Fed Moves Emergency rate

The Federal Reserve raised on Thursday 18th the discount lending rate by a quarter point (from 0.25 to 0.75). The futures of the stock market overnight plugged directly after the announcement and it sent the Asian stock market to negative territory -2%.
After a long period of low interest rates inflation will be the threat for the next 2 years, The quantitative easing strategy is come to its end. The symbolic raise in the discount lending rate is the first milestone for future raise for benchmark interest. In the short term, we expect chairman of the federal reserve Ben Bernanke to ensure that the raise in the benchmark interest rates is not imminent while it actually is. As soon as we see low unemployment we can forecast a raise at any moment.

"Back to Normal Business"
Investors consider the world's financial system has been saved while there has been no substantial change in the financial system, investment banks and speculation can be back to normal business until the next bubble explodes.
Is it good news or bad news?
The change is actually some good news for the financial industry:
* This confirm the consolidation of the financial industry
* Financial institutions do not need "a rescue or emergency rate" that low since the profits and overall confidence between banks improves.
*Now the financial industry is stabilized, investors expect the real economy to confirm improvement with better results translated into corporate results.

Form a Forex perspective:
This is a normal move after the big fears of inflation due to the quantitative easing for too long Federal reserve has printed too much money.
Now we are going to fight inflation. If the inflation is as high as I think, we can expect the US Dollar to drop long term with short term consolidations every time the fed move the rate higher like on Thursday 18 feb, even if the raise was exclusively applied to the discount rate, investors can imagine a further tightening monetary policy.

Conclusion: We can see short term strength in the US dollar but probably long term fall.

If Central banks start to move rates independently, then we will be able to take carry trade opportunities each time. However, I suspect the Fed and ECB to raise fund rates in coordination in a similar fashion they lower them during the crisis.
*The Euro remains weak and maybe too dangerous to play against the dollar at this early stage after the Fed move. I would not recommend a buy in EUR/USD yet.

*However, a good technical opportunity can be to short USD/CHF.

Capital Markets
While I forecast a relative growth for the capital market indexes. I don't believe it is going to be a growth fundamentally based on the economy performance but the "Stock Market inflationary effect". Headlines will probably look for good news as a justification for the coming highs in the stock market while most of the primary effect will be inflation. We may see an relative growth in the stock market with corrections each time we see a raise in interest rates. The growth in interest rates will probably be gradual and carefully planned in the long run, as longer as it can be.
This is a typical effect, basically, we see cheap money (low interest rates) invested for a low price in the stock market (from March to April) then a short stabilization effect for the economy to respond slowly (April to February). Following we may see a lateral/down market due to profit taking and a remaining uncertainty for the next month and half. Then a sustainable growth in price with rhythmic correction each time interest rates are set higher. This last period is expected to last "as long as it can be sustainable for the borrower" i.e until the share of the interest payment in the annuity is higher than the amortization.
Strong inflation would be publicized as good inflation generated by an improvement on the economy and the stock market going up with financial reports justifying it but the actual reason is inflation and the consequences of the quantitative easing. (See: Stock Market Inflation Cycle, previous post).


The Stock Market Inflation Periodicity Theory

(Click the image below to enlarge)
*Model by: Joé Thierry Arys Ruiz © Traders & Analysts C.O. 2010 - All rights reserved

Phase A) Apocalypse: Crisis, Panic and Drastic Monetary Policy
After a Crash, Central Banks starts to lower interest rates drastically to stop the panic and incite investors to invest in the stock market motivating risk appetite with a low revenue in bonds. The problem is that confidence is gone and there is panic everywhere, the stock market plunges with short term picks/highs each time there is a drastic move to the downside of interest rates.

Bottom: Bottom in interest rates, Undervaluation and hope

Once interest rates can't go lower i.e near 0% , and the stock market has completely crashed. An undervalued stock market opportunity is pointed out and hope is feeding risk appetite. "Interest rates can't go lower, companies are fundamentally undervalued and the risk/reward worth it."

Phase B) Bounce:
Despite an economy still fragile, the stock market rises sharply principally because of two main factors:
The first is the tendency of the market to oversold a situation in advance in case of a further crash. The equity market often being used as a future indicator for the economy, oversold and overbought situations remain based on discounted future events. Equity is trading near par value and fundamental investors start to raise the buy flag.
The second and probably most important factor is the anticipated inflation who begins to surface, due to a weak monetary policy. Strong hands (Big Bankers, Institutional Investors, money managers...) enter the market: "If it doesn't climb for the economy it will climb because of inflation".

Phase C) Commercialization: Consolidation
Stimulated by a first intensive bounce of the equity markets, weak hands (non institutional investors, buy and hold public funds...) start to enter the market motivated by a strong marketing from institutional sales. Meanwhile, fears of inflation surge and uncertainty for the economy remains, strong hands take some profits and part of the paper is transferred from strong hands to weak hands. A short period of sideways/down fluctuations is the effect of these fears. Sales forces says: "Every drop is an opportunity to buy".

Phase D) Duration:
1-Monetary Management:
This is where Central Banks have to dose between inflation and growth. Central Banks have to prepare an exit strategy to remove the surplus of money that has been injected trough low interest rates. The whole strategy consist in slowly raise interest rates to fight inflation without stopping economic growth.

2- Deficit Management:
From a government perspective they have to deal between economic growth and budget deficit. After rescue plans, Keynesian policies, bailouts and stimulus packages, the budget deficit has exploded and the whole issue is to restore a balanced treasury by both reducing public spending and raising taxes; all without impeaching economic growth.

Phase E) Exhaustion
*Monetary bubble and the monetary inflation prime:
If both monetary and deficit management is well done then a relative long period of sustainable growth is possible. Meanwhile, by repeating the process from phase A to D over and over again, we notice that the monetary mass has been growing exponentially while the economy has had its ups and downs in a linear fashion. Failing partially in both removing the money that has been "printed" and restoring a government treasury balance simply leads to the effect of adding a monetary bubble to another. The consequence is that each crisis becomes stronger. The same happens for private and public debt, part of the debt and monetary surplus is cumulated as the process is repeated. Precisely this remaining cumulated monetary mass constitutes  what we can call a "monetary inflation prime".

*Slow Growth:
While the effects of the several monetary and government stimulus becomes more or less effective. The stock market has been pushed in phase D by general confidence a better shape of the economy, and the consequent inflation generated by growth.
However the previous inflation prime, the inflation created by the quantitative easing, can reduce economic growth.

Top: Interest rates are too high and the share of the interest payment in the annuity is higher than the amortization of the good itself. The investment for example mortgages becomes unattractive since the situation could be similar to a perpetual debt.  In this situation, credit delinquencies and default in payment surges resulting in another credit crisis. Bond market yields are high and risk appetite is reduced driving equity down.

*Model by: Joé Thierry Arys Ruiz © Traders & Analysts C.O. 2010 - All rights reserved

Next Crisis:
If the monetary inflation prime is low, then we can barely notice it's negative effects on the economy. Then, the inflation rate released is published and promoted as "a purely natural effect of a strengthening economy". The problem Surges when this "monetary inflation prime" is high enough to entirely compensate nominal growth. This leads to a void or negative effective growth (inflation adjusted GDP) then we could see a Monetary  and/or Government Debt bubble explosion.

Click the image Below to enlarge the forecast:
Updated Forecast as of : 12/07/2011

        (Click the image above to enlarge)


Speculative EURAUD

While going throught a decending channel, a counter trend but maybe effective move can be played. Positive european news about the Grece can lead to a sharp rally of the euro with the sellers covering their short positions. This is a risky, since maybe too early move but it can be payfull using good risk management by seting a stop in case bad news surge.

Buy Stop: 1.53056
Stop: 1.52230

The opportunity of the day USDCHF

Employment numbers in Switzerland better than expected+ Uncertainty in the markets + good potential Technical pattern if 2 candles close under the next resistance.

(Click the image to enlarge)


Update on "Competitive Depreciation" EUR/USD

After breaking an extremely important support I have expanded the "Competitive Depreciation Band" It seems that a new area of support has been referenced and hold on for the moment.
The oversold situation seems to slowly change directions. Meanwhile the volume that pushed the Euro at his lows was high, we need a strong volume on the way back too, if we don't see a reversal move with strong volume we could go further down for the euro.

(Click the image to enlarge)


Technical Analysis CAD/JPY

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Technical Analysis EURAUD



Euro/ Dollar: The Depreciation Race

Last pressure on the Euro was due to the market's fear of Greece default and Spain deficit exposure in the media. Meanwhile Joaquin Almunia, the UE commissionaire for the Economic and Monetary affairs completely swiped any Greece default posibility and denied any expulsion of Greece out of the Euro zone. It is understood that Papaconstantinou, Greek's Finance Minister, will present a deficit reduction plan to ECOFIN and he has declared that Greece will be able to find funds via the monetary market with its 10 yr bond now trading near 7%.

Strangely, Greece with 12.7% of GDP of deficit estimates to come back to Maastricht 3% criteria  in 2012 while Spain with 11.4% of GDP of deficit, estimates to be back to norms in 2013. Both countries will present a rigorous deficit reduction plan with the following principles:

- Freeze of Public spending. Notice it also implies reduction and less hiring of state employees.

- Tax increases.

- And finally, legal retirement age pushed from 65 to 67 for Spain.

Obviously all those plans are based on the perspective of a very high economic growth but with unemployment over 18% in Spain and 9.8% in Greece. We may question if the tax increases for the little active workers left would be enough, we also have to consider an  eventual social disappointment from tax payers.

Meanwhile, quoting Joaquin Almunia: "There is no way Greece default" which make many investors think there could be a EU support in case of default. We can suppose the first step would be an absorption of part of the Greek or Spanish debt by the Euro community and a European stimulus supported by the European Central Bank. In the worst case scenario the International Monetary Fund would intervene to avoid a systemic risk.

In fact, a depreciation of the currency is needed to lean the deficit.The question being who will depreciate its currency faster USA or EU. We see very clearly here a "competitive depreciation" we forecast, either on purpose or not, it is there.

That being said we must acknowledge that even if the euro convergence criteria ("stability and growth" in french) is not respected, at least there is such a "pact" in Europe. While USA has no control on their deficit and recently the senate approved a debt ceiling hike: pushing the deficit limit to 14 Trillion dollars of debt.

The Story is not over, today it's Greece, tomorrow it will be USA deficit and we probably will hear more about Spain after, the competitive depreciation ball bouncing between Europe and America.Until China reacts... to be continued...