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Ride the Eurodollars into the Recession

14 March 2008

The Macro Trader’s view:
With the US economy almost unanimously viewed by analysts and traders as already in recession, the debate now centers on its severity and likely duration. With deteriorating conditions in credit markets again causing wholesale liquidity to dry up, the Fed and other leading Central Banks pumped around US$200.0B into the system earlier this week in an attempt to keep credit flowing - the economy’s life blood.

Although the roots of this recession are in the correcting housing market, it is the deteriorating credit markets that are intensifying the slowdown as they are the main transmission mechanism of weakness in the economy. The sense of crisis has travelled from the original sub-prime category and begun to infect other areas of lending such as:
- The regular mortgage market,
- Credit cards,
- Automobile finance, and even
- The municipal bond market.

The Fed’s new injection of liquidity initially sent Eurodollars lower as stocks rallied on fresh optimism that the financial economy might begin to function normally and perhaps make further rate cuts less urgent.

But the market has been quickly disabused of that thought. Today saw the release of much worse-than-expected retail sales data and after the recent weak non-farm payroll report, no one can be in any doubt that the Fed will soon cut rates again.

However, with US Fed Funds currently at 3.0% and December 08 Eurodollars already pricing in a further 75bp reduction, one might rationally ask how much further will this contract go? Answer: a long way.

In response to the 2001 recession the Fed cut interest rates to 1.0% in an attempt to bolster confidence hit by the 9/11 terrorist attacks that year. In the event the recession proved short and shallow.

This time round, the economy could experience something more brutal. A near comparison to the current situation in the US is the relatively recent property crash that hit Japan in the last decade of the 20th Century. Not only did this lead to deflation, but lead to a decade of recession.

In the US, deflation isn’t the worry, stagflation is. But the Fed appears willing to turn a blind eye to inflation as it tries to steady the economy, believing weak growth with eventually ease inflationary pressures.

In this environment we think US interest rates are heading to at least 1.0%, and the recent price action in the Eurodollar market is a period of consolidation before the next leg of the rally kicks in.

The Technical Trader’s view:

Eurodollars have been racing ahead since mid-2007.

But the market has paused for two months at the important band of Fibonacci levels.

That pause over the last two months has taken the form of a Triangle – which has completed.

Disappointingly, the move post-completion has been less than explosive.

But bulls will note that the minimum measured move is as far as 98.40.

Note the importance of the Pivotal high at 97.87.

Bulls not already involved should wait for a clear break above that level as the trigger for the next bull run.

Mark Sturdy
John Lewis
Seven Days Ahead

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If Stocks are bid and Eurodollars offered, where’s the recession?

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Don’t be fooled by the pause: the EuroStoxx 50 still looks vulnerable

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