the medium term
• Very vigorous money and credit growth and the absence thus far of significant constraints on bank loan supply
• Risk of countries’ budget deficits coming close to or even exceeding the 3% of GDP reference value has increased

During the ECB press conference we saw the same Trichet, he is ready to counter inflation at any given time. The Governor said that the growth rate in Q2 is expected to slow, in part due to a strong Q1 growth and they should be analyzed together. During the rest of the session, Mr. Trichet re-iterated the same things as in the last conferences: wage-growth to add to inflation, price stability is essential, euro-area fundamentals are safe, and strong money supply will contribute to inflation.

During the Q&A session Mr. Trichet accentuated that the Governing Council has no bias and they are not committed, but are prepared to assure price stability over the medium term. After this sentence was uttered, the euro selling seemed to stop, at least for a while, after loosing more then 150 pips since the session began.

When the release data doesn’t match

Written by A Forex View From Afar on Wednesday, July 02, 2008

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For some time we have heard that the export industry is thriving under a weaker dollar, but that cannot be seen in the statistics.

It’s true that the ISM release shows that the export industry is expanding, and has been for a long period of time. But it’s expanding at a sluggish pace, with the reading barely above the 50 line, and expansion getting slower and slower.

What is more important is that the export industry numbers cannot be seen where it is critical to see them; in the trade balance. If there really was a strong and flourishing export industry then the trade deficit should have shrunk a little, especially now that the weak dollar is on everyone’s lips, and consumers appear to have reduced their shopping trips for forign made imports. The trade deficit however is not shrinking, and at best the deficit still remains at a floating rate that is far too high for comfort.

The same export industry should have been seen in the employment data too. But it is not. The ADP release just showed that the goods producing industry shred 76k jobs, while the service industry got rid of 3k jobs. Service corporations shed 29k jobs in the last month, while small service business (less then 50 employers) added a robust 34k new jobs. The ADP release is inline with the ISM release, which shows the employment index is contracting at the fastest pace in 8 months.

All this put together shows that things may not improve too fast in the next few quarters, although some improvements can be seen. My call is for a 'no rate increase' on the horizon from the Fed, while the ECB will “unleash” a 25 basis points it seems. Let’s see if we have a classic case of “buy the rumor, sell the news” on the euro, because I can’t see the Euro-zone accepting too easily a 1.60 exchange rate on the eur/usd