Bob and Ted's EUR/USD Outlook for week

Bob
This is a big week for the dollar as it defends its lines against a bullish euro which is seeking to reach the monumental 1.50 price level against the US currency for the first time ever. There are a lot of key data releases on the calendar, with downside risks for the dollar stemming from Retails Sales figures on Tuesday and Housing data Thursday. However the most important indicator on the calendar is Wednesday’s consumer price inflation numbers for December, which will give an indication as to just how much scope the Fed actually has for cutting interest rates. A 50 basis point cut at the end of January is a given at this stage, with Fed funds futures even pricing in the unlikely prospect of a 75 basis point cut. Either way it is difficult to see how the euro will not appreciate further against the dollar in a scenario where US interest rates are going to go lower than those in the euro zone at the end of this month and go significantly lower in the months to come. It now appears certain US interest rates will fall to at least 3.5% (and possibly to 3.25%) by March, while euro zone rates will remain on hold at 4.0% (or rise to 4.25%, if the ECB is to be listened to). That is a swing of at least 75 basis points to the euro on rate differentials from the current position and with further downside risks evident for the US economy, I believe the euro should be able to establish a period of trading above the 1.50 price level through much of the first quarter of the year. The dollar has essentially nothing going for it against the euro and with calls this week from Saudi Arabia’s largest bank for a removal of that country’s dollar peg, this adds further immediate pressure on the embattled US currency. We should see plenty of volatility this week, particularly if the euro gets close to the lifetime high at 1.4966 and edges towards the 1.50 price line. A convincing break above 1.50 could blow away all resistance that lies above this key level and we could rapidly witness a move near to 1.52. Central Banks have not issued any concerns about the euro’s lofty price level, so the chance of any market intervention from this quarter is pretty remote. The key days for price action are Monday through Thursday and upside targets are 1.4870, 1.4910, 1.4950, 1.4980, 1.50 and 1.51. Support will come at 1.4820, 1.4770, 1.47 and 1.4630.

Ted
This is an important week for US data and one which could decide what the Fed does when it delivers its first policy announcement of the year at the end of January. Markets have fully priced in a 0.5% cut this month with up to a further 75 basis points in cuts expected in the coming months. The Fed probably won’t disappoint in January, especially following Mr Bernanke’s dovish statement last week, but looking further ahead, the futures markets may be overly ambitious in terms of the level of easing it is pricing in. There is very much an inflation problem in the US and while all the focus has been on downside risks to growth, if inflation ticks up over the next couple of months the Fed’s hands will be tied in terms of how much it can ease in the current cycle. In fact justifiable criticism can be directed at the Fed for playing a high risk strategy, where it has parked inflation concerns in an environment where oil prices have risen 50% and reached $100 a barrel, during the short 4 month period in which they have been easing interest rates. The Fed’s biggest mistake was to give the market 50 basis points last September, something that sparked a false rally in equities and commodities, bringing equities to unsustainable levels, but oil prices have remained elevated ever since. Were the economic slowdown we are now experiencing primarily contained to the US, the Fed’s current policy would fail spectacularly, because the dollar would depreciate even further against its major rivals, global energy costs could continue to rise and oil and import inflation would put major pressure on US consumption and force the US economy into a sustained period of stagflation. It is a very dangerous balancing act the Fed has to undertake. This week’s consumer price data on Wednesday is critical for the fate of interest rates and the dollar. Also important in terms of market sentiment will be the Retail Sales number on Tuesday. A poor retail sales result will heighten concerns about the economy, although regardless of what the number prints, it is not going to change how far the Fed can go at the end of the month and by consequence what the market has already priced in. We will begin to see a growing realisation in coming weeks of a wider global slowdown and not just a US one, and this should help the US dollar against the euro. This week will be a difficult one for the dollar, with soft data expected for some key performance indicators, but if commodity prices come under serious pressure we could see a shift back into US assets which will boost the currency. The more evidence of a global slowdown we get, the more dislocated ECB monetary policy will begin to look and the heretofore teflon euro will become vulnerable. The dollar must hold the 1.4966 level this week and if it does this against a backdrop of weak US data, it will prove that resistance at 1.50 is quite formidable. Holding the lines might spark a sharp reversal, with a break below 1.4630 opening the way for a ner-term move back to 1.45. Downside targets are 1.4830, 1.4780, 1.47, 1.4640 and 1.4590. Key resistance points are 1.4966 and 1.5010.

Bob and Ted