Dollar Decline: Not a Sure Thing

Since 2002, the Dollar has lost 70% of its value, relative to the Euro. Meanwhile, the same factors that signaled bearishness in 2002 persist in 2008, or even worsened in some aspects. The twin deficits are still growing, though the current account deficit may be leveling off. The US economy is headed towards recession. Inflation is set to rise due to soaring commodity prices and a loosening of monetary policy. As a result, many investors are betting that the Dollar's slide will continue well into the near future.
However, prudent investors would be wise to "handle with care." While not entirely applicable to forex markets, efficient markets theory dictates that inherent in a security's current valuation is all relevant, publicly available information. Thus, all of the bad news listed above has already been priced into the Dollar, to some degree at least. The rule of diversification is in full effect when betting on forex. Thus, rather then putting all of one's chips directly behind one currency, an investors could buy foreign securities (stocks and bonds) instead, which also capture any currency appreciation (and depreciation). Investors can also purchase Treasury Inflation Protected Securities (TIPS), whose yield is linked to inflation and, thus, acts as a hedge against a declining Dollar. The Wall Street Journal reports:
While some market watchers believe the six-year dollar bear market isn't over yet, investors should recognize that trends in the currency markets are typically marked by volatile ups and downs along the way.

Fundamentals Harm Emerging Market Currencies

Since the inception of the credit crunch, one of the themes in forex markets has been the surprising strength of the Dollar. Despite growing economic uncertainty, the US is still viewed as a relatively safe place to invest. On the other hand, emerging markets, especially those with current account deficits, have witnessed capital flight and subsequent currency depreciation. The currencies of South Africa and Iceland, for example, have both experienced declines 20% since the start of this year. Risk premiums had fallen to historic lows prior to the credit crunch, and neither country experienced great difficulty financing its respecive deficits. However, investors are growing increasingly nervous and are shifting capital to countries with stable current account balances. The Financial Times reports:
Goldman Sachs says: "We have long argued that in times of global turmoil suppliers of capital are poised to outperform countries in need of capital. However, it is only since January 2008 that we have seen the current account theme really gain momentum in the FX market."

Risk Control

Controlling risk is one of the most important ingredients of successful trading. While it is emotionally more appealing to focus on the upside of trading, every trader should know precisely how much he is willing to lose on each trade before cutting losses, and how much he is willing to lose in his account before ceasing trading and re-evaluating. Risk will essentially be controlled in two ways: 1) by exiting losing trades before losses exceed your pre-determined maximum tolerance (or "cutting losses"), and 2) by limiting the "leverage" or position size you trade for a given account size. Cutting LossesToo often, the beginning trader will be overly concerned about incurring losing trades. He therefore lets losses mount, with the "hope" that the market will turn around and the loss will turn into a gain. Almost all successful trading strategies include a disciplined procedure for cutting losses. When a trader is down on a positions, many emotions often come into play, making it difficult to cut losses at the right level. The best practice is to decide where losses will be cut before a trade is even initiated. This will assure the trader of the maximum amount he can expect to lose on the trade.The other key element of risk control is overall account risk. In other words, a trader should know before he begins his trading endeavor how much of his account he is willing to lose before ceasing trading and re-evaluating his strategy. If you open an account with $2,000, are you willing to lose all $2,000? $1,000? As with risk control on individual trades, the most important discipline is to decide on a level and stick with it.Determining Position SizeBefore beginning any trading program, an assessment should be made of the maximum account loss that is likely to occur over time, per lot . For example, assume you have determined that your worse case loss on any trade is 30 pips. That translates into approximately $300 per $100,000 position size. Further assume that the $100,000 position size is equal to one lot. Five consecutive losing trades would result in a loss of $1,500 (5 x $300); a difficult period but not to be unexpected over the long run. For a $10,000 account trading one lot, this translates into a 15% loss. Therefore, even though it may be possible to trade 5 lots or more with a $10,000 account, this analysis suggests that the resulting "drawdown" would be too great (75% or more of the account value would be wiped out). Any trader should have a sense of this maximum loss per lot, and then determine the amount he wishes to trade for a given account size that will yield tolerable drawdowns.

EUR/USD: ZEW Investor Survey Likely to Reflect Dismal European Sentiment

Despite a mild improvement last month, investor sentiment throughout the Euro-zone is anticipate to deteriorate as the ZEW survey is forecasted to fall to a record low of -42.0 from -41.4. The news will not be entirely surprising, as the European Commission’s most recent surveys of economic, industrial, and services sector confidence all dropped more than expected.

11-Mar	Euro-zone ZEW Survey (MAR) (10:00 GMT; 05:00 EST)	German ZEW Survey (MAR) (10:00 GMT; 05:00 EST)
	Expected: -42.0	Expected: -40.0
	Previous: -41.4	Previous: -39.5

What Are The Markets Facing?

Despite a mild improvement last month, investor sentiment throughout the Euro-zone is anticipate to deteriorate as the ZEW survey is forecasted to fall to a record low of -42.0 from -41.4. The news will not be entirely surprising, as the European Commission’s most recent surveys of economic, industrial, and services sector confidence all dropped more than expected. Indeed, building price pressures are hurting disposable income for consumers and denting profit margins for businesses, and things are only getting worse. The European Commission’s flash estimate for February CPI held at a 14-year high of 3.2 percent, which leaves the European Central Bank very little room for maneuver regarding monetary policy. Indeed, given ECB President Jean-Claude Trichet’s press conference comments last week, it appears that the central bank remains staunchly hawkish tone as he said, “The latest information has confirmed the existence of strong short-term upward pressure on inflation...The economic fundamentals of the euro area are sound...Yet the level of uncertainty resulting from the turmoil in financial markets remains high. Against this background, we emphasize that maintaining price stability in the medium term is our primary objective in accordance with our mandate.” Another major issue for investors is the value of the euro, as its rapid appreciation to record highs hurts prospects for export growth. On the other hand, the strong currency is helping to offset import price inflation, which is likely why Trichet has only resorted to mild verbal intervention. Overall, Tuesday’s sentiment data will likely highlight the dim prospects for the Euro-zone, and if the figures are worse-than-expected, markets may start to bet that the ECB will seriously consider cutting rates as soon as CPI eases back.

Dollar Falls to Record Lows

Over the last couple weeks, the Dollar has plummeted against all of the major currencies, falling below the $1.50 mark against the Euro for the first time ever. It seems investors are reacting to a spate of negative economic data which are painting an increasingly bearish picture for the US economy. In addition, the Fed seems likely to lower rates further while the ECB will maintain rates at current levels. For a brief period, talk of recession was actually helping the Dollar, as investors predicted that the global economy would be harmed more than the US economy, but it looks like that period has passed. As a result, the EU is growing increasingly alarmed, and the pressure is building for some kind of intervention. AFX News Limited reports:

Euro group president Jean-Claude Juncker said currency markets are overreacting to the short-term outlook for the US economy. " We don't like excessive volatility in exchange rates," Juncker said.

Euro Powers Past 1.50

The dollar extended its losses further, reaching another record low versus the euro beyond the 1.51-handle to 1.5144 while briefly falling past the 106-level against the yen to 105.97. Continued weakness in US economic reports and further pricing in of additional FOMC rate cuts prompted the renewed selling in the greenback. Fed Chairman Bernanke again gave a somber assessment of the US economy in his semi-annual Congressional testimony raising market expectations for more policy easing in the coming months.Bernanke said the “economic situation has become distinctly less favorable”, citing lingering tight credit conditions and a slowing labor market. He expects the housing market deterioration to continue to weigh on the economic in the coming quarters with risks for growth remaining to the downside. Bernanke said the risks “include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further”. He said the Fed expects inflation to moderate; suggesting overall PCE will “moderate significantly” in 2008 to between 2.1%-2.4%. Chairman Bernanke’s testimony reiterates the Fed’s focus on stimulating growth and highlights a shift inflation data has taken, moving to a secondary role behind data impacting growth. The economic reports released today furthered the case for a 50-basis point rate cut to 2.5% when the FOMC meets in March. Durable goods orders in January plunged by 5.3%, exceeding estimates for a 4.0% drop and sharply reversing from December’s 5.0% increase. The excluding defense durable goods orders also posted a sharp drop, falling by 4.7% versus calls for a 1.2% fall from a 2.7% increase a month earlier. New home sales for January also decline by more than forecasts at 588k units, compared with 604k units previously.

USD Losses Accelerate

The beleaguered dollar found no reprieve against the majors, with the accelerated selling pushing the currency to fresh all-time lows against the euro, Swiss franc, 24-year lows versus the Aussie and 3-year lows versus the yen. Underscoring the greenback’s weakness has been the continued deterioration in US economic reports, raising fears of an imminent recession and reaffirming the Fed’s need for further aggressive monetary policy easing over the coming months. The reports today included January PCE, consumption, personal income, February Chicago PMI and the University of Michigan sentiment survey. Inflation remains firm as the January PCE price index edged higher with the monthly figure ticking up to 0.4% from 0.2% and 3.7% versus 3.5% a year earlier. The core PCE price index firmed to 0.3% m/m and 2.2% y/y. Personal consumption was flat in January and personal income eased to 0.3%, down from 0.5%. Boding poorly for the economy and the greenback was a dismal February Chicago PMI report, which fell sharply to 44.5, far greater than the expected decline to 49.7 from 51.5 from January – beneath the key 50-level. However, the University of Michigan sentiment survey in February fell by slightly less than estimates, declining to 70.8 instead of forecasts for a fall to 70 from 78.4 a month earlier. Central bank policy decisions and US economic data will dominate the headlines next week. The ECB, BoE, BoC, BoJ and RBA are scheduled to announce policy decisions, with the Reserve Bank of Australia seen tightening rates by 25-basis points to 7.25%. The key highlight from the US will be Friday’s labor report, with the unemployment rate for February expected to edge higher to 5.0% from 4.9% and non-farm payrolls reversing the 17k jobs contraction from January, growing by 35k.