A Forex Trade for End of Week

Recent economic numbers from the US suggests the recovery may not be as rosy as desired.  This string of disappointments began with the US durable goods report, and goes from there to numerous US economic reports that fall short of expectations.  Today, we had the USD ADP Employment Change - at 158K was well short of the anticipated 200K.  

Following, came the US PMI-ISM Non-Manufacturing Component which was also short of the expected.  

This Friday, we can look forward to the US unemployment rate, expected to be unchanged at 7.7% and the always interesting US Change in NonFarm Payrolls.  The 195K expected new NFP jobs is down from last month's 236K.  The headline number for the NFP is what gets the crowd's attention and the market is quick to respond. 

Often, habitual traders first trade and then analyze.  Last month the big number was caused by an addition of part time as well as second jobs.  Full time jobs were reduced, but that did not stop an initial bullish response to the number.  When using leverage to trade forex, it always best to analyze and trade with a plan.

Prior to the important NFP report, we tomorrow have an announcement of central bank interest rate decisions in both the UK and the eurozone.  It is expected both banks will keep their rates unchanged at .5% and .75% respectively.

A surprise would occur if the ECB would reduce their rate from the current .75%. Since the ECB does not have the dual mandate to stimulate employment, but rather to only control inflation, it is perhaps foolish to consider a rate reduction.  However, the settlement of the Cyprus banking failure may give traders some lingering doubts about the EU and many other economic difficulties in Europe remain.

The unemployment rate in Europe keeps climbing.  It is now a record 12% which means there are 19M people out of work.  In countries operating under the guidelines of the ECB Bundesbank, and IMF rules unemployment is much higher, especially among the young.  But the austerity rules, higher taxes, and lower government expenditures is taking a toll even among the wealthy northern countries. 

The Netherlands, Germany's prudent neighbor, has begun to feel the pain.  According to Spiegelonline, consider the following: the GDP shrunk by .9% in 2012, unemployment went up to 7.7% and housing prices are down 8.6% in the last year. 

The 8.6% housing value decline may be only the iceberg's tip. Continuing, Spiegel says:

"Underwater" is a good description of the crisis in a country where large parts of the territory are below sea level. Ironically, the Netherlands, once a model economy, now faces the kind of real estate crisis that has only affected the United States and Spain until now. Banks in the Netherlands have also pumped billions upon billions in loans into the private and commercial real estate market since the 1990s, without ensuring that borrowers had sufficient collateral.
Private homebuyers, for example, could easily find banks to finance more than 100 percent of a property's price. "You could readily obtain a loan for five times your annual salary," says Scheepens, "and all that without a cent of equity." This was only possible because property owners were able to fully deduct mortgage interest from their taxes.

Instead of paying off the loans, borrowers normally put some of the money into an investment fund, month after month, hoping for a profit. The money was to be used eventually to pay off the loan, at least in part. But it quickly became customary to expect the value of a given property to increase substantially. Many Dutch savers expected that the resale of their homes would generate enough money to pay off the loans, along with a healthy profit."

Times have changed, real estate prices are down, and the banks have €650B of mortgage loans on their books.  Consumer debt, at 250% of disposable income is immense, about twice the amount Spain had in 2011.  The last thing Holland needs, like most of Southern Europe is more austerity.  This downward economic spiral will continue as long as these policies remain in place, and that spiral is moving North.

It will be a surprise if there is a reduction in the ECB rate tomorrow.  With the German 10 year bond yielding 54 basis points under the US rate, this reflects the perception Frankfurt is the safest place in Europe to park your euros.  If, however, the rate would be cut 25 basis points, how would the market react?

Perhaps traders would conclude the European economy is really worse than advertized.  In which case parking money outside of the EU might become fashionable.  Also, the EU bungling of the Cyprus bank crises might be another reason for money to flee Europe.

The EURUSD has enjoyed a small bounce after making a low of 1.2750, making it back close to the 200 day SMA around 1.2850.  (FXE, UUP).  We also note that there has been a sizable increase in the futures open interest over the past ten days.  This probably means the large specs, possibly funds, are adding to their short positions.  With tomorrow's report, followed by the Friday NFP, this pair must be closely monitored.  Our preference is to prudently sell strength, with a target around 1.2650.

About Ralph Shell: Traded personal account profitably for 19 of the 20 years at the CBOT. Ranked as one of the top five Forex opinion leaders on SeekingAlpha.com. Extensive career as a commodity broker and trader, formerly a commodity broker and grain analyst for Merrill Lynch in Chicago. Member of Chicago Board Of Trade for eighteen years. Floor broker for the Sparks Division of Refco for nine of those years. Also a former member of the Kansas City Board of Trade and the Minneapolis Grain Exchange. Floor trader for over twenty years, specializing in soy beans, wheat and the grains. Ten years as grain merchandiser for Continental Grain Company. Grain trading career included five years in the export grain markets as a wheat and then a soy bean trader. Also traded barge grain out of St Louis, and was the Assistant Manager of the South West Region of the US. First foreign exchange contracts in futures and options over 30 years ago well before the days of online retail fx trading. Today, Ralph is involved exclusively with analyzing and trading the forex market.