Euro Or The U.S. Dollar: Which One Wins The Ugly Contest?

Includes: FXE, UDN, UUP
by: Ralph Shell

Later today, the Federal Open Market Committee of the Fed will release the minutes of the previous meeting. The recent economic news from the US has been encouraging even though the US unemployment rate was a tick higher at 7.9%. Since this report, the initial jobless claims have been trending lower. Retail sales held their own despite the higher payroll tax. The US Empire Manufacturing Survey as well as the University of Michigan Sentiment Survey are trending better. Though housing starts were down a bit, building permits were higher.

The positive news has caused some chatter amongst analysts that the Fed may be discussing an exit strategy from the current monthly injection of $85B into the banking system each month. It is my view that concentration on an exit strategy is premature, and should this be the case, the USD may come under some pressure.

The Fed has access to a myriad of data, more than market analysts have. But there are a few topics we think must be considered. First, there is a definite chance the advertised sequester will result in a reduction of federal spending. House Republicans are opposed to the trillion-a-year federal deficit, and are determined to cut spending. Since no spending cuts were touched upon in the State of the Union speech, the administration is seemingly not concerned about cuts. Rather, they feel the government is merely encumbered by a lack of tax revenue to pay for their spending plans. Also, there is a sub plot here. Already the administration is blaming the Republicans for future job losses, a result of spending cuts.

There are two other reasons why I doubt the Fed can see the light at the end of the tunnel that illuminates a recovery. Of primary importance is the rapidly escalating cost of energy. While the Fed's monetary expansion aids the investment bankers who then allocate monies to various asset classes, including commodities, the people on Main Street suffer. For many, their incomes now are less than they were in 2007. Their taxes, if they are working, have gone up, and their disposable income is down. Gasoline prices at these levels over a period of time further reduce consumer discretionary income, increasing the odds for a recession.

The second reason why the Fed will not be concerned with an exit strategy is Obamacare. Bernanke, remember, has enhanced the objective of the Fed. In this new capacity the Fed has set a target rate for employment at 6.5%. Giving banks lots of money, however, does not relate to increased hiring. Small business will be the sector were jobs are created. Small business also is now learning about and frightened of the cost of Obamacare.

Does this mean we want to buy the euro and sell the USD? Not necessarily because the negative inputs in the US economy will take time to unfold, and the single currency has to deal with a major uncertainty now.

In Europe, this weekend's coming event is the Italian election. The former PM Berlusconi was forced from the office by Frau Merkel and friends in 2011, but once again he is running for office. He was replaced by a technocrat Mario Monti, a former Goldman banker and economics professor. Now Berlusconi is staging a come\back, running for office on a center-right coalition. Italy has a cut off date for polls, February the 10th. At that time Berlusconi's party had about 30% of the vote and was gaining.

Under the Monti austerity plan, as proposed by the EU, the tax rate and collection have increased. One of the promises Berlusconi has made is property taxes would be refunded. Support for Berlusconi is strongest in the richest state, Lombardia, and also in the poorest state, Sicily. There are four parties that will get most of the votes, but one party will not get a majority if the polls were correct, and confusion may prevail.

It looks like a Berlusconi vote, because of the weak economy, the austerity plan and the attempts to modify labor laws will be an anti euro vote. So while the US difficulties are longer term in nature, the Italian election uncertainty might mean some pressure on the euro in the near term. There are trading opportunities in a choppy market, but if you are not careful and get on the wrong side, it can get costly. We are hopeful the EURUSD (NYSEARCA:FXE) gives us a rally to the top side of the 1.34 handle where we will try the short side of the pair.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.