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FX Technical Strategy

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Dollar weakness ahead

Thu, Jan 29 2009, 06:29 GMT
by Lloyds TSB Financial Markets Economic Research Team

Lloyds TSB Financial Markets

Market overview

As we near the end of the first month of trading, volatility has remained elevated and sterling has enjoyed (if that is the right word) the majority of this. The recent bearish press was recognised by a few experienced contrary traders that a rally was close, but the timing was open to question. Having seen the initial boost, the question is do we fade the rally or go with it? It is premature to think sterling has long term upward potential against the dollar, but it should squeeze further to 1.4400. Beyond this, the outlook is tied to the strength of commodities and the relative stability of equities. Whilst these themes could fold quickly, for now the resilience of commodities remains and has started to impact bond yields. Should this continue, the market may not be that far away from a medium term risk appreciation strategy.

In 2008 we saw correlations wax and wane, typically with equities and the yen, but the lack of dollar weakness on the back of precious metals' strength (more specifically gold) now seems to be correcting. When analysing which currency to buy, one can end up with a circular argument of not wanting to invest in any, which has led many people to gold. However, the movement in long bond yields yields (the reason for which is still open to debate), could push investors towards risk appreciation trades if it continues much further.

The currencies to watch this week are therefore sterling against the euro where a minor top has been triggered. This could well develop in to a major top in the coming weeks, but we need more confirmation at this stage. The 'high yielders' could then by rotation rally towards the end of the week as long as equities build on current gains. It should be noted that sentiment is still lurching agressively, keeping many longer term players on the sidelines and giving short term traders a challenging environment. However the development of more consistent and manageable trends should not be far away.

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Published on  Thu, Jan 29 2009, 06:31 GMT