The U.S. Dollar Might Fall And Gold Might Rise

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Includes: GLD, UDN, UUP
by: Angelo Airaghi

The Fed could keep Fed fund rates low until 2014 and does not dismiss another series of quantitative easing (QE3). The policy would possibly penalize the U.S. dollar and support gold. The future of Europe is instead linked to three main events.

We are not out of the slump yet.

Last week, the U.S. Federal Reserve indicated the cycle of ultra-low interest rates should go on few more years. In fact, despite recent improvements, the Fed is concerned about the health of the economy in the U.S. and in Europe. As a result, operation Twist remains in full force and QE3 is a possibility, if unemployment fails to decline to acceptable levels. On average, participants of the FOCM meeting see rates low until 2014 and to increase at 4.25% in the longer run. The inflation target is set at 2.0% year-on-year, while growth is forecasted at 2.2%-2.7% in 2012.

How will it affect the markets? Over the longer-run, Fed's decision would penalize the U.S. dollar and eventually support gold. The secular cycle in commodity prices that started in 2012 is still on. It might end in 2014/2015, if history repeats itself. However, February has been negative for gold 80% of the times. On the other hand, the euro/USD is targeting the important resistance line at 1.3240, which corresponds to the neckline of recent head and shoulder's consolidation. A breakout would support the price to the higher channel-line at 1.34.

Although problems remain actual (a huge deficit and high unemployment rate), investors and consumers have become more positive in the past months. G.D.P. rose 2.8% (estimate) in the fourth quarter of 2011. A big support came from household's spending on durable goods (+14.8%) and business spending (+1.7%). Demand from the government kept instead falling for the fifth quarter in a row. Households relied heavily on credit cards and some gains were based on favourable seasonal components. In addition, the weak recovery will be in jeopardy, if Europe fails to continue with the reforms. Nonetheless, just 5% of U.S. exports are directed to more fragile European economies. About a fifth of the S&P 500 companies reported selling 25% of their products to Europe, mainly to the Netherlands and the U.K. A deterioration of the debt crisis and a decline of the euro will affect import demand.

E.U. leaders gather in Brussels.

As Greece is still negotiating terms of debt restructuring, other two nations are under the lens: France and Italy. If the French elections were now, the majority of French citizens would support the Socialist candidate Francois Hollande. Sarkozy would finish only second. The rightist National Front of Mrs. Le Pen is third by a tiny margin. The populist, anti-euro message is gaining consensus and will levitate in the coming months. Will Sarkozy change its political rhetoric and move away from Germany in order to be re-elected?

Weak growth and high public debt are instead the main challenges for Italy. Why? High debt increases interest rates and reduces the opportunities for growth. On January 20, the Italian government has adopted few measures to open up the service sector. For example, a number of shops and licenses for many professional services will be increased. Banks are asked to reduce fees. Finally, the government will try to reorganize the employment market. Will it work? Unfortunately, all these initiatives will produce results only in the longer-run. For now, confidence is low and unions are already protesting in the streets of Rome. The temptation to ride the wave of malcontent and to reject Monti initiatives is increasing for some political parties.

Italy cannot win the battle alone. This week, E.U. leaders will meet in Brussels and might discuss what President Draghi called:"Fiscal compact for the eurozone". It will include transforming the E.M.U into something similar to a fiscal union and finally implementing stabilization mechanisms such as the EFSF/ESM. The eurozone will not survive in its current form. The time for change is now.

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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.