Major Head and Shoulders Possibility

Despite some early downside pressure in Asian trade on Monday, the Euro managed to quickly shrug off the multi-month low by 1.2875 before bouncing impressively back above 1.2900. The bounce was impressive because late Sunday headlines in which France and Germany were seen putting pressure on Portugal to apply for EU/IMF aid, could have weighed much more substantially on the major currency in Monday trade. However, reports of ECB bond buying and comments from Japanese FinMin Noda of Japanese interest in Euro bonds, quickly came to the rescue and helped to prop the market, while denials from Germany’s Merkel and FinMin Schaeuble of the Sunday headlines also helped to diffuse the situation somewhat. Also out denying such rumors of a Portuguese bailout was Portugal’s PM himself who said that such talk is only helping speculators and reiterating that the country will not be applying for aid. Key short-term levels to watch above and below in the Euro now come in by 1.3025 and 1.2875 respectively. A close back above 1.3025 will relieve downside pressures, while back below 1.2875 accelerates declines.

Relative Performance Versus USD Tuesday (As of 12:00GMT)

1. CAD+0.17%
2. EURO +0.06%
3. STERLING+0.03%
4. SWISSIE-0.05%
5. YEN-0.36%
6. KIWI-0.69%
7. AUSSIE-0.90%

In the end, we would suggest that the risk is still very much to the downside in the Euro even in the event of any intraday rallies, with the Eurozone peripheral problems still very much alive and not likely to fade away anytime soon. Meanwhile, it is also worth paying attention to Monday’s US equity close, with the weakness in the DJIA potentially warning of some form of a top in global stocks for now. This would be a risk negative event and could very well accelerate broad based Euro declines. Much like the Greenback had been very sensitive to any negative developments while it was under intense pressure in previous years, the Euro now is in a similar position and seems very vulnerable and exposed to any hiccups within the domestic and global economy.

On the data front, the Australian trade balance came in at a surplus but slightly less than was expected. This data proved to weigh significantly on the antipodean, which has already been under pressure as the costs and damages associated with the local flood continue to escalate. In New Zealand, data was actually quite solid, with both building consents and NZIER business confidence exceeding expectations. But while Kiwi has managed to outperform its cousin on the day, the single currency remains under pressure against the USD as broader market forces dominate. Elsewhere, UK BRC retail sales fell for the first time in 8 months as bad weather wreaked havoc with consumers during the holiday period.

Moving on, Goldman Sachs is back in the news, with GSAM chairman O’Neil saying in the FT that the US could make a big comeback in 2011. O’Neil goes on to say that he believes by virtue of this fact that the US will avoid a Japanese style lost decade. While the comments could certainly help to bolster equities a bit, they also may serve the USD well, as any signs of recovery in the US will likely narrow yield differentials back in favor of the Dollar. Finally, a NY Times article entitled “Euro’s architect warns about currency’s future", has been getting some attention as Ex-ECB member Issing warns that the “Euro’s existence could be compromised unless countries find a way to impose tougher spending curbs on one another and develop a consistent fiscal policy.”

Looking ahead, the economic calendar is quite light into North America. US NFIB small business optimism (94.5 expected) is due at 12:30GMT, followed by Canada housing starts (180.0k expected) at 13:15GMT. US wholesale inventories (1.0% expected) are then out at 15:00GMT. On the official circuit, Fed Plosser speaks on the outlook for the economy at 13:30GMT, while Fed Kocherlakota takes to the stage later on in the day at 19:00GMT. US equity futures have recovered a bit and currently point to a firmer open. Commodities are also bid with gold leading.

TECHNICAL OUTLOOK

EUR/USD:The market remains under some intense pressure, with the latest break below key support by 1.2970 confirming a medium-term lower top by 1.3500 and opening a fresh downside extension towards next key support by 1.2585 over the coming days. Despite the latest drop, daily studies are still not quite oversold and show plenty of room for additional weakness before even considering a material bounce. As such, we expect any intraday rallies to be well capped ahead of 1.3300. Back under 1.2875 accelerates.

USD/JPY: The market appears to be locked in some consolidation with clear directional boas not easily determined. The latest rally has stalled out by the Ichimoku cloud top to suggest that the pressure still remains on the downside for now. Back below 82.00 should accelerate declines and expose the multi-year lows from 2010 just ahead of 80.00, while back above 83.70 will relieve downside pressures and shift structure back to the topside.

GBP/USD: The market remains under pressure and now seems poised for a retest of the platform base from early September at 1.5295. Daily studies are however in neutral territory so we would not rule out the possibility for more of a bounce towards the 1.5700 area over the coming sessions from where a fresh lower top will be sought out ahead of an eventual drop to challenge and break 1.5295. In the interim, we remain sidelined and await a clearer signal.

USD/CHF: Overall price action is certainly concerning for our longer-term basing outlook with the market dropping to fresh record lows by 0.9300 thus far. However, cyclical studies are showing oversold and any additional declines below 0.9300 are not seen as sustainable. The latest bounce back above 0.9600 is certainly encouraging and the rally has also triggered the break of the previous weekly high to set up a bullish reversal week. Look for continued acceleration of gains back above parity over the coming sessions, with any setbacks expected to be well supported above 0.9500 on a close basis.

FLOWS

A well followed investment bank is said to have offers in the 1.3000 zone in Eur/Usd, Eastern European names were noted dip buyers earlier and a Middle Eastern account sales have been seen. An ACB is winning out against reported supply in Cable, a UK clearer was among the sellers. A real money account has been a noted buyer in Usd/Chf this morning to little lasting impact.

TRADE OF THE DAY

EUR/CHF:While I recognize that the entry on this trade is somewhat unconventional, I am a big fan of the trade and am really liking the way price action is unfolding here. The market had come back under some intense pressure since breaking back below 1.3000, with the declines resulting in a drop to fresh record lows below the September 1.2765 bottom to 1.2400 ahead of the latest minor bounce. However, given the intensity of the drop, we still retain a longer-term constructive outlook, and with daily studies once again showing oversold, any additional declines below 1.2400 are not expected to be sustained. The market actually looks to be carving an inverse head & shoulders baseon the hourly chart that should accelerate gains towards 1.3000 on a break back above the 1.2730 neckline over the coming sessions. The recovery back above 1.2500 and ability for the market to now consolidate the recent gains is encouraging for our reversal outlook and as such, we have established a fresh long position in anticipation of the neckline break over the coming sessions. Our stop is just under the record low.POSITION: LONG @1.2550 FOR AN OPEN OBJECTIVE; STOP 1.2390. (We are aware that risk is a little larger here in terms of points. As such, some miight be more comfortable trading the position at 0.75x leverage. For example, a $10,000 account would take a 7.5k position size here instead of a 10k position)