Focusing on ECB's Decision

02/03/2009 11:06 am EST

Focus: FOREX

As the European Central Bank (ECB) is meeting this week in Frankfurt, Germany, the European currency is testing support levels versus the US dollar. There is a 50/50 possibility of having rates moved this time. Nevertheless, more cuts are expected in the near future, since the economic growth is slumping across the entire European continent.

US: Time Running Out, Decisions Needed

After having passed through the House without any Republican support, the proposed $819 billion stimulus package will probably face a fierce opposition this week during the Senate's debate. Only a compromise between democratic and republican positions would unlock a dangerous situation. In effect, there is no room for costly delays, as time is running out, as are the number of solutions available. During the meeting last week, as an example, the Federal Reserve confirmed current policy on rates, but failed to announce when they would buy Treasury securities. It appeared clear, however, that the Fed is ready to improve its monetary assets anytime, and this might not be beneficial for the US dollar over the medium term. Over the short term, the greenback is still finding some support from the low inflationary environment, albeit the economy is still battling to find a way out of the crisis. The first estimate for the fourth quarter US gross domestic product (GDP) showed a 3.8% decline, better than the 5.5% expected, but still marking the worst number of the past 16 years. The decline was broad-based, with the exception of government spending, which increased almost 2.0%. On the contrary, consumer spending (two-thirds of US economic growth) receded 3.5% after declining 3.8% in the third quarter.

The new democratic administration is facing a challenging task, and mistakes would have a lethal impact on market sentiment. In January, the Conference Board consumer confidence index reached the lowest level in history (32 years) and fell to 37.7 from December's 38.6. More weakness is expected shortly, since the expectations index, which tracks the consumer prospective for the next six months, declined to 43.0 from 44.2. In fact, there is not much to rely on. As a result, marking the longest decline of the past 16 years, US durable goods orders slid for the fifth straight month in December (-2.6%) and are down almost 20% on an annual basis. In addition, the real estate market is still dancing near the bottom these past months, despite some signs of strength here and there. In December, existing home sales rose 6.5%, with three out of four regions registering a gain. Median prices are down 15.3% from last year, but inventories are declining and the number of unsold homes fell to 11.7% at current sale rates. A rebound might be possible this year with interest rates and home prices at bargain levels, but first, a base is needed to start prices moving higher again.

ECB Will Pause This Time?

The European currency is again under pressure, as ECB president Trichet did not exclude the possibility of rates declining below 2.0%. The swinging comments of the ECB president, from cutting rates one day, to holding them steady another, are instilling a sense of insecurity among European investors. In reality, rates should decline again this year by 25-50 basis points, even though a pause might be possible over the short term after last month's cut to 2.00%. The economic picture does not look well at all. In January, the unemployment rate moved up to 7.8% in Germany from 7.7% in December. There were 56,000 more people were out of work following the 18,000 registered the previous month. Germans stay nonetheless confident about their future, as the economic measures implemented by the government are getting into the economic system. The IFO business confidence survey moved up to 83.00 from 82.7 in December, while the future expectations index rose to 79.4 from 76.9.

In reality, the short/medium term prospective stays negative for the entire euro zone. In January, the euro zone economic business sentiment index declined to 68.9 from 70.4 in December. It represents the lowest level since 1985, and was broad-based among most sectors with the exception of retail trade. Consumer and industrial confidence stepped down to -31 and -34, respectively, the services index slumped to -22 from -17, and construction receded to -30 from -27. World demand is fading, while internal demand is not growing, and the current account deficit more than doubled in November to euro 16 billion from October's euro 6.0 billion.

GPB/USD Meeting Resistance |pagebreak|

EUR/USD is targeting the important support at 1.27/1.260. It corresponds to the lower Bollinger bands and the trend line from July. It might hold at first touch. A decline below 1.2390 would target 1.21/.19. A breakout failure would take the price to 1.34, eventually 1.40.

GBP/USD appears to be designing an interesting bullish pattern, considering the RSI divergence on the weekly and daily charts. The recent decline found some support at 1.36, and the rebound is challenging the first resistance at 1.45. However, a move above 1.4950 is necessary for a run to 1.52 - 1.55. A breakout failure would instead take the price back to the 1.38 - 1.36 range.

USD/JPY is moving laterally in a very tight consolidation. A decline below 85.50 would target 84.50 and 83.90. A breakout failure would take the price back again to 92.00 - 94.00.

USD/CAD continues consolidating between 1.30 and 1.180. The market found some support at 1.20 and could rebound to 1.26. A move below 1.1780 would instead target 1.16 - 1.14

By Angelo Airaghi of MG Financial Group

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