A GOOD SUMMER – I have been travelling over the past couple of days and am finally settling back into routine. I am also definitely looking forward to a return to fuller trading conditions into September, as many key market participants return to their desks. While I was aggressively bullish on EUR/USD over the course of the summer, my book did not directly benefit from this trade, and instead, I opted to play the Euro long position through the more exotic EUR/AUD cross rate.
PATIENCE PAYS OFF; STRATEGY PLAYING OUT NICELY – This trade was a little bumpy at first, but is finally in the money and starting to show signs of some very promising follow through. Fundamentally, the price action is also welcome given my well publicized three phase global recession view. I had been calling for a shifting away from the Eurozone (US = phase one, Europe = phase two, China = phase three) as the center of the global crisis, and a transplant of this crisis to China. I also warned that as this materialized, highly correlated China economies like Australia would suffer and this would in turn weigh tremendously on the Australian Dollar.
AUD/USD SHOULD BE CLOSER TO 0.8000 THAN 1.1000 – Look no further than the data out of China and Australia this week. All of the economic releases were either worse than previous or softer than expected. I believe we are finally starting to see this play out and this is only the beginning of phase three. While the Australian Dollar has underperformed in recent trade, the currency is still very overbought (I believe) on a relative basis, and should be subjected to intense liquidation going forward. AUD/USD still trades well above parity at present and this is way too high. I believe that given what we are seeing, AUD/USD should be trading much closer to 0.9000 or even 0.8000 than to 1.1000.
PRICING OUT AND PRICING IN – And yet, I have chosen to play the short Aussie trade through the Euro, as I am projecting even bigger upside on this cross rate. Don’t forget that EUR/AUD is a cross that was trading around 2.1000 back in 2008 and recently dropped to fresh record lows by 1.1600. That is some drop!!! This is a drop which begs for a serious corrective rally at a minimum. This projected bounce should be far more impressive than any pullbacks seen in AUD/USD. The charts have been begging for a bottom in EUR/AUD, and as markets start to price out the worst case scenarios from the Eurozone, they will at the same time be pricing in a more accelerated Australian economic slowdown than they had ever anticipated.
STILL WAITING BUT YEN EVENTUALLY SEEN MUCH LOWER – Moving on, I am patiently waiting for the next big break in USD/JPY, which I believe will be to the upside. A break and daily close back above 79.65 should do a good job of strengthening the bullish outlook, while above 80.60 would confirm and open a retest of the yearly highs at 84.20 further up. Ultimately, only back below 77.00 would negate the outlook and give reason for pause. Technically, the market has posted record lows in 2011 and shows plenty of room for a major trend reversal, while fundamentally, the Yen is anything but a safe haven, and the Japanese economy has every incentive to see its local currency much lower.
SAFE HAVEN NONSENSE - The idea of the Yen benefitting from external risk liquidation flows is no longer viable, and I see major Yen weakness going forward, even in times of risk off trade. This is not a conventional call, but one that I am confidently sticking by. The breakdown in this very familiar relationship between the Yen and flight to safety is just around the corner. The Fed Chair Bernanke comments on Friday could influence the direction in the Yen going forward, as any insights into monetary policy direction from the Fed Chair could serve as a catalyst to the next wave of volatility in the Fed sensitive Yen currency. End of month flows are also worth considering, as markets always have a way of pushing on the final day of trade for the month, especially if that day is a Friday.