Week of March 16, 2008-03-16

Highlights:

· USD weakness becoming extreme, no end in sight.
· Intervention prospects are low, but increasing.
· Fed rate decision on Tuesday; market desperate for relief.

USD weakness becoming extreme, no end in sight.

The USD's plunge accelerated further this week, with EUR/USD vaulting over 1.55 to nearly 1.57 and USD/JPY dropping under 100 for the first time since 1995. Gold prices traded through the $1000/oz. level and the Swiss franc hit parity with the USD for the first time in history. USD sentiment remains overwhelmingly bearish and there is a growing sense the dollar risks falling into a death spiral without official action (market intervention to buy USD) to stem its slide. A number of analysts are now on 'intervention watch.' While I agree that the USD's decline has become extreme and the risks of intervention have risen, I have yet to see any indication from G7 officials that they are gearing up for intervention.

Intervention prospects are low, but increasing.

The primary stumbling block remains US reluctance to interfere with market-driven price adjustments. European finance officials appear hesitant to take action unilaterally, with Eurozone group of finance ministers head Juncker this week indicating that intervention was not even discussed at the recent meeting. Japan is, of course, badly troubled by the weakness of USD/JPY, but the JPY remains relatively cheap compared to other currencies, so the case for unilateral Japanese intervention is also limited. Intervention works best when it is supported by monetary policy and economic fundamentals-it's easier to prop up a weak currency if that currency's interest rates are moving higher and growth is positive. In the current USD situation, those two conditions are clearly not met currently, and don't seem likely to be met for several months ahead at least, which also contributes to the reluctance of the US Treasury to support action. About the only element in favor of intervention at the moment would be 'surprise', catching the market off-guard, though that is beginning to fade. For traders looking to pick a bottom for the USD, I would not count on intervention materializing anytime soon. Intervention does become more likely if the death spiral scenario materializes, meaning 2-4% declines on successive trading days. In that event, however, long-USD positions are likely to be forced out before intervention would ever materialize. Traders are likely better advised to keep selling USD-rallies and taking profit as new lows are made. Bear in mind that many USD-pairs are in uncharted territory, keeping fresh USD selling somewhat ambivalent, which the specter of intervention also increases. As such, short-term volatility is likely to remain high, which should give patient traders opportunities to sell USD at better levels. Liquidity conditions will thin out as we head into the Easter Holiday at the end of next week, and that will likely also increase short-term volatility. As well, pay close attention to any shift in rhetoric from G3 (US, Eurozone, and Japan) finance officials suggesting intervention is being discussed.

Fed rate decision on Tuesday; market desperate for relief.

The FOMC will meet on Tuesday next week and the market is in complete panic-mode, with Fed Fund futures having priced in a roughly 50/50 likelihood of either a 75 bp or 100 bp rate cut. It seems that no matter how much the Fed cuts, it won't be enough to satisfy the market. Much of the hysteria developed on Friday as news broke of a NY Fed orchestrated bail-out of a key US brokerage. Prior to Friday, Fed Fund futures had not priced in any prospect of a 100 bp rate cut. When thinking of the Fed's decision, it's important to keep the troubled brokerage's plight in perspective as it was uniquely positioned to feel the pain of the mortgage-backed securities meltdown. This suggests other financial institutions are not necessarily in the same boat and that fears of a systemic collapse in banks is not warranted. That said, major banks and brokerages are reporting 1Q earnings next week and there will undoubtedly be additional write downs of impaired debt and likely quarterly losses at some firms. But the horizon clears up significantly after the 1Q results are out of the way. Turning back to the Fed, the near-tem US economic outlook has clearly weakened, with retail sales falling in February the latest evidence of consumers' retreat. The Fed has provided significant easing so far and looks to offer more as a short-term insurance, but the sixth-month outlook is largely a done deal at this point regardless of what the Fed does on Tuesday. My own expectation is that the Fed will deliver relatively less of a rate cut than markets are clamoring for, leaving room to maneuver in the event the downturn becomes more pronounced or prolonged. From a policy standpoint, the Fed is pursuing rate cuts to improve credit availability, but those efforts are stymied by the on-going credit squeeze. The Term Securities Lending Facility (TSLF) announced this week is intended to unblock the credit log-jam, but it won't come into effect until the end of March. Before the Fed begins slashing rates further, I think they will want to see how the TSLF works. I look for a 50-75 bps rate cut from the Fed on Tuesday; prior to today I would have squarely expected only 50 bps.

Key events to watch for next week

Remember that the Easter Holiday is approaching and it's a big holiday time for Europeans and Americans, so look for liquidity to thin out toward the end of next week and remain below normal in the following week. US data kicks off on Monday with the 4Q current account deficit, March NY Fed Empire Manufacturing Index, TIC data, industrial production and capacity utilization and the March NAHB Housing Market Index. Tuesday's highlight will be the FOMC rate decision in the afternoon, but the morning sees Feb. PPI, housing starts and building permits. Only weekly mortgage application data is out on Wednesday. Thursday sees Weekly jobless claims, the March Philadelphia Fed index, and Feb. leading indicators. No data is slated for Good Friday. Eurozone data is relatively light next week. On Monday we'll see 4Q Eurozone employment; Tuesday sees the release of a new growth forecast from the RWI institute in Germany; Wednesday sees Jan. Eurozone trade balance and construction output; Thursday sees Feb. German producer prices, preliminary March manufacturing PMI's for Germany, France and the Eurozone; Friday sees Feb. French consumer spending and Jan. Italian retail sales. UK data begins on Tuesday with Feb. CPI/RPI. Wednesday will see the BOE MPC minutes released, along with Feb. employment data and the CBI March industrial trends report. Thursday sees Feb. retail sales, Feb. money supply and public sector borrowing requirements. Japanese data begins on Monday morning in Tokyo with the Jan. Tertiary Industry Index followed in the afternoon by the final January leading economic index. Tuesday afternoon sees Feb. nationwide department store sales. Wednesday morning sees the January All Industry Activity index and the government's monthly economic assessment. Friday afternoon sees Feb. convenience store sales.