On Monday, EUR/USD fell prey to some modest profit taking after Friday’s huge gains in a session devoid of major eco releases or other breaking news. In a daily perspective, the pair slid from 1.3633 to 1.3582. Overnight EUR/USD traded in a fairly narrow trading range.

EUR/USD started the European trading session under some downward pressure. It followed a big move higher on Friday that was triggered by a slightly better US payrolls report and the break above the 200 day moving average. In these circumstances, some profit taking was no surprise. The publication of disappointing French and Italian production data for March did of course little to withhold investors of booking profits, but didn’t play a leading role in the price action. The data suggest downward risks to the already very weak expected EMU and national GDP data that will be published on Friday. However, the down-move that started in the 1.3635 area ran already out of steam ahead of the start of the US session in the vicinity of 1.3560 and some return action brought the pair again to nearly unchanged levels. Also this move was short-lived and EUR/USD slid again to the 1.3580 level and held this level going into the close. Equities performed poorly in both Europe and US, while commodities corrected lower too and bonds gained ground. In this context we would conclude that all markets were in correction mode after steep risk appetite induced gains that were registered in the previous days and weeks in commodity, equity and euro markets.

Overnight, Fed chairman Bernanke sounded optimistic on the initial indications on the banks stress tests. He noted that banks are ahead in finding private sector options for increasing their common equity and that several banks plan to issue longterm debt that is not guaranteed by FDIC. However, he hedged his comments by adding that it will take time to know whether the stress tests had restored confidence in the financial system. The chairman also defended the dollar saying that he expects the greenback to remain strong because the US economy is strong and the Fed would keep inflation at bay by rising rates when the time is right.

Today, the US eco calendar contains the March trade balance besides some second tier reports. In February, the trade deficit narrowed unexpectedly sharply allowing the dollar to gain ground on the euro (on a daily perspective). In theory, trade figures are a driver for currencies, but with capital flows much more important the impact of trade balance figures may have lost significance for the currencies unless the surprise is large as was the case last month. For March, a modest re-widening of the deficit is expected on the back of higher energy prices. Unless the figures do surprise, we think that the reaction will be fairly limited. In EMU, the final German CPI report shouldn’t stir much fuss and neither should the Banque de France business sentiment report for April. Some modest improvement is expected, but this would only be a confirmation of the French PMI report reported earlier this month.

Trading will remain interesting because EUR/USD is within striking distance of key technical levels at 1.3738. A sustained break above would accelerate the recent euro ascent, as it would paint a double bottom on the charts with medium term targets of the configuration at 1.4589 and 1.5017. Equities play currently an important role in the FX market and also here key resistances are looming. Especially, the 943 level in the S&P is attracting a lot of attention, because a sustained break would be a technical important signal that the bear market is over. Given the high profile nature of the resistances in both EUR/USD and S&P and given the strong multi-week rally in equities, we suspect that these levels won’t be taken out so easily. We are encouraged by yesterday’s price action, even if we admit that the EUR/USD correction was of very minor importance, which may encourage the euro bulls. Re-iterating our view, short term players might book profits on euro long exposure, preferable close to the 1.3738 level, while also longer term investors might prefer putting some protection on their positions. The ST outlook however remains euro positive as long as the pair stays above 1.3470/52 (break-up daily and broken 200 day moving average), where some buy-on-dip tactics is favoured. At the start of trading today, Bernanke’s comments may help the euro (risk appetite) at the margin, but the risk is that equities still have to correct further.

Global context. Over the previous months, currency markets were driven by various factors. The swings in risk appetite/risk aversion were the dominant factor on all markets and the currency market was no exception. Bad news was most often dollar supportive. The euro received a better bid when investors turned more courageous. This pattern was a few times interrupted by central bankers. However, those CBinitiated swings were only temporary in nature. At the end of April, the euro even performed a nice rebound, supported by better than expected EMU sentiment indicators. Longer-term, we are still dollar cautious as the execution of the quantitative easing policy in the US remains a factor of uncertainty for the US bond markets and for the USD. We don’t call victory yet and EUR/USD sentiment is affected by several conflicting influences, but recent euro gains are encouraging. The more gradual ECB approach on quantitative easing compared to the BoE and the Fed is a LT supportive factor for the single currency. However, technical considerations make us think that the EUR/USD couple needs some consolidation/correction following recent gains. A further correction in the equity markets would nicely fit into that expectation.

On Monday, USD/JPY lost some more ground, extending the correction for the third consecutive session. It is tempting to see the yen gains as a result of weaker equities, but the yen gained on Friday too when equities were stronger. So while the risk aversion/appetite theme might have played a role yesterday, we would look more to the technicals for an explanation. USD/JPY failed to retake the 100 level, which is a disappointment for the dollar bulls and convinced some short term players to throw in the towel. So the pair reverted deeper in the existing range of 95.70 to 101.44. In a daily perspective, the pair slid from 98.47 to 97.48 almost one big figure and trades currently marginal lower at 97.30

Today, Asian equities, including Japanese ones, are modestly lower. There is disappointment about the Chinese trade figures that showed a steeper than, expected decline of exports in April suggesting that global demand is still very subdued. Also imports disappointed, which may indicate that domestic demand has not revived much yet. The Chinese Fixed asset investment figures, also for April, were more encouraging. Japanese leading indicators were uneventful, while the more important machine tool orders aren’t released yet. The Japanese 10-year bond auction went well. All these factors had little impact on trading though. Following recent gains the yen is closing in on the lower boundary of the current range (see below). The pair showed little direction and momentum in the last two months and we don’t see an imminent driver emerging. Therefore, we favour range trading.

Global context. Over the previous months, the yen lost part of its safe haven status as markets grew more concerned on the Japanese economic performance. Nevertheless, an improvement in global investor sentiment in March supported a second USD/JPY up-leg and the pair tested the key 100.55/102.20 resistance area. Sustained gains beyond this area proved to be difficult and a technical correction sent USD/JPY to a 95.63 reaction low last week. Mid last week, the correction lost momentum and the pair performed another rebound. However, this rebound again halted ahead of the 100/101.45 resistance area. So, range trading in the 95.63/101.45 trading range remains the preferred scenario.

On Monday, EUR/GBP extended its rally for the third consecutive session, but closed well off intra-day highs. Indeed, the pair moved from 0.89508 to an intra-day high of 0.90373 before closing at 0.89842. General themes and more in particular profit taking in equities and commodities played havoc with sterling (and other currencies that are perceived as higher risk) with the BoE decision last week to take its aggressive quantitative easing one step further maybe still lingering in the minds of some investors. However, technicals are also prominent in play. The failure of EUR/GBP to drop below 0.8786 low earlier last week convinced traders that the downside in the pair is better protected, helping EUR/GBP to eke out more gains.

Also overnight the pair ticked up, despite the publication of surprisingly strong housing and retail data (see below) that should have bolstered sterling.

Overnight, some encouraging UK eco data were published. House prices fell at their slowest pace in 15 months in the three months to April, according to RICS and new buyer enquiries rose for the sixth month. The BRC reported very strong retail sales for April. So the dataflow out of the UK continue to surprise on the upside which is encouraging. Later today, the March trade and production data for March will be published. The trade deficit is expected little changed, while production is seen as ongoing weak (-0.9% M/m and -12.8% Y/Y). The DMO will hold its 2030 Gilt auction and recently the DMO had difficulties in enticing investors for its issuance. With an enormous budget deficit to finance, any signal that financing is a problem is of course a negative for sterling too. Taking all these factors into account, EUR/GBP may be on its way for a test of 0.9082 level (previous high).

Global medium term context. After a forceful rebound in March, EUR/GBP was captured in an ongoing downtrend. At some point, it even looked as if the pair was heading for a test of the key 0.8637 area. However, mid April, the sterling rebound ran out of steam (Reaction low in the 0.8787 area). The UK budget announcement and the weaker than expected Q1 GDP two weeks ago, again brought the fragile situation of the UK economy in the spotlights. However, the subsequent EUR/GBP rebound didn’t show a strong momentum and the pair again tested the 0.8787 previous low. In a longer-term perspective, we have been advocating for quite some time that a sustained rebound of sterling was premature. In this respect, we take some comfort from recent price action after the ECB and BoE interest rate decision and the failure to drop below key support. The combination of a rather aggressive QE approach by the BoE and a much more cautious approach by the ECB should continue to give the euro downside protection against sterling, at least in a short-term perspective. We hold on to our cautious buy-on-dips approach. Shortterm the pair develops in a sideways trading pattern between 0.8765 and 0.9156. Intermediate resistance comes in at 0.9081 (ST reaction high). Short-term, we put the risk for some follow-through gains higher in this range.