So the market appears to finally be coming to its senses and the US Dollar is back on the bid and once again, doing what it should be doing in the current market environment. The anticipation of the Eurozone package in the month of October resulted in a massive sell-off in the buck and resumption of risk correlated buying which in our opinion had been far too aggressive and will be more than offset in November. The positive effects from the Eurozone deal were overstated and the clear fact remains that there still is a great deal of work that needs to get done in order for the region to transition to a path of sustainable economic recovery. Bond spreads in the zone continue to widen, while economic data is far from encouraging. Throw in some broader global macro wrenches, with MF Global blowing up and Australia moving to cut rates in reaction to slower China growth, ongoing problems in the Eurozone, and we are not at all surprised to see the markets shift very quickly back into a risk off mode.
But this time, risk off takes on a whole new meaning in our opinion. Any broad based risk liquidation from here on is a risk liquidation which does not offer the same safe haven options. The Swiss Franc has basically been eliminated from the equation, while the latest actions by the Japanese Ministry of Finance have also mitigated the potential appreciation of the Yen in risk off markets. For several months now, and well before the SNB actions, we had been warning of things playing out this way, and sure enough they have. We warned that both Switzerland and Japan would take action against the massive appreciations in the respective currencies to record levels, and we also warned that the result of these actions would open the door for a deluge of one way traffic into the Greenback. The US Dollar is now the only currency which is capable of handling the massive safe haven flows and we expect that this fact will drive a major appreciation in the buck over the coming months.
In our macro analysis, we talked of the spread of the crisis to the Eurozone well before this was on radar screens and we say this not to promote the accuracy of the call (because there was plenty of pain in being right when the markets weren’t listening, as many of you know), but to warn that there is still another phase of this global recession which has yet to spread to China, the commodity bloc and the emerging markets. Many of these economies have benefited in recent months in non-traditional ways, as safe-haven alternatives that have not been exposed to the US and Eurozone troubles. But the fact remains that these economies are very much exposed and should not be in a position to wear multiple hats and benefit as safe-havens when they are in fact risk correlated assets. Just as market participants were incorrect when they assumed that the troubles in the US were isolated to the US economy back in 2008, they are incorrect in assuming that the Eurozone crisis is isolated to the Eurozone economy. Global markets are tightly intertwined and we are already seeing evidence of a slowdown in China and softer economic data from the region, and we believe that these messages are coming through more clearly today, with the likes of the RBA highlighting this fact in its latest interest rate decision.
The impact of the RBA rate decision should be huge and although the cut was priced in, the realization that interest rates in certain economies might be too high due to an unanticipated (by these countries) continuation and exacerbation of the global recession, could open the door for more monetary policy reversals and accommodations. From a yield differential standpoint, this will inevitably shift the balance and force a liquidation in these higher yielding investments in favor of lower yielding currencies that had been used to fund these investments. We therefore see even the Euro benefiting against higher yielding currencies, with much of the bad already priced into the Eurozone, and not enough bad priced into these higher yielding alternatives which were believed to be insulated. However, ultimately, we contend that the US Dollar will be the prime beneficiary going forward, and we recommend aggressive long USD positions across the board over the coming months. It is also worth noting, that any sign of sustained recovery out of the US, will likely result in an aggressive reversal of monetary policy from the Fed, which also will benefit the buck as yield differentials narrow in favor of the Dollar. All in all, we continue to see the US Dollar as the place to be. Our favorite trades at the moment are short Aud/Usd, Nzd/Usd, and long Usd/Cad and Usd/Jpy.
Looking ahead, there is plenty of economic data out on Tuesday, highlighted by UK GDP and US ISM manufacturing. But event risk for the remainder of the week is the more important focus with all eyes on Wedensday’s Fed decision and the start of a new reign, with Mr. Draghi heading up the ECB rate decision on Thursday. US equity futures and oil prices are a good deal lower, while gold tracks moderately higher.
TECHNICAL OUTLOOK
EUR/USD: Last Thursday’s intense rally has now been completely offset and the market finally looks like it has carved out a fresh lower top by 1.4250 ahead of the next major downside extension. From here, we look for a break and close back below 1.3650 to confirm bias and accelerate declines towards critical support at 1.3145. Below 1.3145 will then open the next major drop towards our longer-term objective into the lower 1.2000’s. Any intraday rallies should now be very well capped ahead of 1.4000, while only back above 1.4250 would negate outlook and give reason for pause.
USD/JPY:Monday’s surge has resulted in an end to a very tight multi-week trade largely confined to the 76.00’s and a likely shift in the overall construct, with the pair carving out a major bottom by 75.50. The price has now broken back above the daily Ichimoku cloud for the first time in several months to confirm a potential shift in the trend, and Monday’s close above the cloud reaffirms. Next key topside resistance comes in by 80.25 and a break above this level will likely accelerate gains and expose the 82.00-85.00 area further up. Look for any intraday setbacks to be well supported above 77.50 with only a close back below this level to delay. Back above 79.55 accelerates gains.
GBP/USD: The market has finally reached the major double bottom objective just over 1.6100 that was triggered on the break of neckline resistance at 1.5715 back on October 12. From here, scope is for a resumption of what we believe to be a broader downtrend and we expect the 200-Day SMA, which coincides with the double bottom objective, to cap gains on a daily close basis ahead of the next major downside extension. Look for a break and close back below 1.5950 to confirm and accelerate, while only a close above the 200-Day SMA negates. Monday’s bearish outside day formation strengthens outlook.
USD/CHF: The market has been in the process of a major correction since peaking out at 0.9315 on October 6. However, the overall outlook remains constructive, with the pair looking like it is in the process of carving a major base ahead of some significant upside over the coming weeks and months. Look for the latest round of setbacks to be well supported in the 0.8500’s, where a fresh medium-term higher low is sought out ahead of a bullish resumption back towards and eventually through 0.9315. Ultimately, only a weekly close below 0.8500 would concern. A daily close back above 0.8860 will confirm bias and accelerate gains.
--- Written by Joel Kruger, Technical Currency Strategist
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