After nearly breaking the intense bullish sequence of 27 consecutive closes higher than the previous daily low on Friday (as we had projected), the Euro finally officially broke the sequence on Monday in dramatic fashion, dropping some 70 points in the final hour of trade. As per our analysis in previous commentary, the break of this sequence could now open a further drop of some 300-400 points before we see any real resumption of Euro buying.
Relative Performance Versus USD Tuesday (As of 10:35GMT)
The recovery in the US Dollar over the past few days has been brought on by a scaled back expectation for a second round of quantitative easing from the Fed, which had initially accelerated following the Bernanke speech on Friday. While it is certainly true that the Fed Chair outlined the possibility for another round of quantitative easing, the fact that he did so should not have come as a shock to market participants with the subject of the speech being “Monetary Policy Objectives and Tools in a Low-Inflation Environment.” However, the fact that Bernanke failed to hint at any timing for such measures, or offer any real specifics on the policy, while also reminding investors of the “if necessary” language in the monetary policy statement, was indeed unexpected (not by us), and therefore resulted in some profit taking on USD shorts. This was the set-up for the anticipated reversal and fundamental catalyst for the start to the comeback in the Greenback.
So from here, what then would be the next market event to trigger additional USD buying and help build momentum for the current USD rally? Well, that came late Monday when Treasury Secretary Geithner was out with some rather strong language on the US Dollar that we believe should send a clear message to the markets.
While it is certainly true that the US has maintained a questionable strong US Dollar policy in light of what appears to be actions on behalf of the government that would be anything but USD positive, to us, it is highly telling that Treasury Secretary Geithner went over and beyond on Monday with regard to the official stance on the US Dollar. Should the Treasury Secretary have wanted to keep things status quo, he simply could have just said that the US maintains a strong USD policy. However, Geithner came out swinging after saying that the USD would remain the reserve currency in our lifetime, the US supported a strong Dollar, and the US would not resort to policy to force a devaluation in the currency.
We believe this should send a strong message to the markets that just maybe, the US does really maintain a strong USD policy, and as we have said in previous commentary, the fact that the USD is weaker right now is more a function of loose monetary policy in order to stimulate growth, rather than a specific desire or mandate to weaken the currency in order to rebalance the economy.
We need to remind ourselves that the world relies heavily on a stronger US Dollar. The system works because the US is able to consume product from abroad at attractive prices because the US Dollar is stronger and other currencies are happily weaker. Other major economies heavily rely on their export sectors and therefore are encouraged to have a weaker currency in order to promote their product. This is why quantitative easing measures (that devalue currency) in other economies can be more easily justified and why we feel the Fed should be much more sensitive (and we believe they are) to the longer-term impact and inflationary threats from the implementation of additional quantitative easing measures.
We acknowledge and commend the Fed for their efforts to this point and feel they have done an excellent job at managing the economy and prioritizing the immediate threats over the longer-term fallout from such policy. However, from here, the risks for any additional QE measures should be weighed heavily, as we fear that if the Fed goes to far, it will pass that hyperinflationary pointof no-return just like Japan did several years back. But in this case, the fallout will be more substantial and threatening to the global economy.
In our opinion, US government and Fed officials are very aware of this and have stepped up their efforts to remind us of this fact. Bernanke continues to retain a balanced and cautious approach, only willing to implement additional easing measures “if necessary.” The markets have incorrectly chosen to focus on the other language which outlines such measures, and has for the most part ignored the “if necessary” language. But perhaps these latest remarks from Geithner highlight a coordinated effort to make it all the more apparent that just maybe, another round of quantitative easing is in fact not guaranteed, and even if we do see another round, it will not be anything like what the markets have been pricing in.
Geithner’s comments are sending a strong message to us and that message is to not be overly aggressive in selling the Dollar. No economy has ever flourished and prospered as a dominant global power with a weak currency, and we think that the US government is well aware of this fact and ultimately, will do what is necessary to ensure the stability and strength of the Greenback.
The technical evidence for a major USD rally is being confirmed on the fundamental front, and while we would not abandon the possibility for renewed USD selling at some point, for now, the risks are for the US Dollar to continue to mount an across the board come back. Our target for the Euro over the coming days comes in by 1.3500-1.3600.
Elsewhere, the RBA released the Minutes from the latest central bank decision which were rather balanced after the central bank failed to signal to investors that they would be looking to hike rates at the next meeting. The RBA said that they would need to continue to monitor data and developments before being able to make another decision. The central bank also conceded that the stronger currency helped to offset the need for additional rate rises. We believe that just as QE2 has been incorrectly priced in to the markets, so too has the strength in the Australian Dollar. In our opinion the antipodean is at risk for a major depreciation over the medium and longer-term, with the currency at cyclical highs and the very hot economy at risk for a cooling off.
Meanwhile in the Eurozone, data was on the whole quite mixed, with the current account coming in weaker, while the ZEW was much stronger. However, any bids on the back of the stronger Eurozone ZEW, were easily offset by a weaker than expected German ZEW print. Overall, the data hardly factored into price action. Over in the UK, economic data failed to inspire any confidence in the Pound, with CBI business optimism and trends total orders coming in far worse than expected.
Looking ahead, US building permits (575k expected) and housing starts (580k expected) are due at 12:30GMT, followed by the Bank of Canada rate decision (on hold at 1.00% expected) at 13:00GMT. The official circuit is stacked with speakers today, and the aggregated comments could very well influence price action. ECB President Trichet speaks on the topic of the economy at 12:30GMT, followed by Fed Evans, Dudley, Lockhart, Fisher, and Kocherlakota, all speaking on the topic of the economy as well, at 13:40GMT, 14:00GMT. 15:30GMT, 16:50GMT, and 17:20GMT respectively. Bank of England Mervyn King then takes his turn on the topic of the economy at 18:50GMT, followed by Fed Chair Bernanke at 20:00GMT. Fed Duke ends the run of speakers at 23:00GMT. US equity futures and commodity prices are tracking lower into the North American open.
EUR/USD: The market has finally broken a major bullish sequence of 28 consecutive closes higher than the previous daily low, with the pattern having supported a massive push higher in the Euro over the past several weeks from roughly 1.2600-1.4100. Daily studies have turned down from overbought and the close below 1.3935 on Monday officially negates the sequence and opens the door for deeper setbacks towards 1.3500 over the coming sessions. Any intraday rallies should be very well capped ahead of 1.4000, with a break below 1.3775 to accelerate. The market has also managed a close below the 10-Day SMA for the first time since early September.
USD/JPY: Daily studies are well oversold and the latest setbacks have stalled out for now just ahead of the record lows by 80.00 from 1995. A bullish hammer close last Thursday and Friday could suggest that the market is finally ready for a short-term correction, but we would need to see a break back above 81.85 to help reaffirm these prospects and officially relieve downside pressures. Back below 80.90 opens the door for a direct test on the critical barriers at 80.00.
GBP/USD: Rallies have been very well capped above psychological barriers at 1.6000 and the market has since stalled out and reversed course in favor of a bearish resumption. The risk from here is for additional weakness, with a break back below 1.5755 to confirm bearish outlook and accelerate declines. Ultimately, only back above 1.6000 would negate outlook and give reason for pause.
USD/CHF: Setbacks have most recently managed to extend to fresh record lows by 0.9460 ahead of the latest minor bounce. However, while the overriding trend still remains intensely bearish, we like the idea of a major bottom carving out at current levels, in anticipation of some significant upside over the shorter-term and longer-term. Daily studies have just crossed up from oversold levels, while weekly studies are still well oversold and show plenty of room to run to the upside. As such, we look for a close back above 0.9600 to confirm bias and open a major reversal.
An ACB and corporate demand in Usd/Jpy with heavy offers from Japanese accounts. IMM and model types buying on the way up in Aud/Usd. An ACB is a buyer of Eur/Usd along with real money demand, and an Asian name and German bank are notable sellers in Cable.