The Dollar out-muscles the Euro but both are in trouble

We judge the Dollar remains vulnerable against all the other majors with the exception of the Euro. But if the current small improvement in the data accelerated, the Fed might need to review its QE2 policy, only then would we see a stronger Dollar across the board. And on balance the charts remain sceptical of such a change.

The Technical Trader’s view:

MONTHLY CHART

The Dollar’s strength has been clear against the embattled Euro since the beginning of November.

The pull-back through the triple support of

(1) the rising diagonal from June 2010 and

(2) the horizontal support from the Prior High at 1.3334 and

(3) the Fibonacci retracement support

is not yet quite certain on the weekly chart.

But look closer…

DAILY CHART

The pull back certainly paused at the 1.3334 level.

But that pause has created an additional continuation pattern - a Bear rising wedge – which has completed.

In short, the bear Euro, bull Dollar trend is intact and looks like continuing.

But the Dollar Euro is misleading: both look vulnerable against other currencies. Take the Dollar Swiss: first the long-term context

MONTHLY CHART

The breakdown of the Dollar against the Swiss has been a long time in the making.

But the push beneath the Prior Pivotal Low at 1.1193, in conjunction with the completion of a continuation Triangle sets up the Dollar bears nicely.

And not surprisingly the Euro is under even worse pressure against the Swiss:

MONTHLY CHART

This is clearly a more advanced bear scenario.

The breakdown through the Prior Lows, and the emergence of a possible Bear continuation Triangle (albeit not completed) far beneath the 1.4399-1.4317 band.

The Dollar may be outperforming the Euro, but they are both in trouble elsewhere.

The Macro Trader’s view:

The Dollar currently presents an interesting case because of the following macroeconomic scenario:

- The Fed remains committed to QE2 since it still judges the economy is not growing fast enough to generate sufficient new jobs,

- Inflation remains low and the Fed is concerned it could go lower,

- Obama has performed a Tax cut U turn which has now won Senate approval, and

- Data is mixed.

Does this argue for Dollar strength or weakness? Currently we are seeing both strength and weakness depending on which major currency one measures the Dollar against.

The Dollar/Euro rate is testimony to Dollar strength. The Euro remains under pressure as the Euro zone Sovereign Debt crisis remains unresolved. Ireland has voted in favour of the EU/IMF rescue deal, but questions remain unanswered about other troubled Euro zone economies.

The rating agency Moody’s has placed Spain on negative watch, as it judges a bail out is unlikely; the Spanish economy is too big for the others to support, and in any event the German Government seems to have little stomach for funding any more costly rescues, which has led German opposition MP’s to claim Merkel is not pro-European.

This lack of agreement between Euro zone member governments serves to further undermine the Euro and highlight the enormity of the task in front of them, since the most obvious answer; issuing Euro Zone debt in place of individual Sovereign Euro denominated debt has been ruled out by the Germans.

But against the Swiss Franc the Dollar looks less sure-footed. The trend has been Dollar bearish over a long period and while traders may prefer the Dollar to the Euro, the Swiss Franc has the edge over the Dollar. When Bernanke announced QE2 there was criticism from several quarters, but most accepted the Fed had to act. The US economic recovery had slowed to a crawl, unemployment wasn’t coming down, and already weak inflation was edging uncomfortably close to deflation.

However, last week Obama suddenly changed policy and agreed to support an extension of soon-to-expire Bush tax cuts. His change of stance is purely political; he wanted a 2nd stimulus, but Congress refused and in a couple of weeks a republican controlled House will make it even less likely he would be able to win support for increased spending, so he has taken the only option available; supporting the renewal of the tax cuts. Although not his preferred route, it still pumps money into the economy and is a de facto second stimulus.

Traders are mainly unhappy with what they see as a further substantial erosion of fiscal health as the measure will add at least US$1.0T to the national debt in less than two years. The US debt to GDP ratio was already on course to hit 100% in a few short years, cutting tax without addressing the deficit is Dollar negative.

But before rushing out to sell the Dollar, activity data has started to turn a little stronger. Although the most recent non-farm payroll report was weak, both recent ISM surveys were stronger. More recently the trade deficit sharply narrowed and retail sales beat consensus. And only yesterday industrial production reported a stronger than expected increase. So suddenly data has started to turn Dollar positive. The FOMC met earlier this week and some analysts wondered if they would alter their QE2 policy in the light of the Obama U turn, but they didn’t.

We judge the Dollar remains vulnerable against all the other majors with the exception of the Euro. But if the current small improvement in the data accelerated, the Fed might need to review its QE2 policy, only then would we see a stronger Dollar across the board.

Mark Sturdy

John Lewis

Seven Days Ahead

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Signs of Weakness Start to Appear in GBP/USD

The FX Specialist view - From this year’s May low a good recovery in GBP/USD has been seen, but bull fatigue is starting to show and the latest slip back is retesting first key support. A break of this would temporarily sideline the bulls.

• WEEKLY CHART The bounce off the 76.4% pullback has so far failed just ahead of the 76.4% recovery level. A further setback looks quite likely before any further attempt on this resistance.
• DAILY CHART: In the FX Specialist Guide we have been looking at the bull channel base projection which helps to gauge market momentum. It has begun to fail as support, putting bulls on a cautious footing. After a s/term bounce (resisted around the 50% rebound level, not shown) the slightly lower 38.2% pullback has come under scrutiny again – this is viewed as the key level, with break below to herald a deeper correction phase. This then initially open up the 1.5294/65 area, 07-Sep low and 50% pullback, where next s/term support seems likely. Overhead resistance is offered by the early Aug high around 1.6000, ahead of the 1.6094 19-Nov high.

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Is Silver’s Uptrend Looking Tired?

The Commodity Specialist view - The long term picture in Silver still looks very bullish, but shorter term the chart structure could be changing, with certain signs of bull fatigue starting to appear. At this stage these still need confirmation though.

• MONTHLY CONTINUATION CHART: Following the break of the 21.185 2008 high we turned attention to a Fibo projection near 29.00, which was easily reached. The chart remains in a strong position for now.
• DAILY CHART - MAR-11: A new 2010 high was seen last week, but note the negative RSI divergence at the time –are bulls tiring? First confirmation of fatigue would come from a drop through the small channel base projection at 26.50 currently, with a further sign of weakness to come from a break of recent support near the 25.00 level. In the Commodity Specialist Guide we had already been waiting to see if the chart structure was changing, heralding a longer-lasting pullback/consolidation phase. We await developments.

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Short Term USD/JPY Bulls Look Well-Placed

The FX Specialist view - The downtrend in USD/JPY from the May high came close to the major 1995 low in early Nov, where support has emerged. After rebounding shorter term bull signs have been seen, and we expect further gains to be made before any resumption of the long term bear trend.

• MONTHLY CHART In the FX Specialist Guide we continue to note the positive RSI divergence, which questions the longer term bears’ resolve. See how the major 1995 low just under 80.00 was neared, with support beginning to emerge.
• WEEKLY CHART The downtrend has so far fallen short of the projected bear channel base, our next support on this chart. First resistance here comes from the late 2009 84.81 low – see also Daily chart, though.
• DAILY CHART: The breach of the bear channel top and 23.6% level favours shorter term bulls now, with any dips viewed as temporary. Potential supports here include the 82.00 area and the lower 81.20 76.4% pullback. At this stage the next upside focus is on the 85.86/93 area, 38.2% recovery and 16-Sep high. However, the more key, pivotal resistance area is 87.60/88.00, 50% recovery and old key support.

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Bonds: Is the top in place?

The long Bull Run in bonds that tracked the financial crisis/recession increasingly looks over. Earlier this year when growth started to return to the developed economies, Government Bond markets remained well supported, but not now. Why is that?

The Technical Trader’s view:

WEEKLY CHART

The US Treasuries has fallen hard from close to their Pivotal Prior Highs at 128-22, through the first supports of significance at 121-21.5 and 122-14.5.

This is a significant breakdown, and should not be underestimated.

But the lack of a compelling Reversal pattern or Top formation robs the bears of short-term momentum.

WEEKLY CHART

So too, has there been a vicious pull-back in the Bunds from the massive resistance of a cluster of Fibonacci levels.

But note that in this case the market’s steep decline has yet to break the vital band of support 124.60-126.53.

The diagonal from 2008 is an added bear factor, but that band needs to be broken for the bears to really triumph.

Nor indeed, like the TNote, is there a top formation in place yet in either the medium or short-term…

These bond markets have come far and fast, the source of the next bear impetus is as yet unclear.

The Macro Trader’s view:

The long bull run in bonds that tracked the financial crisis/recession increasingly looks over. Earlier this year, when growth started to return to the developed economies, Government bond markets remained well-supported. Not now.

When the Euro zone sovereign debt crisis broke in the spring, bonds rallied anew as traders rushed into US Treasuries, UK Gilts and Euro bunds; traditional safe-haven trades. But now they are all under pressure despite the Euro zone debt crisis gripping markets again, forcing Ireland to seek an EU/IMF/EZ/UK rescue, and other peripheral Euro zone Countries seeing their bond yields hit new highs.

Basically traders fear the fiscal stance of many Euro zone Countries are unsustainable. They are also becoming anxious about Germany’s ability to underwrite too many more rescues. In fact, the German Government is anxious too. Chancellor Merkel does not want to increase the rescue fund. The Chancellor would also like more of the burden of future rescues to fall on private investors in Eurozone government bonds; this too has unsettled bond markets with the once safe Bund looking vulnerable to further selling.

Then there is the US fiscal position. President Obama has run up enormous debts, but unlike most Euro zone Countries that have implemented austerity budgets, he believes the US can go on writing IOU’s forever.

In the UK the Government has implemented drastic spending cuts, and so far the economy is holding up well. Some think once the cuts bite growth will slow, others think the Bank of England should be hiking rates to control inflation which has remained persistently above target for an extended period. The Gilt draws no benefit from the spending cuts and also looks vulnerable to further selling.

But recent bearish price action has its roots in the US. Politicians have been arguing about whether or not the Bush era tax cuts that are about to expire, should be renewed/extended to help support the economy. President Obama had opposed this. He argued they were too focused on the middle classes and did little to help the poor.

But suddenly he changed his mind this week and agreed to extend them, subject to votes in both houses of Congress. However there are some powerful critics of this U turn on both sides of the political divide.

The Bond markets took fright. If agreed, these tax cuts would add about US$1.0T to the national debt in just 2 years and keep the budget deficit to GDP ratio at around 10%. This is clearly unsustainable and Moody’s has again questioned the US’s ability to hold onto her AAA credit rating in such an environment.

Traders fear such a move, which together with the Feds current QE2 policy would prove inflationary as it amounts to a 2nd fiscal stimulus the US can hardly afford.

We judge the environment is turning increasingly bearish for Bonds and a vote in Congress in favour of extending the tax cuts without off setting spending cuts, would likely provide the short-term trigger the Bears seek.

Mark Sturdy

John Lewis

Seven Days Ahead

For the complete and illustrated version of this and future Updates be sure to sign up at www.sevendaysahead.com

Gold Bulls Showing Uncertainty

The Commodity Specialist view - The overall chart structure in Gold has remained firm, with consolidation at the higher levels occurring. However, we stay on the alert for early signs of bull fatigue with overhead resistance not far away.

• GOLD - WEEKLY CONTINUATION CHART: The break from the former wedge pattern saw the market come close to the projected bull channel top (1465 now). This offers current resistance. Supports come from the former wedge top around 1300, then the 1264.80 Jun high.
• GOLD - DAILY CHART FEB-11: This week’s brief new all-time high ended in a negative Key Reversal Day. Not that significant in itself, but further weakness that sees the 1331.10 16-Nov low breached would sideline the bulls and strongly suggest that a more prolonged correction phase was underway. Below the old wedge top support around 1300 the key, pivotal level is considered to be the 1271.00 21-Jun high (also a key reversal day). Failure here would have negative implications for the medium term.

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Recovery in USD/CHF at Key Resistance

The FX Specialist view - After reaching a high for the year in May USD/CHF slipped steadily back, piercing the major 2008 low in Oct. Subsequent recovery has been relatively modest so far, and key resistance is currently holding the bulls back.

• WEEKLY CHART The drop back in 2010 eroded the major 0.9674 2008 but found support around the bear channel base we had drawn in. The top of the first resistance area on this chart comes from the rising old support/return line at 1.0065 currently – it is so far working.
• DAILY CHART: The recovery has put pressure on the 23.6% retracement at 1.0000 – a clear break of this and the resistance line from the Weekly chart would be an initial bull signal. Attention would then turn to the 1.0328 level, 06-Aug low (and base of Jul/Aug congestion) and 38.2%. S/term we wait to see if dips prove temporary. Ideally weakness should hold above the s/term rising support line at 0.9655 if a resumption of the bear trend is to be avoided.

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Stocks back from the brink

The change of sentiment at the ECB has allowed ECB President Trichet the freedom to warn the markets that the ECB could start buying Bonds in size and the mere prospect has lowered Bond yields of Portugal and Spain and seen stocks rally hard as traders judge the crisis might just be brought under control. Whether or not the Euro zone debt crisis is over is too soon to say, but equity markets are breathing a huge sigh of relief.

The Macro Trader’s view:

As the Irish economy came close to meltdown and the World held its breath to see if the Euro zone would put together a timely rescue big enough to satisfy markets, equity markets sold off. Indeed, even after the rescue deal was announced markets remained nervous.

The fear was that Ireland was just another domino in a line ready to fall with traders switching their attention from one weak peripheral economy to another. The first to require a rescue was of course Greece and although Ireland adopted a severe austerity program earlier in the year, it wasn’t enough.

The Irish Banking system was in deep trouble and Ireland simply didn’t have the resources to rescue its own banks. But traders were not convinced the crisis was over and they turned their attention to Portugal and Spain.

Both countries saw their bond yields soar to record levels, prompting Portuguese authorities to warn about the real threat now facing their banks. Spain was also forced to deny she needed financial assistance, which was echoed by the EU authorities.

But still traders were not convinced and for a while stocks and bonds sold off in tandem. If Portugal ultimately required a rescue, that would be manageable. But if Spain too needed a rescue that was something completely different. Spain is the Eurozones fourth largest economy and where would the burden fall? With Germany of course. And even Germany cannot absorb these de facto transfers of debts endlessly.

But at last the ECB woke up to reality. There may not be a central Bond issuing authority in the Euro zone, but there is a Central Bank and it can pump liquidity into the system in any size it chooses. Which is what has been happening, and in addition, it can purchase any quantity of Euro zone originating debt in any size it chooses.

Until recently some on the ECB’s governing council have been against this, most notably the German representative Prof Weber of the Bundesbank. But now he too has realized the real dangers facing the Euro, the Euro zone and the EU itself.

The change of sentiment at the ECB has allowed ECB President Trichet the freedom to warn the markets that the ECB could start buying Bonds in size and the mere prospect has lowered Bond yields of Portugal and Spain and seen stocks rally hard as traders judge the crisis might just be brought under control.

Whether or not the Euro zone debt crisis is over is too soon to say, but equity markets are breathing a huge sigh of relief.

Mark Sturdy

John Lewis

Seven Days Ahead

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Crude Oil Bulls Remain Confident

The Commodity Specialist view - Earlier this year the slip back in Crude Oil price was supported by the 38.2% retracement, with bears unable to make further headway. The subsequent recovery still looks sound, with the May high remaining under threat of being breached.

• BRENT CRUDE - WEEKLY CONTINUATION CHART: Recovery from the 38.2% pullback earlier pushed beyond the prior highs shown. These have so far provided support. The May high remains under threat, with a break higher to turn attention towards the 61.8% recovery level around 105.00.
• BRENT CRUDE - DAILY CHART JAN-11: A recent dip held above the 81.24 19-Oct low, helping to preserve current bull momentum. The chart looks well-placed to make a better break of the 76.4% level to challenge the 93.24 May high. Beyond here we can start calculating higher projection levels.

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