Last week's very important shift in rate policy at the ECB, and its action to raise its key interest rate a quarter point, when taken in tandem with the fact that the Fed has reduced U.S. rates to a 2% low-point, should have further weakened the U.S. dollar. However, a clearly spoken non-bias by ECB President Jean-Claude Trichet, and Fed Chairman Bernanke's heavy on the hawkish commentary have successfully supported the dollar so far.
ECB Intentions Clear
It's very clear that the inflation-troubled ECB, which had telegraphed its impending move, also hoped it might keep further dollar softness in check. European producers are losing market share to competitively priced American goods, impacting the euro zone economy. Europe could bear this to some extent, since it allows for some lower cost goods to reach European consumers. However, it has been clear that the impact of cheaper American goods has been outweighed by an overall increase in the cost of living. The June jump in European inflation, as defined by the 4% HICP measure, presented impetus for the ECB to act. There was no longer time to wait for American economic stabilization if medium to long-term inflation was to be kept in check.
Fed's End of the Deal
At the same time, just a week earlier, the Fed stopped its expansionary campaign as it decided to hold interest rates steady. Our Fed, while keeping rates and capital cheap, also continued on its propaganda campaign to support the dollar with words. A steady stream of hawkish words have been born of Fed mouths, and more so as the ECB signaled what was to come last week. In its most recent policy statement, our beloved Fed stated that even though it still expected inflation to moderate this year and next, that uncertainty remained high as a result of commodity price momentum. The ECB said just about the same thing last week.
So, it would seem that the Fed and ECB are quite considerate of each other. The world's most developed and significant markets have much in common, and thus much to gain by working together to insure global stability. As each market flirts with recession, they both also face the same threat of inflation due to global demand stresses.
In the meantime, the key support for oil collapsed temporarily, which was certainly hoped for and perhaps even schemed by the central banks. Of course we are talking about the presumed demise of the dollar that nobody witnessed. When the dollar bought into central bank lobbying and held its ground, oil moved markedly lower. Still, its slippage only lasted until renewed geopolitical concern (read Iranian missile tests) jacked up oil again. The central banks can manipulate the markets all they want, but there's not much logic anyone can infuse into the Iranian mindset.
Even so, the price of oil did not stage a remarkable comeback Wednesday on the Iranian news. It only snuck its head back up before collapsing again toward the end of the day. This leads us to make one of those predictions of ours. As we stated some weeks ago, oil should trade lower; we previously looked to a range from $125 to $135, if memory serves me right.
Momentum took crude higher, and, excuse the lack of technical description here, it just looked uncomfortable there above $141. We were even getting prepared to publish a "Sell Before $150 Trashes You" article. Demand destruction became apparent, and regulation is on the way to making oil trades less liquid. Yesterday, the Petroleum Status Report painted another heavy weekly draw from inventory, and oil could not even hold its ground. Heck, Iran fired off missiles and oil could not look up!
The momentum is looking the other way now, but here's where we make no sense... the same goes for the dollar. For this reason, oil should again find support before it reaches $125... and Iran is not going away. We see the dollar softening, and at some point, that should offer support to the cascading price of oil.
Central bank shenanigans can only fool the market for a short time. Despite all the hot air blowing, eventually the smart money will realize the ECB is raising rates, just as the Fed stopped cutting. The Fed remains tied to data, and basically handcuffed in the short-term. In other words, the dollar has to weaken, as long as it has not already overcompensated.
Ahead of the Fed meeting in August, the economy will be on its own as economic stimulus evaporates. We would bet against the dollar and avoid oil all together for now, because a congruence of momentum unwind for oil is countering the factor of dollar demise. If you need something to do with yourselves, we have another suggestion to use against the dollar, gold.