September S&P 500

Merger and acquisition talk helped futures to temporarily advance. In addition, brokerage firm “upgrades” helped the indices to firm. Also, there was some limited strength on ideas that rising commodity prices could help the earnings outlooks for metal and energy producers.

There was some support when the June 25th Federal Open Market Committee meeting statement was a little less hawkish than some analysts had expected. We observed a sign of weakness when stock index futures under performed this bullish news by trading lower.

Prices have come under pressure more recently due a variety of bearish fundamentals. For one, there is talk that the global credit crisis will slow construction spending and economic growth in the U.S. for another year and a half. In addition, the CEO of a large U.S. steel producer said “we have not seen the worst impact on the economy yet.”

The market was hurt after a respected fund manager said global write downs, due to losses in the credit markets, could be as high as $1.3 trillion. This is substantially more than the International Monetary Fund’s estimate of $945 billion. One money manager said banks are only “one third through” their credit related write downs.

Demand for U.S. architectural services dropped last month, according to the American Institute of Architects. Their billings index dropped to 43.4 last month from 45.5 in April. This leading indicator of the construction industry suggests further pressures on the economy into 2009.

More recently, prices came under pressure again due to rumors of an imminent attack by Israel on an Iranian nuclear facility. Some of the weakness was linked to reports that General Motors may need to borrow as much as $8 billion, as weakening North American auto sales reduce cash flow, while some of the selling can also be attributed to reports that United Parcel Service reduced their second quarter profit forecast.

The Fed is fighting a two-front battle and they only have the resources to fight one. They can either support the dollar through the use of a hawkish interest rate policy or they can support the economy and the stock market through accommodation and lower interest rates. Currently they have chosen to fortify the U.S. dollar through the use of a tough stand against inflation. This appeared to have at least temporarily worked, since the greenback was able to bounce off of its lows a little. However, at what cost when the state of the economy and stock index futures are taken into consideration? Threats of higher interest rates or actual higher interest rates from the Fed are exactly opposite of what is needed in an environment of economic weakness and lower stock prices.

I have received many questions lately pertaining to downside price objectives for stock index futures. My analysis tends to focus on timing objectives rather than on price objectives when a major market move is taking place. However, once our timing objective has been met, whatever the level of stock index futures is at that time will be the price objective. For now, expect lower futures prices, at least through the first quarter of 2009.

September U.S. Dollar Index

The U.S. dollar fell against most currencies due to higher crude oil prices, along with renewed concern about the health of the financial industry. Scaled back expectations of substantially tighter credit conditions from the Fed are also undermining the U.S. dollar.

At some point in the next month or two, the Fed will back further away from their hawkish interest rate policy stance. When this happens the U.S. dollar will break support levels under the April lows and begin a new leg to the downside.

Longer term, we can expect the U.S. Dollar Index to fall to new historical lows. This bear market in the greenback is likely to continue well into 2009.

September Euro

The euro temporarily traded lower after it was reported that euro zone manufacturing and service sectors contracted in the most recent reporting period. The euro zone Purchasing Managers Index fell to 49.5 in June, while the manufacturing number was 49.1. The 50% level is considered to be line of demarcation between expansion and contraction.

More recently, the euro advanced to a two month high against the U.S. dollar ahead of the European Central Bank meeting. It was widely expected that at that meeting the ECB would raise their benchmark interest rate by 25 basis points to 4.25%. Recent surveys of economists showed 57 of 58 were predicting a rate increase. The ECB has maintained their current 4% interest rate since June, while the Federal Reserve has lowered interest rates seven times from 5.25% to 2%.

Expect further gains for the euro including a move to new historical highs against the U.S. dollar.

September British Pound

There was some temporary strength in the British pound on news that British retail sales jumped by 3.5% in May, which is the quickest pace since the series began in 1986. Most of the increase was in the food and clothing categories. The median guess called for a .1% decline. Last month’s report showed a. 3% drop.

The U.K. currency traded lower after it was reported that U.K. house prices fell in June by the most amount this year. The pound was also pressured on ideas that the Bank of England is now less likely to increase interest rates after a member of the Monetary Policy Committee said economic growth will be “much slower” over the coming year.

We can expect the pound to trade steady with the U.S. dollar, but it should continue to lose ground against the euro.

September Swiss Franc

The Swiss franc fell after the Swiss National Bank kept interest rate policies unchanged when an increase had been expected. This caused the Swiss currency to lose additional ground the euro.

In spite of the relatively low interest rate structure in Switzerland, we can expect the franc to continue to gain on the U.S. dollar, although it will probably not be as strong as the euro.

September Japanese Yen

The Japanese yen fell to a record low against the euro on ideas that interest rate differentials will continue to move in favor of the euro. The European Central Bank is likely to raise interest rates one or more times this year, while the Bank of Japan will probably maintain current monetary policy through the balance of 2008 and possibly into 2009. The chance of an interest rate increase from the BOJ from the current level of .5% to .75% by the end of the year is only 40%.

Some of the recent partial recovery in the yen can be attributed to recent severe weakness in stock index futures. This is the normal reaction to lower stock index futures since the low yielding, “carry trade” currencies are liquidated, when risk aversion in overseas investments occurs.

Expect further short covering gains as stock index futures continue to come under selling pressure.

September Canadian Dollar

The Canadian dollar advanced after the Bank of Canada Governor Mark Carney said the unprecedented rise in commodity prices requires a “relentless focus on inflation.”

There were some additional temporary gains in the Canadian currency after it was announced that Canada’s annual inflation rate increased to 2.2% in May from the 1.7% increase in April. Higher inflation rates pushed interest rates up, which in turn, is attracting funds from overseas.

However, the anticipated slower economic growth in Canadian is offsetting the bullish impact of upward pressure on interest rates.

Expect the Canadian dollar to remain in a trading range of 97.00 to 102.00.

September Australian Dollar

The Australian dollar came under temporary selling pressure after the Reserve Bank of Australia kept their benchmark interest rate unchanged at 7.25% and indicated that they were unlikely to raise interest rates in the near term.

The Australian currency, along with most other major currencies, firmed later on ideas that the Fed will not increase interest rates any time soon. This is a very bullish fundamental, since it maintains the current yield advantage that the Australian currency enjoys.

In addition, the Australian dollar is being underpinned by rising commodity prices, including iron ore, copper and grains.

More recently, the currency surged to a 25 year high against the U.S. dollar on news that retail sales increased .7% in May from the previous month.

Our analysis continues to indicate that the Australian dollar is likely to advance to a parity level of one to one against the greenback.

September Eurodollar

All charts provided by APEX

Flight to quality buying came into the market on the rumors of a military strike on an Iranian nuclear facility. Political instability is likely to remain a longer term supportive factor.

There is a growing feeling that the Fed now has less room to tighten credit conditions in an atmosphere of economic and stock market weakness. Our studies suggest that there will be no near term increase in rates from the Fed and, as the economy continues to weaken, there will actually be mounting pressure on the Fed to reinstitute a more accommodative policy stance. The Fed is walking a fine line between talking tough on inflation, while not indicating that a near term interest rate increase is imminent. Most likely, as we get closer to next meeting, market expectations for a rate increase will diminish. . Financial futures have factored in a 27% chance that the Federal Open Market Committee will raise the fed funds target rate by 25 basis points to 2.25% at their August 5th meeting. This compares to a 36% possibility last week.

Expect higher prices for eurodollar futures. We also anticipate that the eurodollars will continue to gain on the longer dated maturities.

For more information about this article, please contact Alan Bush 1.800.243.2649 or email at alan.bush@archerfinancials.com.

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