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The case for selling Euribor Futures

18 July 2008

The Macro Trader’s view:
After the ECB hiked rates at its meeting earlier this month, Trichet announced at the press conference that followed that policy-makers had no plans for further hikes over the medium term.

The rate hike they had just enacted was portrayed as a one-off aimed at containing 2nd round inflation effects as they recognized there was little they could do to influence the price of oil and other commodities that were behind not only Euro- zone inflation, but the rise of inflation globally.

This seemed a responsible approach since the Euro-zone economy had just begun to show signs of cooling, something policy makers had feared, and the main reason why the ECB had sat on the fence for so long - they feared hiking rates just when economic growth was about to slow.

However, events have moved on: the economy is starting to slow, especially the German economy, but inflation continues to rise, as oil prices etc continue to make new highs. And the ECB thinks it can detect signs of the feared 2nd round inflation, mainly in the Labour market, and only last week Trichet began dropping hints that policy could be tightened again.

That is quite unlike the Fed and MPC, who are attempting to walk a tight rope between nursing growth and fighting inflation - the Fed having acted decisively by slashing interest rates and the MPC taking a more cautious approach but still finding room to ease policy.

The ECB has a track record of fighting inflation, even during times of relatively weak growth. Are the current conditions such that the ECB will risk a recession to control inflation, even though it is generated externally and at a time when the developed economies are potentially facing one of the most serious financial crisis in generations, which could yet develop into the worst slowdown since WW11?

We think the ECB will ultimately revert to form and judge that fighting inflation is their main priority. They hold the view that the best way to achieve solid sustainable growth is by providing a low inflation environment.

That may well be the case, but in current conditions, we think inflation is beyond the control of any single major Central Bank. The world has truly changed and the co-operation of China and India will be needed to reverse the current inflation trend if no one single country is to suffer disproportionately.

But despite that the ECB will not simply sit back, cross fingers and hope commodity and oil prices will correct lower. For them that would risk inflation becoming imbedded generally and that they will not accept.

So although the Euro zone economy may ultimately suffer a worse downturn than otherwise, might seem necessary, we believe the ECB will hike rates further and take any flak arising from a slowing economy on the chin.

The Technical Trader’s view:

This not a Double Top.
But it is akin to one.

And without doubt the market is at a Pivotal low whence it has bounced before.

So if that prior low at 94.75 from the Autumn of 2000 were to break we feel that it would act as significant overhead resistance to attempted rallies....

But will it break?
The detail of the market shows how the market has bounced from that Prior Low – but has run straight into resistance from a Low at 96.21.

Watch carefully to see whether the market has the bull energy to overcome that level.

Certainly, so far, there is no compelling bull reversal pattern in place.

The reluctance to get up through the resistance at 95.21 is clear so far.

Mark Sturdy
John Lewis
Seven Days Ahead

But additional bear evidence would be required for us to get bearish for a retest of the long-term pivotal lows.

Wait for a break of the 95.00 Prior High support.

The short run signal for a break down beneath the Long run Pivot would be a close beneath the lows 94.59 and 94.4650.

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