Category — Oil

With mixed news coming out of the world’s remaining superpower in recent weeks, the recent US dollar rally induced widespread befuddlement. With Europe suddenly looking economically worse-off than America, it is easy to understand why the USD has rallied against the EUR. However, the USD has rallied against many of the major currencies, including the JPY and the CHF. In other words, it is not only bad news coming out of the Euro-Zone that is fueling this USD rally. So, the important question is what exactly is causing this rally?

One obvious corollary is oil prices. Having fallen about $20 (or about 15%) in the past week or so, relaxed oil tensions have allowed the USD to achieve solid gains. However, the Forex market is rarely so simple in its explanations of cause and effect, so it would be unwise to solely attribute this USD rally to oil prices. However, the main theory that I am proposing is related very closely to oil prices, whose unprecedented levels are causing rising inflation all throughout the globe.

The hidden culprit, I believe, is foreign government entities. As the bulk of the commodity world – including oil – is priced in US dollars, the weakened state of the USD has been a primary component of the widespread inflation. The issue of permanently lowering oil costs (or oil demand) has not dissipated by any stretch. In lieu of a radical shift in the energy industry, however, is a simpler, temporary solution: a stronger USD. As countries have come to witness the terrible effects that the oil situation is wreaking on their economies, I believe that they are beginning to act in a manner to try to build up the USD.

It is unclear if the past few days are indication of any real changes or if they are just testament to the EURUSD being in a range-bound market. However, if the USD continues to rally and oil continues to fall, then perhaps we could be witnessing a long-overdue correction. Should that occur, inflation concerns could begin to lessen, and then central banks might be able to focus more on fixing other problems. As always, only time will tell.

Upcoming Figures
EUR German IFO Current Assessment (Jul)
EUR Euro-Zone Current Account (May)
GBP Retail Sales (Jun)
JPY Consumer Price Index (Jul)

Today we have the last part in the three-part series focusing on oil. Again, we hope that you have enjoyed our debate, and look forward to possibly having more debate-style discussions in the future.

Question #5: How will the current energy situation impact America’s relationship with oil?

BB: More than anything, this recession has forced the general public to look in a mirror and see that there is a severe problem. Our addiction to oil has been justified or excused in the past, but no longer. The public– I believe – is ready to admit the problem and look for solutions. One interesting plan was proposed just the other day by billionaire oilman T. Boone Pickens, who is advocating a shift away from foreign oil towards wind power and natural gas (from within the US). It is one of many potential plans being put forth as a way to wean America off of its dependency on foreign oil. Another thing to point out is the timing of this recession. 2008 is an election year where either candidate is more likely to push a more progressive energy agenda than the former president. As a result, many are hopeful that between a more forward-thinking government and a more concerned public will lead to dramatic change in the next decade or so. Despite the best efforts of the current presidential administration, the problems of climate change and high energy costs are now front and center in the public’s conscience, and the next administration will likely pursue “greener” energy policies. I expect that with the next twenty years, America will cut its foreign oil imports by at least 15%. Through the development of more efficient cars and an overall dedication towards cleaner energy sources, I think that the current energy situation will successfully help the US become less dependent on oil, though it may take some time to see pronounced effects.

JK: Americans addiction to oil will continue until the price rises to a point that eliminates demand. The public is not serious about eliminating their carbon footprint. If they were, then lawns would be brown and a victory garden would grace every house. This leads to the conclusion that Americans will not change their way of life until forced too. Americans can not continue their way of life on wind, solar, or wave power. The amount of electricity generated by these sources is minimal and our entire energy infrastructure is not designed for it. If greener technology is to be undertaken then the entire infrastructure needs to be changed, which will happen as a result of sky high oil not a moral imperative. Boone Pickens made the wind power investment to generate stable revenue; he is looking to turn a profit not save the world. Profits are the American way, hope and change is nice but useless without employment. If America’s addiction to oil is too be cured nuclear energy, car pooling, and public transit will play a much larger role. Oil imports will not decrease until cold fusion is invented, or the price is too high. No matter what happens in the long run the short run will continue to be painful. Our relationship with oil will continue to be an expensive love hate relationship. The current price increase will cure the disease but it is a chemo therapy cure for the cancer of oil addiction.

Question #6: Is there any way that oil prices will fall dramatically in the near future?

JK: The price of oil has fallen $9 in two days; however don’t expect this to persist. The price of oil will continue to go up for the simple fact that oil’s rise is demand based. The current dip is a hiccup within the market, the trend has not changed. One of the rules of FX is don’t trade against the trend, this applies to commodities as well. The only way for the price to fall is for demand to diminish, which happens when the price rises. OPEC producers are concerned with the price of oil because they know that the farther it goes up the more alternative sources become profitable. Hence the Saudi output increase because if demand diminishes then so do Saudi coffers. Some will blame speculators whose profit is based on positions based on the direction of oil. No oil changes hand only cash, they are not hoarding oil just taking a position. Blaming speculators is like saying that gamblers affect the direction of a baseball game. Speculators do not influence the price of oil; they profit from it, and lose from it. All commodities have doubled over the last couple of years, and their rise has been demand driven. The transparency of expectations that futures contracts create help airlines and chemical companies secure lower financing to expand production. The price of Oil will not fall in the future until demand diminishes, or supply increases. With all producers at almost full capacity, the demand side of the equation is the only adjustable factor. The only solution is a fall in demand which will not happen at the current price. There is no easy solution, but a bad solution is more regulation. A popular policy that would hurt individuals because clarity would diminish and financing costs for transportation and airlines would increase. Speculation is a hedge used by these industries for future price increases and taking it away would cripple them.

BB: It’s very unlikely… but stranger things have happened. One man quite familiar with global markets, George Soros, has expressed his belief that the current oil prices are a bubble, which would imply that a large fall in price will eventually come. However, I find this hard to imagine happening anytime soon. If the demand for oil persists at or near current levels, why would the price dramatically drop? John is right about this… the price won’t fall until demand does. Unless there is some sort of shock (a new invention, new legislation, etc.), the price is not likely to fall back down. Eventually, however, there will be a point when the price of oil has reached an unsustainable high. At that time, enough people will have finally been “priced out” of using oil in their everyday lives, and as a result, the demand will slowly start to go down. However, this scenario is only likely to play out if we continue today’s trends of increasing supply, demand, and prices. Should we find a way to buck those trends, perhaps by utilizing alternative energy sources, then the process of falling price of oil could happen sooner. I ultimately view oil falling in price as inevitable; one day, we will wake up and there will be none left. However, in the short run, I do not foresee any reprieve for energy costs.

Today is the second part of the series regarding oil. We hope you enjoy our debate, and again, if there are any questions that you would like to see debated relating to oil, please post a comment for us.

Question #3: Can oil prices lead to stagflation? Will they?

BB: Let me put it simply: they can, and they will. Unless something occurs which halts the rise of oil prices, it is very likely for the dreaded situation of simultaneous high inflation and stagnant growth to occur. Of all the terms in economics, there are few as feared as ‘stagflation.’ The last time that stagflation was prominent was in the 1970’s, which also just so happened to have been a time of sky-high oil prices (see where I’m going with this?). Those oil shocks were widely blamed for the stagflation’s onset, and though silly policies by the Federal Government and the Federal Reserve played their part in making the situation worse, it was oil prices that created the situation. That historical lesson does not leave me with an optimistic outlook. In theory, we should learn from the mistakes of our predecessors, yet in this case, that may not be enough. Unless something is done to stop the rise of oil prices, the trends that have already been establish (rising inflation, decreasing growth) are likely to continue until we enter a period of stagflation. Uh-oh.

JK: It depends; the fact oil contributed to stagflation is undeniable. However the assumption that oil shocks bring about stagflation is false. Stagflation is simply rising unemployment and inflation, an oxymoron but possible. The stagflation of the 1970’s was brought about by a variety of factors namely, because central bankers didn’t do their jobs correctly. Inflationary expectations rose, because the initial response to the rise in oil prices was to cut interest rates (sound familiar). Almost all Central banks pursued this pro-growth, pro-cyclical policy, which lead inflationary expectations to rise. If you listen to the press conference from ECB President Trichet one thing you can conclude is that he is terrified about inflation. He highlights the dangers of short-term policies that can alter long term inflationary expectations. When they set in then the domino effect of a wage price spiral can be initiated which will only make a bad situation worse. Oil can be considered a necessary but not a sufficient condition for stagflation. However the given the current situation stagflation will most likely occur, due to the prolonged period of time that oil has been at its current price. The spill over effect can be seen in every countries PPI. The wage increase can be observed in China and India. As for the OECD, a lot of pain awaits because imports which that have contained inflation will become very costly. Let us only hope that Central Bankers choose the prudent course of containing long term inflationary expectations, not promoting short term growth.

Question #4: Will the price of oil lead to the USD losing its premier status in the FOREX world?

JK: No, these types of responses are typical from Mahmoud Ahmadinejad and Hugo Chavez. Both stand up individuals, but both with little or no trade ties to the United States besides oil. Yes, Chavez does export millions of barrels to the U.S. but these countries need to export just as much if not more than U.S. needs to import. One of the reasons that oil is above $140 is because the U.S. dollar has depreciated. The reason for this depreciation is our current account deficit, excess government spending, etc. The rise of oil did not crush the dollar; the depreciation of the dollar gave the price of oil a shot of steroids. The dollar is king because the domestic economy creates 13 trillion dollars annually. As long as the risk premium associated with U.S. investments continues to be low and the U.S. stays on the forefront of technological innovation the premier status will not change. The dollar will lose its premier status when China can build a 747 or provide financial consulting. Currently China fills container ships with of knick-knacks, not very inelastic, and definitely not reserve currency export.

BB: As much as I hate to do this, I agree with John. The critics of the USD have been howling for decades, and I don’t expect this current recession to alter much. The only way that the USD could be knocked off its pedestal is if it becomes so weak that it can no longer function in its many roles, such as the reserve currency for the world, the currency for commodities, or the currency involved in the bulk of FX trades. In the end, it would be too monumental of a project to shift away from the USD, and even if the “powers that be” decided to, which currency would take its place? The only truly viable candidate would be the EUR, yet that has only been around for about a decade, so it lacks the historical track record of the greenback. So while it is possible that the USD might eventually lose its spot as top dog, that time is many years down the road. Even if the price of oil is shifted to another currency in the next few years (also unlikely), I do not anticipate the USD losing much prominence.

One of the major sources behind the world’s current economic woes is soaring oil costs. While we have discussed this problem in recent weeks tangentially, my colleague John and I have agreed to more deeply explore this issue. John has graciously agreed to join me in debating several oil-related questions for the next few days. We hope you enjoy our discussions, and should you have any questions that you would like us to discuss, please do not hesitate to post a comment.

Question #1: When will oil hit $150/barrel? $200/barrel? $400/barrel?

Benjamin Beller: We actually have a bet going on this first one… remember when oil was near $100 and it flirted with that figure for while before crashing through? I think that the oil market will slow down before crossing this sentimentally-important mark, so I predict Monday, July 21, 2008 for $150/barrel.

John Kenderski: Oil closed today at 146.18 on the NYMEX a 1.92 % rise from yesterday. One of the golden rules of trading is not trading against the trend. If the market has appreciated over 40% since January, why would it stop? Regardless of speculation, demand supply, dollar weakness, or the factors moving the price of oil it has appreciated around 7% a month in 2008. Expect July to be no different with oil closing above $150, so I’m predicting $153.50/barrel by July 30, 2008. It is simple trend analysis which Ben cannot deny.

BB: In the words of Ari Gold, “Deny ’til you die.” I think that unless there is a major event (attack on Iran, divine intervention, invention of cold fusion, etc.) within the next six months, the price of oil will reach $200/barrel by December 25, 2008. Merry Christmas.

JK: If you go by back tested data of 7% a month then by December 25, 2008 the price of oil will be $215.29. However this is too simplistic and is a ceteris paribus argument assuming the current trend continues. The current increase in the price of oil is a demand based increase, the trend will continue but the slope will abate. I agree with Ben that the price will be more around $200, at this point supply will satisfy demand.

BB: $400/barrel? If oil ever reaches this level, I don’t think (read: hope) that it will take place until 2012 or so. At this point, oil will have become too expensive for most consumers, and as a result, we will witness a major paradigm shift in how people utilize their automobiles. At the current ratio of oil price/barrel to gas price/gallon, it would cost over $11/gallon to fuel up. If you’re worried about stagflation now, you ain’t seen nothing yet.

JK: I disagree. Oil will never reach $400/ barrel because at this price demand would diminish. The current rise in oil prices is a globalization phenomenon, because increase transportation of goods across borders has increased the demand for oil. Once it becomes too expensive to produce goods in China and ship them, to the US production will be moved closer to the domestic market, decreasing the demand for oil. Look at the US automotive sector and observe the result of $4.00/gallon gas. Fuel efficient vehicles are becoming a necessity, and the extinction of the SUV is imminent.

Question #2: Is the problem due to supply and demand factors or speculation?

JK: The current spike in oil is a multi faceted issue that can be attributed to a variety of factors. Speculation, OPEC, Supply, Demand, or Dollar depreciation – they all have influenced the price. Principally this particular boom in price has been demand driven. The demand from BRIC countries and other emerging markets has outpaced the current supply of oil substantially. It is an undisputable fact that oil comes from bad, unstable places. This only increases the price of oil because there is a risk premium associated with the price. Iran and Nigeria are not nice places, not to mention Russia or Iraq. Obscene amounts of oil come from the third world; these countries can barely provide water to their people, let alone augment oil production. There is a world-wide shortage of engineers, and the engineers that exist are not products of the Saudi Arabian public school system. Thus augmenting production in these countries is not likely. Nationalization of oil industries are populist policies that in the long run lead to stagnant output. For example Russia’s state controlled Rosneft has not augmented production since it illegally took over Yukos. The reason, state assets don’t have to produce a profit, they just have the tax payer make up the difference. The result is no creative destruction, no technological leaps, and for the oil industry stagnant production. The above reasons demonstrate that the increase in the price of crude is a supply demand phenomenon. It is dry and boring but the combination of lack engineer’s, oil nationalization, and risk premium all have contributed to the recent price. These supply reasons, juxtaposed with the fact that China wants to become America. The Chinese infrastructure binge is anything but oil conserving, not to mention their manufacturing efficiency. I admit the argument of speculators sounds better because then we can blame a particular adversary, but it is not factual. The price of oil is headed in one direction because of supply and demand, not because of an evil gnome in the pits of Chicago that manipulates the price of crude oil.

BB: I’m not calling speculator evil gnomes… but I am holding them largely responsible for current oil prices. Since 2002, oil prices have increased by more than 500%… if you think that is primarily due to Chinese growth, OPEC supply, or a weak dollar, you’re not in the right ballpark. In psychology, we have a term describing these types of beliefs: denial. I am not saying that other factors aside from speculation have had an impact - they certainly have. But as figures such as Saudi King Abdullah or George Soros have explained, the reason for the explosion of prices is due primarily to speculators. Along with hedge funds, speculators have pushed prices higher and higher in their never-ending (and to be fair, totally justifiable) pursuit of profits. Some authorities, such as certain political leaders in Germany, have already proposed a worldwide ban of oil speculation. While such dramatic moves are unlikely in the near-term, it is likely that there will be moves against speculators in the future. Oil prices are simply rising too rapidly, and unless something is done to curb the influence of speculators, the outlook is grim for the future of oil.

In the past 15 years, the automobile industry has witnessed monumental shifts, such as the boom in the popularity of the SUV, a Japanese company becoming the world’s largest automaker, and the rise of the hybrid. However, one thing in common between June of 1993 and June of 2008 in the world of automobiles is that roughly the same amount of cars were sold. Today it was announced that US auto sales reached a 15-year low, and I think that it is a fitting reflection of the larger economic situation.

For over a hundred years, automobiles have been mass produced in America. Their presence has encouraged, perhaps more than any other invention, the amazing growth that has occurred in both our cities and populations. When Americans navigated the Oregon Trail in the 19th century, their journeys would last five or six months. Now, because of the automobile, that famous trek could be completed within two days (if you drive like my father does) or three days (if you drive like someone who values their own life).

There are plenty of reasons for why so few cars are being sold. Many of those reasons are similar to the problems facing many of the world’s top economic authorities: oil prices, credit woes, price instability (inflation), etc. Despite automakers best attempts to entice buyers, the fish just aren’t biting on those lines, no matter how appealing the bait. The bottom line is that gas in the US is over $4 per gallon, with no end in sight. Unless a new car can get you fantastic mileage, the odds that a person even wants to consider buying one is slim to none.

Perhaps, in some twisted way, this is a sign of more responsibility being taken by individuals. Perhaps this is an indicator that more people are looking for alternative ways to get around town. Perhaps this is a sign that the US is finally going to start demanding less oil… perhaps probably not. There is a long way to go before the US will kick what my colleague John labeled “our heroin-like addiction to oil.”

When I studied ‘Black Wednesday’ and the subsequent recession that the UK experienced, I read an interesting commentary on the episode. The economist wrote that the whole process was necessary in the long-run in order to “wring out” inflation from the UK’s economy. So perhaps, if certain pieces fall into the right places over the next few years, this current recession might be able to help “wring out” high oil prices and our addiction to automobiles from the US economy. If that ever happens to be the case, maybe today’s announcement will be seen as a landmark for when consumers finally began the long-overdue process of ending “our heroin-like addiction to oil.”

Upcoming Figures
AUD Retail Sales (May)
EUR Euro-Zone Producer Price Index (May)
AUD Trade Balance (May)

Last week I mentioned that though the G8 conference would impact the US dollar in the short term, the ultimate fate of the USD will ultimately be determined more by Bernanke than by anyone else. The Group of Eight’s meeting has come and gone, offering little good news for the USD. In the FOREX market, that “little good news” led to bad news for the USD, as the greenback surrendered some of the territory it had gained last week. So with the conference in the rear-view mirror… let’s look ahead.

In his most recent column, Robert Novak wrote that despite his publically hawkish stance, Bernanke is more concerned with growth rates. Furthermore, Bernanke feels that oil and gasoline prices, if they continue to rise, could lead to the dreaded state of halted growth in addition to rising inflation. Assuming that what Novak is reporting is accurate, it would seem that Bernanke’s pronouncements last week were a charade. In other words, Bernanke isn’t likely to walk the walk. However, this might not be a bad thing. Many see the economy as not yet ready for a rate hike, and so perhaps holding rates constant for the next several months would be the best thing for the US economy.

The USD has ended the rally it began last week, and while the short term prospects are dimmer than they were several days ago, the jury is still out regarding the long term. On the one hand, disappointing economic data that keeps coming out (most recently in the US: poor manufacturing results) would indicate that the USD is in for more stormy seas. However, analysts are noting that it has been years since people have held such bullish opinions about the USD. Many feel that the dollar is “due,” meaning that after taking its lumps for years, it is poised to finally recover. With the Saudis agreeing to pump more oil, perhaps the stars are aligning for a USD recovery. However, it’s hard to know the future for certain. As it is written in one of the Harry Potter books, we humans are not very good at reading the stars.

Upcoming Figures

AUD Reserve Bank of Australia’s Board Minutes (Jun)

EUR Italian Trade Balance (Euros) (Apr)

GBP Consumer Price Index (May)

EUR Euro-Zone Trade Balance (Euros) (Apr)

USD Current Account Balance (Q1)

USD Housing Starts (May)

JPY BoJ to Publish Minutes of Board Meetings

Despite last week’s small gains against the euro, the U.S. dollar fell against the European currency on speculation of further weak U.S. growth. It may seem like old news, but investors fear further losses on securities backed by subprime mortgages to weaken the U.S. economy. Today, Germany’s IKB Deutsche Industriebank AG reported losses directly linked to the U.S. subprime mortgage crisis. Along with last week’s Deutsche Bank report, this indicates corporate debt to be at risk from the weak housing market. The dollar fell to 1.3678 against the euro this morning, a 0.3 percent drop from last week.

The risk of owning corporate debt has sky-rocketed, also a factor in the euro gain. Bond buyers have been demanding higher risk premiums on corporate debt as risk-aversion has increased. According to index data by Merril Lynch, the spread that investors demand on corporate debt instead of holding U.S. Treasuries has widened 20 basis points this week to 128 basis points. Investors fear corporate debt will be taking hits from the subprime meltdown.

Currency Outlook and Strategy:
Tomorrow at 8:30 a.m. the U.S. Commerce department is due to release a report on U.S. consumer spending. Economists from a Bloomberg news survey speculate personal spending rose 0.1 percent in June, the least since September. Ever since U.S. personal spending has slowed from a 5-month high in December, the dollar has fallen 3.5 percent against the euro. Even though a weak spending forecast is already factored in the EUR/USD price, there is room for a further fall if the U.S. Federal Reserve decides to lower interest rates. Kenta Inoue, economist and currency analyst at Mitsubishi UFJ Securities in Tokyo, states: “I expect the U.S. economy to slow and the Fed to lower rates in the 4^th quarter. There is still room for rates to rise in Europe, so investors will start to favor European currencies over the dollar.”

And this brings up another question: Will the European Central Bank raise their federal funds rate above the current benchmark of 4.00 percent? There is much speculation the ECB will hold onto the current rate after its next meeting on August 4^th, but is likely to raise rates later in September. This increase may mean further appreciation in the euro, a main worry of French President Nicolas Sarkozy. But recent data has shown an appreciating euro has not hurt the euro-region as a whole. Exports from the EU rose 9 percent in 5 months through May from a year earlier, the second fastest pace in 6 years. This begs the question why an appreciating euro has not hurt exports. The reason is that against the currencies of the EU’s 25 trading partners, the euro has increased less than half as a much as against the U.S. dollar. Exports to the U.S. may have been hurting, but with Germany as the world’s largest exporter, exports to other countries have more than made up for losses.

Another benefit from a rising euro has been lowered costs of oil, which is priced in U.S. dollars. The price of oil has risen 26 percent this year to $76.73 a barrel today. Despite hurting some European corporations like Airbus and Peugeot (charts), the overall euro-region seems to be withstanding the euro impact. The ECB is forecasting economic growth at 2.6 percent for 2007.

Inflation has always been an important concern for currency analysts, if only because it has a direct relationship with interest rates.  Central banks have a mandate to keep inflation under control, and so signs of rising inflation indicate a strong currency.  But the new paradigm of an increasingly international economy could leave monetary policy makers impotent in the face of global inflationary surges.

Commodity prices are near record highs, and interest rates do not have the power to completely moderate supply-side inflationary pressures.  Oil is selling for almost $80/bbl, and there are market analysts who believe we are likely to see $100 oil by 2008.  That would put oil at the $100 level one full year before Goldman’s now infamous oil projections of last year.  Gold and food prices are also through the roof (they are the primary driver of high prices in Australia and New Zealand).  With growing demand for commodities from developing economies, price pressures are not in line to let up anytime soon.  In the forex market, the most prominent consequence of the commodity boom is the incredible rise of the three major commodity currencies (Canadian dollar, Australian dollar and New Zealand dollar).

But more troubling for fans of domestic monetary policy is that inflation is also being stoked by rising prices for finished goods and services.  This phenomenon has surprised many observers because it seems counterintuitive to the idea of globalization.  Free trade was supposed to lead to higher efficiency and lower prices.  But with emerging markets all over the world on the rise, we are seeing more and more wealth in the developing world.  A booming economy naturally leads to higher prices, and the Chinese yuan, Indian rupee and other emerging market currencies have appreciated significantly this year.  Goods from these countries are now more expensive, and so as we buy imports from the rest of the world, we see China and India and Brazil exporting inflation.

Growing wealth in the world’s developing areas has other consequences of inflation as well.  Rich foreigners buy assets in the developed economies, and more buyers drives up the price of these assets.  This is partly the cause of exploding real estate prices in London.  For those concerned about the US dollar, we should note that the weak dollar makes US assets especially attractive.  It is as if US products were being sold at a discount relative to prices in the past.  This is why foreign ownership of US securities reached record levels last May.  But forex traders should still keep track of the current state of the US dollar.  Traders like to invest in markets that are growing (and economies that are healthy.  So while a weak dollar might be good for the US economy, a weakening dollar is bad.  And with central banks less powerful in the face of the new global economy, we might not be able to do anything about it.

As the U.S. dollar fell to record lows against the euro last week, technical analysis may indicate an earlier than expected rebound in the short run. Last week traders speculated long-run rebounds due to the U.S. economy benefiting from a weak dollar and from pressure on the ECB by Nicolas Sarkozy to cool a strengthening euro. But as traders have been eyeing the Relative Strength Index (RSI) on the EUR/USD pair, there is a possibility of a short-run rebound.

The RSI measures the strength of a currency pair price movement typically within the past 14 days. When the RSI is over 70 there is a good chance the price movement will fall. At over 70 most sellers who have been looking to sell perceive the current price to be the best price. On the other hand, buyers will likely wait for the price to fall when the RSI is in fact over 70.

Thus, in the context of the current EUR/USD pair, the RSI is at 76.34 today hinting at a future fall in favor of the dollar. The U.S. currency did in fact make a small gain to $1.3817 per euro this morning. This level is up from last week’s record low of $1.3845, but not enough to indicate an actual rebound. Nevertheless, the high RSI value may indicate a rebound sooner than expected.

Currency Outlook and Strategy:
On July 25^th, the National Association of Realtors is due to report figures on last month’s existing U.S. home sales. It is expected that U.S. existing-home sales have fallen the lowest in 4 years. This could further hurt investor confidence in the dollar. Looking across the Atlantic, European Central Bank Executive Board member Lorenzo Bini Smaghi states he is not worried about euro appreciation. But Nicolar Sarkozy, newly elected French President, thinks otherwise.

Tim Shea, currency analyst at FXCM, concludes: “This week in the Euro looks very quiet news-wise. We’ve got next to nothing on the European calendar, and pretty much just housing data and GDP in the USA. So, watch the housing numbers and the Dow for some direction, and don’t forget about $75 per barrel oil.”  

Recent developments in the forex market do not bode well for the US dollar.  Short-term economic data is bearish.  The long-term outlook for the US economy is getting worse every day.  And the currency crosses are not just about dollar weakness as there is strong support for the other highly traded currencies (even the yen).  To exacerbate matters for dollar bulls, there is a movement to unravel the dollar’s preeminent position as the financial medium of choice internationally.

A good place to start is the economic data released today: US Retail Sales.  The Commerce Department reported a drop of 0.9% blowing past initial estimates of a drop of only 0.1%.  It is the largest one month drop since August 2005.  With oil prices above $70 per barrel and home values tumbling, consumers are being stretched further than many economists had anticipated.

The recent numbers put the US economy in a precarious position.  Higher job and wage growth should be conducive for a steady pace of expansion.  But the retail sales number is particularly significant.  Retail Sales accounts for one half of all consumer spending which itself accounts for two-thirds of the economy.  A slowdown in this sector could be a harbinger for a larger contraction.  Concern over this matter, coupled with the continuing problems over subprime loans sets the stage for greater bond demand and lower interest rates.

As if that wasn’t enough bad news for the US dollar, Iran has made some very troublesome moves.  Bloomberg News has reported the National Iranian Oil Co. just asked Japanese oil refiners to pay for their oil imports ($10.1 billion worth) with yen instead of dollars.  With rising tensions with the United States, the Iranians are trying to hedge their risk by limiting their dollar exposure.  To this end, Iran is also seeking to diversify their foreign exchange holdings, limiting US dollar reserves to 20% of the total while buying more euros and yen.  Central bankers in Venezuela, Indonesia and the United Arab Emirates are pursuing much the same course with regard to their foreign exchange reserves.  USD/JPY is now down 0.22% to 122.13.  Much of the reason the US dollar has been able to maintain much of its strength all these years despite long-term double deficits is because of its preeminent position as the currency of exchange throughout the world.  If that position is being eroded (and it looks like it might be), then the decline of the dollar might be just beginning.