Currencies Well Bid But Euro Still Capped Below Key Resistance

It is good to be back on the desk after being away for a couple of days and in the end, nothing much has really changed. Overall price action in the Euro remains consolidative, with the market stalling out ahead of some key resistance by 1.3500 and rolling back over. The intense Euro rally in the previous week is now being attributed to nothing more than a major bout of profit taking on shorter-term USD long positions, and some market participants are once again back to focusing on broader Eurozone structural deficiencies. Nevertheless, the single currency has been very well supported in Tuesday trade and has found renewed interest on increased optimism over the outlook for the region (EFSF package) and some very solid data in the form of the German ZEW.

Relative Performance Versus USD Tuesday (As of 11:35GMT)

1. EURO+0.89%
2. STERLING +0.72%
3. SWISSIE+0.54%
4. AUSSIE+0.43%
5. CAD+0.24%
6. YEN+0.17%
7. KIWI+0.03%

If one other currency stands out at all in Tuesday trade thus far, it is most certainly the Pound, which outperforms across the board on the back of some solid data and elevated inflation readings. Nationwide consumer confidence came in much better than expected, while RICS house price data was encouraging with the data series producing less of a deterioration than consensus estimates. Meanwhile, the latest CPI readings were through the roof and have added to Sterling’s bid tone as investors start to price in the increased possibility for rate hikes. Consequently, Cable has managed to easily clear psychological barriers by 1.6000. Still, this is a market that we are much more comfortable selling into rallies rather than looking for opportunities to buy, with the overall structure tilted to the downside, and any rallies on strong data and speculation of rate hikes not expected to last.. As such, we have issued a recommendation to sell on a rally to 1.6090 today (see below).

Also on the strategy side of things, while most major currencies are well off of their respective multi-week highs against the Greenback, the Canadian Dollar has been doing its own thing and continues to trade by multi-week highs. In our opinion the currency is not likely to remain well bid for much longer, with longer-term technical and cyclical studies warning of the formation of a major top in the Canadian Dollar. In light of this, we will also be aggressively looking for opportunities to buy USD/CAD on dips into the 0.9800 area.

Elsewhere, China is back in the news as things heat up ahead of President Hu’s visit to Washington, with a Chinese spokesman warning that US lawmakers should avoid harming the overall interest in China/US trade. We will be watching developments here closely but ultimately do not expect to see anything that moves the markets too much on this end.

Looking ahead, there is some key event risk in the North American session, with the Bank of Canada set to decide on rates at 14:00GMT. While no change is expected (1.00%), we would be on the watch for any accompanying language out from the central bank that expresses concern over the relative strength in the Canadian Dollar. With USD/CAD trading by multi-week lows, we would not at all be surprised to see any comments re the strong currency open the door for a decent bout of CAD liquidation. Also out in North American trade is US Empire manufacturing (13.00 expected) at 13:30GMT, TIC flows at 14:00GMT and NAHB housing at 15:00GMT. US equity futures and gold prices are bid, while oil consolidates and trades flat on the day.

TECHNICAL OUTLOOK

EUR/USD:Although the market has rallied quite impressively out from the recent multi-week lows set by 1.2875, we continue to classify the bounce as corrective, with any additional rallies expected to be well capped by the 1.3500 range highs ahead of some fresh weakness. As such, the preferred strategy is to stand aside for now and look to sell a little higher up. Ultimately, only a close back above 1.3500 would give reason for concern and delay outlook.

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.

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 a 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 0.9400 on a close basis.

FLOWS

An ACB and a Middle Eastern account have been on the bid in Eur/Usd. Usd/Jpy is being supported by cross demand from Japanese names. A Middle East account and a hedge fund have driven gains in Cable. Usd/Chf sales by an ACB which has been seen selling Usd’s across the board.

TRADE OF THE DAY

GBP/USD: The latest break back above 1.5910 delays bearish prospects for the time being and now opens the door for additional strength towards the key 78.6% fib retrace off of the October-November major move which comes in by 1.6090. Nevertheless, our core bias still remains bearish and any rallies into this fib retrace are viewed as a formidable sell opportunity in favor of some renewed downside pressures. A test of this level on Tuesday will also have the daily ATR well exceeded and hourly studies severely overbought to make for a very attractive entry with what should be limited downside risk. Look for a break and close back below 1.5835 to confirm bias and accelerate. A close above 1.6100 concerns.STRATEGY: SELL @1.6090 FOR AN OPEN OBJECTIVE; STOP 1.6215. RECOMMENDATION TO BE REMOVED IF NOT TRIGGERED BY NY CLOSE (5PM ET) ON TUESDAY.

Are Spanish Auction Results Keeping Euro Propped Up?

Although the Euro has managed to mount an impressive recovery, with the market trading well off of the multi-week lows set on Monday by 1.2875, we continue to classify the move as corrective, and fully expect to see a bearish resumption over the coming days. For now, the market has been propped by a potential EU aid package for Portugal, and solid bond auction results out of both Portugal and Spain. Also seen helping to keep the Euro somewhat bid have been comments from Germany’s Merkel who has pledged to protect the Euro with “whatever needed.” However, it is quite evident that despite efforts to intervene on behalf of the ailing Eurozone economy, there is a long road ahead which is likely to produce some unpredictable and unwelcome results. As such, we see any additional gains being well capped below the 1.3300 figure on a close basis, and would recommend considering to build into short positions on a rally towards 1.3300 (no specific trade recommendation here at the moment).

Relative Performance Versus USD Thursday (As of 11:05GMT)

1. KIWI+0.42%
2. EURO -0.01%
3. AUSSIE-0.02%
4. YEN-0.07%
5. STERLING-0.10%
6. CAD-0.22%
7. SWISSIE-0.69%

There is some event risk worth mention today, although we do not expect any surprises. Both the ECB and BOE are scheduled for rate decisions, and as is usually the case, the risk from the BOE comes from any changes to the QE program, while risks to the ECB decision will originate from the post decision Trichet press conference. At the end of the day, we do not expect to see any surprises from either central bank, but will be watching closely should anything materialize. While the beleaguered Eurozone peripherals are obviously problematic for the health of the Eurozone economy, we expect Trichet to downplay any such threats and maintain a less pessimistic outlook. Meanwhile, UK inflation data has been concerning of late and definitely makes it harder to justify the ultra accommodative monetary policy, but here too we do not expect any changes with the central bank still needing to focus on the current economic recovery. Data released in Europe overnight has failed to materially influence price action with German wholesale sales improving from the previous month, while UK data was mixed with industrial production slightly weaker and manufacturing production a little stronger.

Moving on, although price action in the Australian Dollar is rather subdued on Thursday thus far, we would be on the lookout for a pickup in volatility over the coming hours. While the currency still remains well bid on dips for now, the much weaker than expected employment data only helps to reaffirm our downgraded outlook for the local economy. Economic data results over the past few months are not as promising as they once were, and we continue to see risks to the downside in the Australian Dollar despite the attractive yield differentials. December jobs data showed a net gain of only 2.3k after the market had been looking for an increase of 25k. Additionally, while the unemployment rate showed a drop to 5.0% ,which was on the surface better than expected, the decline was more likely due to a lower participation rate due to a softer overall employment sector.

In terms of where the value lies at the moment and over the coming sessions, we continue to look to the Canadian Dollar as a currency that is on the verge of a sizeable depreciation. This currency has held up so well over the past few sessions, and USD/CAD trades by multi-month lows into the 0.9800’s thus far. Cyclically, the market looks to be quite stretched, and our technical studies suggest that a major trend shift is on the horizon. At this point the fundamental catalyst has yet to present itself, but we will be paying close attention. Our strategy will be to continue to look for opportunities to buy USD/CAD on overdone intraday dips in anticipation of said correction. On Wednesday we had issued a buy recommendation that never materialized, and we will once again look to be buyers at lower levels in Thursday trade if given the chance. Also on the strategy front, we have finally exited our entire EUR/CHF long position from 1.2550 at 1.2825 on Thursday for a nice profit.

Looking ahead, the BOE (unchanged 0.50% and 200B) and ECB (unchanged 1.00% expected) rate decisions filter over into the North American open at 12:00GMT and 12:45GMT respectively. The attention then shifts to North American economic data at 13:30GMT with the release of US producer prices (0.2% expected), the trade balance (-$41B expected), initial jobless claims (402k expected), continuing claims (4100k expected), and Canada international merchandise trade (-C2.0B expected). US equity futures and commodity prices are tracking lower, led by moderate declines in gold prices.

TECHNICAL OUTLOOK

EUR/USD:Although the market has rallied quite impressively out from the recent multi-week lows set by 1.2875 earlier this week, we continue to classify the bounce as corrective, with any additional rallies expected to be well capped by the 1.3300 area ahead of some fresh weakness. As such, the preferred strategy is to stand aside for now and look to sell a little higher up. Ultimately, only a close back above 1.3300 would give reason for concern and delay outlook.

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: As we had written in our commentary from previous daily analysis, the current bounce was not to be unexpected despite our bearish outlook, with the market in the process of carving out a fresh lower top below 1.5900 ahead of the next downside extension. At this point, we do not see gains extending much further and would recommend looking to consider selling rallies towards 1.5850 on Thursday.

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

An ACB has been selling around the day’s highs in Eur/Usd along with Middle East and Eastern European sellers. Export sales reported in Usd/Jpy with a real money account on the bid. A corporate account has been a dip buyer in Nzd/Usd.

Markets Calmed After Euro Debt Auction

Portuguese Auction Gives Euro Relief

The euro found a bit of relief overnight as a much anticipated auction of Portuguese debt was fairly well subscribed.  The initial results of the auction saw the EUR spike higher against the USD through the 1.30 level, only to be sold off again to settle near the 1.30 mark at the time of writing.  This price action suggests that traders are still dubious as to the prospects for a workable solution to the European debt crisis and as a result there are ample offers in the market to sell EUR at levels above 1.30.  Bloomberg reports that plans are in the works by the EU to put together an aid package for Portugal that would guarantee lower interest rates on bailout loans.  The plan could be in the amount of 60 billion euros and would be an attempt by European lawmakers to subdue the crisis that has caused so much strife in the region.  Many market participants have been questioning the health of the Eurozone due to these debt issues and the viability of the euro as a going concern has even been brought up.  If these reports do come to fruition it would signal that the EU was being proactive in their attempts to contain the crisis rather than bail out nations after they get into trouble.  The market wants to see a concrete plan before they embrace the euro again, so until something tangible is in place we can expect to see price action similar to today’s, where any rally in the euro is met with significant selling pressure. 
M&A Talk Fuels CAD Rally
The Canadian dollar has reached a 32 month high overnight against the USD as news that Cleveland-based Cliffs Natural Resources has agreed to purchase Canadian miner Consolidated Thompson for over $4 billion in cash.  The purchase will be made in Canadian dollars, so clearly the flow will be significant enough to push the USDCAD pair to a new low in the mid 0.98 cent level.  The Loonie has been fairly quiet this week and intraday ranges have been tight as little in the way of Canadian (or international for that matter) data has been enough to knock the CAD from its current strong levels.  From a purely technical perspective the CAD is beginning to look a little overbought and has been able to withstand changes in risk sentiment over the past few weeks with little movement.  The Loonie now seems to be reacting favourably to good economic data from the US, our largest trading partner, but has also been able to withstand recent bouts of risk aversion that have seen other commodity linked currencies falter.  The question on many people’s minds right now is whether or not the Loonie can stay below par for any longer.  Data from Canada has been good but inflation is far from out of control, thanks in large part to the strong Loonie, so the Bank of Canada could be on hold in the near term.  Secondly, an overly strong dollar is far from what our government wants as it places a big strain on our manufacturing sector causing our products to become more expensive relative to the rest of the world.   For the time being it seems as if the CAD will be content to follow the news and equities in order to find direction until something tells us otherwise.  Canadian trade balance figures are released tomorrow and could have a big impact should the figure come out far from expectations.
Aussie Shows Resilience
The Australian dollar is off its recent lows against the US in the 0.98 cent region even as devastating floods continue in Queensland.  RBA board member McKibbin was on the tapes last night suggesting that the floods could wipe out as much as 1% of Australian GDP growth for this year.  This report initially caused a selloff in the AUD but it has come back on good developments in Europe this morning.  The RBA has maintained that they will be vigilant on interest rates should inflation continue to rise, and with commodity prices staying firm there is a good chance this will materialize.  This tightening bias has effectively put in a floor for the AUD for now, while data and equity market developments will continue to dictate price action.
Have a great day.

European Tension Escalates

Euro Stabilizes on Intervention, Japanese Vote of Confidence

Panicked selling of Portuguese government debt drove the European Central Bank to intervene in the secondary bond markets yesterday, alleviating strain and putting a temporary floor under the euro. Later in the session, the euro moved up against the yen but exhibited surprisingly little movement against the other crosses after Japanese Finance Minister Yoshihiko Noda said that his country would use some of its foreign exchange reserves to buy European debt.
A Portuguese bailout mounted via the European Financial Stability Facility has become a near certainty in the market's eyes. A rescue of Spain is the next possibility on the horizon, but the country’s relative fiscal strength makes such an outcome slightly less probable. Belgium is rapidly moving toward crisis, with its government paralyzed, debt levels topping 100% of gross domestic product, and bond yields on a steady upward march. 
The coming trading cycle should see another spike in volatility in the euro, in advance of the Portuguese debt auction. Spain and Italy are also due to sell securities on Thursday. Amid the uncertainty, many traders with large short positions will trim their exposures, while others will seek to place new bets on the currency's direction –leading to choppy trading conditions. Sharp reversals are common in this sort of environment, making it a good time to consider placing limit orders.
Aussie Falls on Flooding
The Australian dollar weakened against all of its major rivals as floodwaters threatened Brisbane, the country's third largest city. The currency is now sitting just above the .98 barrier against the US dollar, after topping 1.0225 only two weeks ago. 
According to numbers released yesterday, November's trade surplus contracted as coal shipments declined in value and imports rose. Exports contribute roughly 20% of Australia's gross domestic product. Traders expect a further contraction in the weeks ahead as flooding damages mining and transportation infrastructure across Queensland state. Depending on the extent and duration of the economic damage, weakness in the Aussie may not last long, as there is little indication that this unfortunate event will substantially affect longer term growth prospects. 
Interest Rate Momentum Sustaining Canadian Dollar
Canada's dollar regained ground after slipping earlier in the trading cycle, trading near the .9930 mark once more as commodities provided support and domestic bond yields continued to march higher. Traders are steadily moving benchmark interest rate hike expectations forward as conditions in the country's largest export market improve and domestic lending continues to grow. 
A third of Canada's gross domestic product is generated through exports, approximately 73% of which go directly to the United States. US growth forecasts from the major banks and government bodies have been aggressively upgraded in recent months, raising hopes that Canada’s exports will gear up accordingly.   
Deputy Governor of the Bank of Canada Agathe Côté was the latest in a line of policymakers to warn about consumer debt risk, highlighting the 170% growth in home equity loans over the last ten years as a particular area of concern in a speech yesterday. Home equity loans tend to be indexed to floating interest rates, making them particularly sensitive when rates rise sharply – an echo of the adjustable rate mortgages that caused so much havoc in the US economy two years ago. 
The central bank raised benchmark rates in an effort to slow lending last year, and clearly remains motivated to put the brakes on further debt increases. Whether the Bank will hike rates in the face of a strong dollar and uncertain export conditions remains to be seen, but rising yield differentials are providing support for the currency at the moment. This is reminiscent of the dynamic seen early last year, which bolstered the exchange rate for almost six months before interest rates were actually increased.  

Inflation Back?
After meetings in Switzerland, the traditionally inflation sensitive European Central Bank President Jean-Claude Trichet put the subject back on policymaker agendas, saying; “This is no time for complacency and the solid anchoring of inflation expectations is considered something that is important by all of us”. Trichet is remembered for hiking rates the last time that prices were rising sharply just prior to the financial crisis. He called for central bankers to maintain vigilance, saying "We have to deliver price stability and need to be credible in this delivery".
While prices are not moving as quickly as they did in 2008, inflation indicators are steadily ticking up around the planet, as economies improve and commodity prices rally. Central banks created massive amounts of new money in the wake of the financial crisis, and much of this liquidity has sloshed into the real economy over time. As Warren Buffett said in 2009; “Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation”. 
Prices have skyrocketed in much of the emerging world, and annualised increases are already well above central bank comfort levels in the United Kingdom and Europe. At the same time, deflationary conditions remain entrenched in the United States and Japan. 
History suggests that relatively high inflation rates tend to cause exchange rates to depreciate. When prices rise more quickly, a country’s goods become less competitive and export revenues fall. Demand for the currency drops as fewer foreign buyers purchase it, and domestic consumers sell it to buy foreign goods. 
As always, markets act on expectations. High inflation expectations often lead to downward adjustments in exchange rates as traders act in anticipation of future conditions. 
The seventies and eighties were marked by wide variations in inflation rates, which drove extensive dislocations in foreign exchange rates. It is difficult to know whether the modern central banking system will successfully calibrate stable inflation paths in the years ahead, but it is very likely that price expectations will once again become a large influence on global currency markets. Something to keep an eye on – particularly for corporate treasurers with dual, correlated exposures to interest rates and currencies. 

Happy trading!

China Buying Euro, New Year

Rumours of China Buying Supports Euro

The Euro got a much welcomed helping hand from China of all countries overnight, after news reports surfaced that China was going to buy between 4 and 5 billion Euros worth of Portuguese debt. The reports went on the state that the deal had China buying in both the primary and secondary markets through Q1 of 2011. The news was much needed relief for the Euro which has been under siege this week.  Talk from ratings agencies of further downgrades to peripheral countries in the EU has weighed heavily on the common currency which bounced off of fresh all-time low against the Swiss Franc and Australian Dollar following the reports of China buying European assets.
While the China reports are a faint sliver of hope for the EU, further softness in the Euro is expected as we close out the year. Simply put, the problems in the EU are much, much bigger than 4 or 5 billion Euros, and at this point, the root causes of the debt concerns don’t appear to have been resolved. In fact it feels eerily like the end of December 2009 with all of the negative sentiment currently surrounding Europe. With thin holiday trading taking hold in the markets, jumpy and erratic movement is expected, as lower volumes will see imbalances created in the market whenever larger transactions occur. However speculators minds will be focused on friends & family at this time of year, rather than jumping into the markets with their billions of hedge funds dollars. This is likely to have a calming effect which will keep ripples in the market from growing into waves.
British Growth Forecasts for 2011 CutIt was reported that Quarter-over-Quarter GDP is down in Q3 to 0.7% from 0.8% the preceding quarter and the Current Account deficit grew to GBP 9.6 billion in Britain during the European session. Trade was widely expected to help push the British economy into a period of recovery, however so far is only acting as a drag on growth. In response to this new data the British government cut is growth forecasts for next year.
 Adding another dimension to the situation, the current government has pledged to get a handle on Britain’s largest ever peacetime deficit. Plans include cuts to spending by GBP 81 billion and a further GBP 29 billion in new taxes. However analysts have noted that growth has not picked up the way policy makers had hoped, and inflation remains well above the target 2%. This situation potentially leaves the Bank of England little in the way of manoeuvrability should it need to step in to control the runaway inflation. British business associations have also been quick warn against pulling support out of the economy too quickly. Given the concerns that tight fiscal measures may jeopardize the current recovery in the United Kingdom, the opposition, not wanting to miss the party has jumped in and accused the government of cutting too deep too quickly. It’s a rocky road ahead both politically and economically for a coalition government that is already struggling.
The Day and Week AheadExisting Home Sales in the US is out this morning with expectations around 4.72M. Tomorrow is a little busier in the North American Session, with: Canadian Q3 GDP (market expectations are around 0.3%), weekly US Unemployment Claims (always exciting), US Core Durable Goods orders for the month of November, and US New Home Sales. A strong number in today’s Existing Home Sales would be the third month of growth in the last four. Coupled with a strong New Home Sales number tomorrow, it would support the growing notion that the housing market in the US may be turning the corner after the sub-prime mortgage disaster. Friday has nothing of importance on the docket as it is the last day before the Christmas weekend, generally the beginning of the quietest period of the year in money markets, which ends on the first business day of the New Year.