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It's Not What You Say, It's How You Say It
Greetings from Singapore! This week, it's all about language; the language of the Fed, the language of the CEO of a major U.S. corporation, and the language of the Group of Seven Industrialized Nations, better known as the G-7. As we'll see, the ability to interpret what is being said – as well as what is not being said – can give traders insight into the markets.
Many analysts believe that when we look back on the first quarter and indeed the first half of 2008, it will be understood that the U.S. was in a recession, but it won't be official until all of the GDP (Gross Domestic Product) revisions have been made. This is because a recession is most commonly defined as two consecutive quarters of declining GDP. If the U.S. economy is in a recession, it is because of a slump in housing prices and a tightening of credit markets. Some members of the Fed's rate-setting Open Market Committee said at their March 18 meeting that they saw the risk of a "prolonged and severe downturn'' in the U.S. economy, which certainly doesn't bode well for the immediate future of the greenback. The surprise here is not the fact that the U.S. economy is in trouble, we can all see that. No, the surprise is the fact that the Federal Open Market Committee (FOMC) would use such clear and honest language, instead of their usual tactic of verbal hedging and opaque statements. Thank you FOMC for a refreshing and rare dose of reality.
An Ominous Warning
The FOMC isn't alone in making dire predictions about the U.S. economy. On March 13, General Electric CEO Jeff Immelt said the company's forecasted annual earnings of $2.42 per share was "in the bag". Less than a month later, the stock plummeted on a report that the U.S. economic bellwether missed earnings badly, and the company lowered its full-year earnings forecast to between $2.20 to $2.30 per share. GE's market value plunged by $47 billion on April 11, as the stock lost 13% of its value in response to the news. It was the worst one day performance for GE shares since the stock market crash of October 1987. On an earlier conference call, analysts demanded that Immelt explain why he told retail investors on a March 13 webcast that GE would meet its annual forecast of at least $2.42 a share. His reply was chilling: "Two days after the webcast, the Bear Stearns situation took place," Immelt said. "The last two weeks in March were a different world in financial services."
That is an amazing statement, because if Immelt is to be believed, the credit problems that markets faced prior to the Bear Stearns debacle could be dwarfed by what we may face in its aftermath. If Immelt is correct, it means that after 300 basis points in interest rate cuts from the Fed and after large and numerous injections of liquidity by the world's biggest central banks, and after the Fed's financing of the Bear Stearns bailout, the situation has not improved, it has only gotten worse. GE missed its forecast for its commercial finance unit, and this was blamed as the cause for the overall earnings miss.
CEO's and other officials often use current events as an excuse for poor performance, and it is usually a thin excuse. It's much easier to blame outside forces than it is to truly take responsibility. The question is this - was Immelt using Bear Stearns as a crutch to excuse his own company's poor performance, or is there something really frightening lurking just below the surface, ready to reveal itself in the earnings reports of other financial services companies? Only time will tell if Immelt is telling it like it really is.
Group of Seven Expresses Concern
On April 12, the Group of Seven Industrialized Nations, or G-7, amended language in their statement to express concern about the falling U.S. Dollar. "Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability," the statement read in part. This is their way of expressing concern about the U.S. currency without mentioning it by name.
The USD strengthened a bit in response to the comments, which will likely serve to create a better entry point from which to short U.S. Dollars. In fact, the G-7 comments drove the EUR/USD currency pair straight down to its 20-day exponential moving average. This is a good example of a fundamental event (the G-7 meeting) as the catalyst for a technical event (the exchange rate reaching and then reversing on the moving average). EUR/USD has found support on the 20 day EMA numerous times in recent weeks (see figure 1).
Figure 1: EUR/USD bounces off of its 20 day EMA after G7. Source: Saxo Bank
The G-7 is powerless to stop the fall of the USD, and their comments do not portend any action on their part. The phrase "empty words" comes to mind. The G-7 is merely acknowledging what the rest of us can already see, and the reaction of the dollar is likely to be temporary, since there are no teeth behind the words. The European Central Bank has maintained a 4.00% benchmark interest rate, and this has served to strengthen the Euro vs. the U.S. Dollar, the British Pound, and other major currencies. If and when the ECB and other major central banks decide to take action, either by reducing interest rates or by intervening in the open market to prop up the U.S. Dollar, only then will these words carry any real weight, and provide more than temporary relief both to the overheated Euro and the wobbly greenback. Until then, these words simply create an opportunity to buy Euros at a cheaper price, or to sell U.S. Dollars at a more expensive price.
Food For Thought
In recent days, there have been riots in Haiti, Cairo, and the Phillipines over skyrocketing food prices. The International Monetary Fund has warned that if inflation isn't tackled now, hundreds of thousands of people may be pushed deeper into poverty. The World Bank has already announced that 33 food-importing countries could face social unrest in the coming months because of rising food costs. News reports indicate that the rising cost of basic foods have already sparked protests in Cameroon, Mozambique, Senegal, Yemen, Uzbekistan, Bolivia and Indonesia.
Nothing will cause political unrest more quickly than a populace suddenly faced with starvation. The rising cost of rice, a food staple for much of the world's population, could be much more devastating – and life threatening - than skyrocketing energy and metals prices. This crisis has the potential to create mass starvation, topple governments around the world, and create chaos in general. We'll be keeping a close eye on this situation in coming weeks.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through