Reversal of Fortunes in the FX Market; Sterling Emerges as Top Performer

FUNDYS

While there haven’t been too many developments on the fundamental end of things over the past few hours, we have been noticing interesting price action in some of the currencies. Markets that had been the standout outperformers in the previous week’s lightened holiday trade, have been suffering in the early year, with Aussie, Yen and Swissie all showing some relative weakness in on Tuesday. Conversely, a market that had been showing relative weakness is now the star performer. Price action in the Euro has taken a backseat for now, although the market has been able to brush off talk of another downgrade to Greece, slightly weaker German employment data, and headlines of a potential Eur45B government bond redemption, to mount a rally back above 1.3400. Broader macro flows and a higher than expected Eurozone CPI estimate seem to be more influential at the moment.

Relative Performance Versus USD Tuesday (As of 11:20GMT)

1. STERLING+0.87%
2. EURO +0.26%
3. CAD+0.08%
4. YEN-0.41%
5. KIWI-0.59%
6. AUSSIE-0.70%
7. SWISSIE-1.15%

Although the Pound is still trading within familiar ranges against the buck, the single currency has been on fire today (price action most evident in Gbp/Chf and Gbp/Aud), to easily trade back above 1.5600 thus far. First and foremost, a much better than expected manufacturing PMI has been seen as a major force behind some of the latest buying. Also seen helping to bolster the UK currency has been some positive flows on the back of leveraged, semi-official and model accounts, along with some positive M&A related flows. Finally, and FT survey has concluded that UK austerity measures are unlikely to send the local economy into a double dip recession.

As we look at the other side of the coin, there certainly can be some fundamental justification for the Aussie weakness on Tuesday. The Australian AIG performance of manufacturing index fell by 1.3 points to 46.3 in December, to put in the fourth consecutive month below the critical 50 boom-bust level. This has opened a major round of profit taking on long positions, with the currency backing off from post-float record highs by 1.0260. Tuesday’s early break below Monday’s low is technically significant, with the market ending a sequence of consecutive daily higher lows.

Meanwhile, technicals have played somewhat of a formidable role in the latest Usd/Jpy bounce, with the market stalling out by the 81.00 area last week, which loosely coincides with the 78.6% fib retracement off of the major November-December 2010 move. While at this point it is too early to gauge whether this latest recovery has any teeth, we would not rule out this possibility and would look for further bullish confirmation on a break back above the daily Ichimoku cloud which comes in by 83.00.

Although local fundamentals are less influential when talking about price action in the more macro weighted Swiss Franc, the weaker than expected PMIs out of Switzerland on Monday have not been helping to advance the Franc to additional record highs. But it is probably the improved global risk appetite and solid demand for global equities that have really helped to open some across the board weakness in the single currency over the past session. This is also an overextended market that is very much exposed to some corrective adjustments at a minimum.

As far as the Greenback is concerned, we continue to remain constructive with the outlook. Economic data is really starting to show signs of legitimate recovery and Monday’s strong ISM manufacturing showing is representative of this fact. Additionally, whatever the timing, Fed policy has only one way to go from here, and at some point, the shift to a less accommodative bias will ultimately benefit the US Dollar. Comments from Fed Mishkin who says that “Q3 in unlikely” and that the US economy is “stronger right now” help to strengthen our core USD bullish outlook.

Looking ahead, US factory orders (-0.2% expected) are due at 15:00GMT, followed by the release of the more highly anticipated December FOMC Minutes at 19:00GMT. Domestic vehicle sales (9.2M expected) and total vehicle sales (12.3M expected) cap things off for the day at 22:00GMT. Interestingly, US equity futures and oil prices are well bid while gold is being sold.

TECHS

EUR/USD:The market has mostly been locked in a choppy consolidation over the past several days, but a lower top looks to have carved out by 1.3500, with a break back below 1.2970 over the coming sessions to confirm and open the next major downside extension towards the 1.2585 platform base from August 2010. As such, any intraday rallies above 1.3400 should be used as formidable sell opportunities. Only a close back above 1.3500 negates bearish outlook. Monday’s break back below Friday’s low sets up a potential bearish reversal day and encourages bias.

USD/JPY:The latest setbacks have stalled out after the market had come under some intense pressure in the previous week to break back below the daily Ichimoku cloud and threaten a retest of the multi year lows from November 2010 just shy of 80.00. However, we have since seen a formidable bounce by the 78.6% fib retrace off of the November-December move and this could warn that the market is once again poised for a rally. Look for a break and close back above the top of the Ichimoku cloud by 83.00 to confirm.

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 the process of unwinding from oversold levels, 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. But the latest topside failure ahead of 1.5700 is encouraging.

USD/CHF: The latest price action is certainly concerning for our 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. Our strategy is to continue to take shots at buying, but ultimately, look for a break and close back above 0.9400 to confirm short-term reversal and relieve immediate downside pressures.