Forex - Merkel's Comments Haunt the EURO

Forex News and Events:

Safe-haven trades were slightly stronger this morning during the Asian session. The absence of any fresh economic news kept large participants sidelined this morning. Risk aversion was driven by further spread widening of peripheral EU bond spreads against Germany. The trend was set in motion yesterday as the S&P closed 1% lower and risk-correlated assets took their cue from the stock index.

Although the level of rhetoric in Japan continues to be ramped up, the Nikkei dropped 2% on risk aversion and Yen strength. Finance Minister Noda provided the usual comments, something about him watching Forex movements carefully and that he’s willing to take decisive actions, including FX intervention, if the situation warrants it. BoJ Governor Shirakawa upped the ante by giving the market his clearest response to the Yen strength to date. He stated that the “JPY strength illustrates the market’s concern with the EU stress test and current banking environment” and not necessarily the fundamentals of the Japanese economy. The BOJ maintains that they are watching the effect of JPY strength on growth and that should downside risk emerge, the central bank would take necessary action. Nevertheless as we had stated numerous times - verbal intervention will not affect the JPY at this point and the market quickly pushed the USDJPY back to its 15-year low.

In Europe, Merkel's comments yesterday asserted that Germany would not support the bailout fund forever and that the crisis mechanism in the EU needs to have a limit. The statement is buzzing through the market today as participants fear that should a global double dip recession come to pass, Germany may not stand behind the EU. We can’t stop thinking about Ambrose Evans-Pritchard article citing Dr Sinn’s (Head of the IFO Institute) dire prediction for the EU and Greece.

As EU peripheral sovereign bond spreads continue to widen, fears will continue to grow over the Eurozone’s banks and sovereign risks. The sagging global recovery demonstrates the EU sovereign crisis is far from being over. German industrial orders for July printed below expectations at-2.25 verse a +0.5% expectation, which didn’t give the market any additional assurances.

Our base scenario in the near term is that the weakness we are seeing in the US and early signs in Asia will hit the EU shortly. The commitments to hold to austerity measures will come under increased political and media pressure. With no short term solutions, we suspect that these fears will keep risk-correlated trades subdued and traders will be looking to buy USD, CHF and JPY. On a final note, the general market expectation for the BoC is a 25 bp hike, however just barely. The market is pricing in 17 bps of tightening and recent economic data should have underwhelmed policymakers. We still anticipate a 25 bp hike with a dovish accompanying statement. In the near term, look to short CAD strength.

As for today, the Beige Book should be the main event, however the market is not expecting anything new or enlightening from that release. However, if we do get some clarity on the US recovery or additional support for the market’s paranoid over credit contagion, we could see some USD price action.

Today's Key Issues (time in GMT):

06:00 EUR Germany: Trade balance (€ bn, sa) Jul
07:30 SEK Final GDP, % 1.2 exp, 1.2 P prior
08:30 GBP Industrial production, %m/m (y/y) 0.4 (2.0) exp
08:30 GBP Manufacturing output, % m/m (y/y) 0.3 (4.9) exp
10:00 EUR Germany: Industrial production, % m/m (y/y) 1.0 (12.5) exp
18:00 USD Fed Beige Book report released Aug
18:30 USD Minneapolis Fed President Kocherlakota (FOMC non-voter) speaks
19:00 USD Consumer credit, chg, $ bn Jul -5.5 exp

The Risk Today:

EurUsd The break below our 1.2780 pivot level played out beautifully yesterday, with the pair plotting a smooth course all the way to our target of 1.2680 (the 100-day moving average) –hitting a low of 1.2676 before rebounding in early trade this morning. Once again we see 1.2780 as a key technical level within this range so anticipate sellers to step in as the rally approaches there; should we continue to move higher then next level is the range ceiling 1.2930. There is pretty formidable resistance at 1.3000; not only due to its psychological importance, but also because it currently coincides with the back of our former 2-month uptrend. Our bias remains that EURUSD will eventually be heading lower in the medium-term; so if anything we’d be looking at the aforementioned resistance levels as areas for short-entry. Key supports to watch are the 100-day moving average which now moves down to 1.2673, 31 Aug low at 1.2625, and the range floor 1.2588.

GbpUsd Once again, the range-trading environment dominates GBPUSD price action; with yesterday’s sell-off halting just beyond 1.5300 support (and a few pips ahead of a 2-week trendline) before bouncing sharply back towards the significant 1.5490 level. For the third time in a week we have seen sellers at 1.5490 halt the rally and drive the pair back lower, so for now our directional bias neutral to slightly bearish. At these levels in the range the risk-reward favours short positions, so we would sell around 1.5470 and set our stop just through 1.5525 (trendline resistance), looking for a return to 1.5300. With downtrends still in vogue at the moment, there is clearly scope for an extended move through 1.5300, so next level to watch is 1.5235, before major support kicks in at 1.5115-25 (50% fibonacci level and 21 Jul lows). For the bulls to buck the trend, they will first need to conquer 1.5490, then 1.5580 (23.6% fibonacci retracement of 1.4229 –1.6000), but then the way is clear for a test of major resistance at 1.5715.

UsdJpy USDJPY’s critical support at 83.60 has been breached this morning (posting a new low of 83.35), so we have gone short just below there and are sitting tight for remaining bulls to start reluctantly liquidating into these new 15-year lows. As discussed yesterday, we believe that the break below 83.60 represents the activation of a descending triangle pattern on the hourly chart with a target of 81.35, so that’s our goal, and we have positioned our stop just through 83.90 (a few pips beyond yesterday’s peak). There remains weak 2-month downtrend support at 82.65, but considering the enormous significance of this plunge into territory not seen since 1995, it seems that only the possibility of aggressive and imminent BoJ intervention will be able to salvage the pair from another ugly plunge lower. We, like the rest of the market, are losing conviction this is coming anytime soon, so with the 14-day RSI not even in oversold territory after the latest drop (35-36 at the last look), our short-to-medium term target is the 79.75 –80.00 area where the pair bottomed out on that sell-off 15 years ago. On the topside the key levels of note are the 85.22 peak from last Friday, major resistance at 85.90 and 86.50 (5 Aug high).

UsdChf Even yesterday’s miss in Switzerland’s unemployment could not push USDCHF meaningfully higher, and instead the 1-month downtrend has continued to direct the price action lower. Next level on the downside is the 1.0065 low from 1 Sep, but in truth we still think that a return to parity is inevitable. Certainly the relative fundamental analysis supports a move lower for the pair, and indeed our technical analysis can only offer a few remaining supports at 0.9960 (3 Dec 2009 low) and 0.9920 (26 Nov 2009 low) before USDCHF enters new territory and much greater scope for further CHF strength. Expect rallies to be hindered by resistance through 1.0130 (trendline resistance), 1.0185, and 1.0240 where the rally came to an abrupt halt on 3 Sep. Extended rallies likely to be blocked by 1.0550 (13 Aug high), 1.0640 (27 Jul high), and 1.0676 (200-day moving average).

Resistance and Support:

S: Strong, M: Minor, T: Trendline, K: Keylevel, P: Pivot