Currency Contest

Euro Takes Out Key Short-Term Support to Open Fresh Drop

Joel Kruger,

With the Euro unable to take out 1.3420 in the early week, we had warned of a potential corrective rally towards 1.3700 before the selling resumed. However, the correction never really played out and the Euro remains well offered on even the shallowest of rallies to suggest that we could soon see a fresh downside extension to retest the key October lows at 1.3145. Look for a sustained break below 1.3420 on Wednesday to confirm and accelerate declines. Today’s break below 1.3420 is a significant short-term development, as it now opens the door for yet another broad based round of USD buying against all currencies.

While the Euro is the most influential in terms of gauging directional bias and overall risk appetite, it will not be the hardest hit now that the 1.3420 level be taken out. Instead, the downside break will expose the higher yielding commodity currencies, which have relatively outperformed in recent years and are now at risk for major liquidation as market participants realize that the global recession even extends to these markets. The Australian Dollar is the strongest candidate for relative underperformance going forward, as we continue to project that a third wave of the recession will spread to China, which ultimately will weigh heavily on the correlated Australian economy. China’s latest HSBC flash PMIs came in below the critical 50 boom/bust level, and this in conjunction with a generally downbeat market environment should continue to weigh on the Australian Dollar going forward, even against the Euro.

We have been very short Aussie over the past several weeks, both against the USD, where we are short from 1.0550, and against the Euro, where we are long EUR/AUD from 1.3300. While most have understood the logic behind the short AUD/USD trade, many had questioned the motivation for a long EUR/AUD position with things so bad in the Eurozone. As we explained back then, and as appears to be now materializing, the fact that we still see a third wave of the global recession spreading towards Australia, and the fact that we perceived the worst case scenario to already be priced into the Eurozone, was the primary driver for this strategy. While we have booked some profit on both our short AUD/USD position and long EUR/AUD position, we continue to project major Aussie weakness against both of these currencies over the coming weeks and months.

Other headlines seen negatively influencing risk sentiment on Wednesday have been chatter of a Dexia bailout and comments from Pimco’s El Erian that US economic conditions are “terrifying.” In the European session, the as expected 9-0 unanimous policy and asset purchase decision disclosed in the Bank of England Minutes, failed to influence price action. Meanwhile, Eurozone PMIs were on the whole mixed, with manufacturing consistently weaker, while services were better. Eurozone industrial new orders were however disastrous and did not doing anything to help the single currency’s cause. To add more fuel to the fire, the German bond auction was very poorly received and said to have been the catalyst to trigger the breakdown below 1.3420.

Moving on, Wednesday will be the last full day of trade for the week, with the US markets lightening up significantly for the Thanksgiving Day holiday. Markets are always unpredictable in these times of lightened volatility, so the best place to be could very well be on the sidelines until normal market conditions resume next week.

Technically, we continue to defer to the EUR/USD monthly chart, which has been extremely useful this year. The market looks like it has been in a steady downtrend since positing record highs in 2008, and is now in the process of a carving out the next major lower top below 1.5000 ahead of a retest of some multi-month range lows in the lower 1.2000’s. Once the lower 1.2000’s are tested, it is entirely possible that we see further acceleration towards parity, but at this point, it is way too premature to make such calls and we will have to step back an reassess when the market gets down to our lower 1.2000 area objective.

Looking ahead, the calendar is quite busy in North America, with durable goods, personal spending, personal consumption, personal income, initial jobless claims, and Michigan confidence all due. On the official circuit, Bank of Canada’s Carney is slated to speak. US equity futures and oil prices are tracking a good deal lower on the day, while gold has reversed early gains and is also offered.