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Sunrise Market Commentary: Currencies

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EUR/USD is testing the longstanding uptrend line

Wed, Nov 18 2009, 08:29 GMT
by KBC Market Research Desk

KBC Bank

On Tuesday, global markets entered somewhat of a consolidation phase after the strong rally in almost all asset markets on Monday. Stocks fell prey to a moderate profit taking move and this correction was also visible in the EUR/USD price action. EUR/USD drifted lower throughout most of the session and the move even accelerated early in the US trading hours. Market comments still saw some support for the US currency from Fed’s Bernanke’s comments on Monday evening. We don’t join this analysis. Bernanke didn’t give any sign that the Fed is preparing any action to support the dollar. The strong dollar should be supported by the Fed’s determination to achieve its dual policy focus of price stability and maximum employment. Price stability is no big issue for now and the fragile situation on the labour market justifies the Fed extending its loose policy stance for a prolonged period of time. So, within this framework, the dollar won’t get any material support from the Fed any time soon. Once again, the US is stalking about a strong dollar, but that doesn’t mean its wants the see the dollar stronger in the near future. On the contrary. Nevertheless, over the previous days we already indicated that we felt some fatigue in the EUR/USD upward momentum. This was still the case yesterday. EUR/USD dropped to an intraday low in the 1.4810 area early in US trading as US stocks lost some ground at that time. So, the pair dropped temporary below our LT uptrend line. However, US equity markets recouped the earlier losses and this gave EUR/USD some downside protection, too. The pair closed the session at 1.4876, compared to 1.4970 on Monday evening.

After the close of the European markets, Mr. Trichet in a speech made a small amendment to its usual mantra that a strong dollar is in the interest of the US. He said that it was in the interest of the entire international community. Eurogroup chairman Juncker joined Trichet’s analysis, but also said that the current level of the euro didn’t harm the European recovery. The comments, as usual, had hardly any impact on the currency markets. This will probably remain the case as long as this dollar rhetoric on both sides of the Atlantic is not accompanied by hard policy action.

Today, the calendar in Europe is thin. In the US, the CPI, the housing starts and the permits are on the agenda. The housing data have most potential to move the markets. Maybe the risk for the housing data is still a bit to the downside. As usual, one might expect the reaction on EUR/USD to go via the stock markets. So, good/bad news will be good or bad for EUR/USD. Mr. Obama will finish its visit to China today, but we don’t have the impression that this will yield a high profile result in the USDCNY debate. So, by default, currency traders will still have to take their clues for trading from the price action on the equity markets, even as we have the impression that this trading theme is losing power. The S&P holding close the recent highs after Monday’s rally is a constructive sign and if confirmed, this should also give EUR/USD downside protection. Nevertheless, we still have the impression that a swift break above the 1.5063 high in EUR/USD won’t be easy.

Global context. Already for quite some time, the swings in risk appetite/risk aversion were the drivers on the currency markets. Improving investor sentiment towards risk is still considered a good reason to sell the US dollar. On top of that, the dollar has become (or is at least perceived to have become) the preferred currency to fund carry-trade deals. Lingering uncertainty on the huge US financing needs, some international debate on the status of the dollar and the Fed’s intention to run an expansionary monetary policy for a prolonged period of time offer additional ammunition for carry traders to use the dollar rather than other currencies. This has put the dollar in a vulnerable position. We stay dollar skeptical as long as we don’t get a clear signal that the Fed is coming closer to reversing its very stimulating monetary policy. Recently, several key Fed members, including Bernanke, obviously refrained from giving such a signal. The opposite was the case. The swings in risk appetite/risk aversion might accelerate/slow the decline of the dollar against the euro. This theme of risk appetite/aversion at some point will stop playing its role as a guide for currency trading in general and EUR/USD in particular. This point is probably coming closer. However, at least for now we don’t see a new trading theme yet that will be able to take over anytime soon. So, until further notice, we maintain our assumption that the trend remains in place, even as the pace is slowing.

Looking at the (technical) charts, the break of EUR/USD above the range top at 1.4438/48 and above the 1.4719 (Dec high) improved the picture, but the move continued to develop in a gradual way. Nevertheless, the corrections, if any, were very limited, too. The pair tested several times the longstanding uptrend line since March, but a break didn’t occur. We maintain a cautious buy on dips approach, even as we feel that the momentum of the uptrend is waning, too. So, we wouldn’t be surprised to see EUR/USD shifting into a sideways trading pattern going into the end of the year. The 1.4626 reaction low marks a high profile MT support. The recent highs in the 1.5063 area might be the top of this pattern.

On Tuesday, USD/JPY basically held a sideways trading pattern. The pair revisited Monday lows in the 0.8880/75 area. A rather disappointing performance of the Asian stock markets probably played a role. However, a break to new lows failed and the pair started a gradual comeback. As is already the case for quite some time, there was again no clear story to drive the price action in this pair. Sometimes investors try to take a clue from the risk aversion/risk appetite theme. The next day, some traders try to draw some conclusions for the currency from the worrisome fiscal situation and the uncertainty on the Japanese budget going into 2010. However none of these issues is able to impose itself as market theme. So, in technical trading, the pair rebound off from the recent lows and closed the session at 89.25, little changed from the 89.05 close on Monday evening.

This morning, Asian stock markets show again a mixed picture. Japanese indices continue to underperform most other indices in the region. The direction of the causal link between Japanese stocks and the yen is often a difficult exercise for interpretation. However, the underperformance of the Nikkei doesn’t call for a sharply higher yen.

Global context: USD/JPY reached a reaction high in the 97.80 area early August. Despite positive global investor sentiment, the dollar could not hold on to its gains against the yen. The link between USD/JPY and global investor risk aversion/risk appetite became less tight and sometimes it even reversed. The dollar (and not the yen) was said to have become the preferred funding currency for carry trades. So, the price action in USD/JPY to some extent joined the global dollar trend (decline). The long-term trend obviously remains USD/JPY negative. We turned more cautious on USD/JPY shorts on technical considerations as the pair came closer to the 88.00/87.10 range bottom and we were looking for re-entry opportunities in the 92/93 area, an area reached end October. At that point, we advocated re-installing USD/JPY short positions for return action lower in the trading range. We hold on to our bias. Recent price action suggests that a break below this range bottom will be difficult, too. So, profit taking on shorts in case of the return action to the low 88.00 area might be considered.

On Tuesday, sterling extended its gradual rebound against the euro. The break below the 0.8900 EUR/GBP support area reinforced the move. The UK inflation for October came out slightly higher than expected at 1.5% Y/Y. This not a big issue, but it matched the short-term sterling positive sentiment. So, EUR/GBP could extend its decline after the release/ EUR/GBP closed the session at 0.8848, compared to 0.8902 on Monday evening.

Today, the UK calendar contains the CBI industrial tends, but the market focus will be on the minutes of the previous BoE meeting. Last week, BoE’s King left all options open whether more asset purchases would be needed or not. The on raising the QE amount was probably split. It will be interesting to see whether some members voted for no rise in the amount of asset purchases. We don’t have a strong view in the voting, but in such a scenario, the sterling rebound might have some further to go.

Global context: Since early August, sterling sentiment deteriorated again as then BoE raised the asset purchase program to £175B. On top of that, BoE’s King at that time already called for an even greater effort, indicating that the Bank intended to maintain a loose policy for a prolonged period of time. This triggered a new sterling selling wave. At the September and October meetings, the BoE took no additional policy steps. However, the debate on additional QE steps was still ongoing, especially after the poor Q3 growth figure. Nevertheless, a sterling short-squeeze kicked in since mid October, even as speculation on additional QE continued. EUR/GBP even dropped below the 0.8984 support. This was an important technical warning. The November BoE decision to raise the amount of asset purchases (surprisingly) didn’t any harm for sterling and reinforced the feeling that the sterling correction might have some further to go. From a fundamental, long term point of view, we didn’t see any reason to turn sterling positive in a context where the BoE is lagging the ECB in scaling down (a much more aggressive) monetary stimulation. However, in a short-term perspective, we couldn’t ignore the sterling constructive mood/technical picture. Over the previous two weeks, the pair extensively retested the 0.8900 support area. The pair failed to move away from this area, even in case of sterling negative headlines and Monday’s break below our 0.8897 stop loss area occurred. This was a strong warning that the GBP correction/rebound might have some further to go. We keep sidelined for now. The 0.8830 break-up area is the next support on the charts. A sustained rebound above the MTMA (today at 0.8944) is needed to call off the ST alert. A break above the 0.9061/65 reaction high area is still needed to turn the ST picture again positive.

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Published on  Wed, Nov 18 2009, 08:50 GMT