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The housing market in the United States is collapsing. It’s no longer a secret. Nor do you have to be an economist to see how the real estate contagion is taking its toll on the broader American economy.
Heck, the evidence of an economic slowdown was already piled high, and last Friday’s jobs report was the cherry on top of the whipped cream!
Before that, analysts had been reluctant to forecast a full-blown recession precisely because U.S. employment remained solid. But a dismal pace of new payrolls and a heated up-tick in unemployment made it clear just how bad things have gotten in the labor market.
Now, at a time when credit has seized up and market sentiment has turned increasingly negative, the dreaded ‘R’-word is out in full force. Many think the U.S. is already in recession; most others now feel a future recession is the most likely outcome.
So, is a U.S. recession largely factored into the currency markets? After all, investors were betting heavily against the dollar in 2007.
My answer: NO!
The question is not if but rather how much the next interest rate cut will be. And aggressive action from the Fed could drive the dollar to new lows.
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Ben Bernanke, in his prepared speech on Thursday, basically signaled that the Federal Reserve will cut interest rates further to aid ongoing economic weak spots.
Currencies responded just how you’d expect they would — they rallied sharply against the U.S. dollar.
But there was one notable exception — the British pound barely budged!
That’s what I call poor price action. And poor price action portends further weakness on the horizon for the British pound. It’s that simple.
What’s more, the fundamentals pushing the dollar lower are very similar to the fundamentals in the U.K. Let me explain …
The United Kingdom Chooses a Bad
Role Model; Horrible News for the Pound!
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| Mervyn King, the Governor of the Bank of England, has a tough road ahead of him — and so does the British pound! |
Could the British pound become the “dollar of 2008?” In other words, will currency investors batter the pound as much as they killed the dollar last year? At first, it sounds absurd. That’s because we’ve become used to watching the two currencies trade against each other rather than in tandem.
But when you look at what’s happening in the U.K., the idea of a falling dollar and a falling pound makes more sense.
At a time when the dollar story is getting stale, it’s easy for analysts and investors to simply transpose much of the negative U.S. dollar story right onto the British pound.
Weakening housing? Check. Crunching credit markets? Yup. Economic weakness on the horizon? Sure looks like it!
Remember, three weeks ago, I told you that the housing and credit market in the United Kingdom would presage a significant slowdown, just the way it has in the U.S.
Look at the fundamentals:
- In the fourth quarter, U.K. house prices fell 0.8% — the first time this has happened since 2000.
- Retail sales rose only 0.3% in December, smack in the middle of the holiday season. That’s the slowest pace in 21 months.
- Core prices in the U.K. are at the lowest level in 13 months — wiping away the Bank of England’s need to fight inflation.
- The savings ratio among Britons has dropped below zero for the first time since the late 1980s and household debt service makes up a whopping 14% of incomes.
Those point to downside ahead, for both the U.K. economy and the pound.
Apparently, more currency traders are coming around to my way of thinking, too. The British pound fell to an all-time low against the euro and more than a ten-month low versus the U.S. dollar this week.
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Now, take a look at this chart …
As you can see, the British pound broke through major long-term support levels!
Yet despite the writing on the wall, the BOE didn’t blink during its January monetary policy meeting, which concluded on Thursday. They chose not to cut interest rates.
I think that was a huge mistake! The way I look at it, they’re just postponing the inevitable.
It’s obvious the U.K.’s central bank is starting to face the same demands that pushed the Federal Reserve to begin its series of interest rate cuts. What matters now is how soon the BOE succumbs to evidence of a weakening U.K. economy.
The natives are going to get more and more restless if interest rate cuts remain on hold. And you can bet they’ll display their frustrations by selling the heck out of the pound!
My first target for the British pound is $1.93 — the nearest point that could offer up decent support.
Best wishes,
Jack
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