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Euro/Dollar: A Closer Look at the Power of 27; Why Today Could be the Day

By Joel Kruger, Technical Strategist
15 October 2010 08:12 GMT

FUNDYS

The Euro has now put in 27 consecutive daily closes above the previous daily low, with the dramatic sequence helping to keep the bull trend firmly intact. However, upon closer analysis, we wonder if 27 could finally be it, with the market poised to reverse sharply on Friday and close back below Thursday’s 1.3955 low. Why now? Well, there is a confluence of very compelling technical and fundamental evidence that would suggest that Friday could very well be the day.

Relative Performance Versus USD Friday (As of 7:30GMT)

  1. YEN+0.30%
  2. STERLING+0.14%
  3. AUSSIE+0.14%
  4. EURO+0.01%
  5. CAD+0.02%
  6. KIWI+0.03%
  7. SWISSIE-0.15%

The technical evidence can be credited to my colleague and fellow technician Jamie Saettele, a wonderful analyst who went into our lab and ran a study of the last time such a sequence in the Euro had occurred. To our amazement, the last time, was back in February and March of 2008(February 8 –March 17 2008), when the Euro put in exactly 27 consecutive daily closes above the previous daily low before eventually reversing. The pullback that ensued was short-lived and only lasted a few days, but the drop was still quite impressive, with the market giving back some 600 points in that short period of time (1.5900-1.5340 from the 17th to the 24th). The only other time that such a sequence occurred was in January 2004 where the market put in 30 consecutive closes like this before reversing. In this case the market also eventually corrected by some 600 points, although it did break higher just after the sequence break, by some 100 points before the actual reversal occurred (still very compelling).

2008 SEQUENCE OF 27 DAYS BEFORE REVERSAL/2010: WILL WE SEE ANOTHER REVERSAL?

Euro_Dollar_A_Closer_Look_at_the_Power_of_27_body_tradeofday.png, Euro/Dollar: A Closer Look at the Power of 27; Why Today Could be the Day

With daily studies so overbought right now, as reflected through the RSI, it would not at all be surprising to see a reversal off of current levels irrespective of such a sequence. While we acknowledge that there is still room on a medium-term basis for a run up to challenge some major falling trend-line resistance off of the record highs, which comes in towards 1.4500, the greater risk from here is for a substantial short-term depreciation, much like the one we saw back in March 2008, before consideration is to be given for a bullish resumption. Friday is as good a day as any to see such a reversal, with market participants often inclined to lighten up on positions ahead of the weekend.

This helps to segue into our next point, which is the potential catalyst for such a reversal. We always like to formulate our strategy through technical analysis, but find the process all the more gratifying when we can assign a potential fundamental trigger and basis for our technical strategy. In this case, the fundamental catalyst is ideal, with the timing of the event perfect for yet another reversal following the 27 day sequence.

While retail sales and inflation data due out later in the day could very well contribute to such a reversal, it is Fed Chair Bernanke speaking in Boston at 12:15GMT on the topic of "Monetary Policy Objectives and Tools in a Low-Inflation Environment" that get us excited with the prospects. The timing is perfect with the USD so heavily oversold and QE2, the primary driver of the latest USD sell-off, already so heavily priced in to the markets. It would therefore stand to reason, that with the implementation of this policy so widely expected at present, any risks from here are to the downside.

A good friend and mentor, who is the chief currency strategists at one of the major US banks, outlines his assessment of today’s Bernanke speech and offers his views on what exactly may not yet be priced into the markets and what could fuel some additional moves in the markets. While he offers three strong points that could push the Euro even higher (1. Fed indicating that it would tolerate inflation above target levels. 2. Indication that the Fed would be targeting nominal GDP. 3. An endorsement of USD depreciation as a result of this new policy), he also offers 4 equally attractive points that would undoubtedly force at least some form of a major short-term corrective pullback in the Euro.

Although he concludes that ultimately, the risks are tilted to more USD depreciation, he also acknowledges the possibility for some form of a sell-off in the Euro before we see another round of Dollar depreciation. This compliments our analysis and further supports the idea that we could indeed be on the verge of a major short-term reversal on Friday. Here are the 4 points that he lists which are not priced into the markets and could very well spark a fundamental reversal in USD sentiment.

  1. An indication or suggestion that USD weakness is undesirable
  2. Any indication of a target interest rate level which suggests that the Fed would want to limit using QE as a tool
  3. Any indication that verdict on additional monetary policy easing measures is still out
  4. Any indication that recent economic activity has not been as bad which would remind of the “if needed” language

While we are fully aware that Bernanke could very well send a message that the Fed is ready to move forward with QE2 as per the initial 3 points above, which would ultimately weigh on the US Dollar some more and negate our thesis, the influence and presence of a very overextended technical market and prior sequence of 27 closes from March 2008, gets us very excited about the prospects for a reversal and potential that Bernanke will indeed disappoint QE bulls with a focus more on the latter 4 points discussed above. We have seen a number of Fed officials come out in recent days expressing some opposition to additional quantitative easing measures, and this further adds to the case for some form of a let-down to USD bears at today’s speech.

In our opinion, there is a greater risk for a let-down to QE bulls on Friday, and we expect to see a strong reversal day in the Euro that results in a close back below 1.3955 to end this dramatic sequence and signal some form of a shift, at least over the short-term. We would target a drop back towards the 1.3400-1.3500 area before the possibility of a bullish resumption and test of that critical falling trend-line resistance by 1.4500 in the Euro.

Looking ahead, retail sales and CPI are due at 12:30GMT, along with empire manufacturing. Also out at 12:30GMT are Canada manufacturing sales and new motor vehicle sales. University of Michiganconfidence and business inventories follow at 13:55GMT and 14:00GMT respectively, with the US monthly budget statement capping things off at 18:00GMT. On the official circuit, Fed Lockhart speaks at 12:00GMT, with Fed Chair Bernanke following shortly thereafter at 12:15GMT. US equity futures and oil prices are mildly bid, while gold trades flat and consolidates by record highs.

GRAPHIC REWIND

Euro_Dollar_A_Closer_Look_at_the_Power_of_27_body_dxy10.png, Euro/Dollar: A Closer Look at the Power of 27; Why Today Could be the Day

TECHS

EUR/USD: (See Below)

USD/JPY: Daily studies are well oversold and the latest setbacks have stalled out for now just ahead of the record lows by 80.00 from 1995. A bullish hammer close on Thursday could suggest that the market is finally ready for a short-term correction, but we would need to see a break back above 81.85 to help reaffirm these prospects and officially relieve downside pressures. Back below 80.90 opens the door for a direct test on the critical barriers at 80.00.

GBP/USD: Thursday’s close back above 1.6000 officially delays the prospects for a bearish reversal and potentially opens the door for some fresh upside towards 1.6500 over the coming sessions. However, we would warn that daily studies are starting to approach overbought levels, and the risk for any sustained gains beyond 1.6000 over the coming days does not look promising. Back below 1.5885 would be required at a minimum to put the focus back on the downside.

USD/CHF: Setbacks continue to extend to fresh record lows in the 0.9400’s. However, while the overriding trend still remains intensely bearish, we like the idea of a major bottom carving out at current levels, in anticipation of some significant upside over the shorter-term and longer-term. Daily studies are attempting to cross up from oversold levels, while weekly studies are still well oversold and show plenty of room to run to the upside. As such, we look for a close back above 0.9600 to confirm bias and open a major reversal.

FLOWS

Lots of chatter of European/UK M&A deal to go through with large LHS fix order in Eur/Gbp. An ACB on reverse diversification has provided support in dips in Eur/Usd while a semi-official name is on the offer. Over-night Japanese account’s sold Eur/Jpy before a German name stepped in. Its one-way traffic in the Usd/Jpy with exporter’s, real money accounts, an Asian CB and a macro fund all on the offer.

TRADE OF THE DAY

Euro_Dollar_A_Closer_Look_at_the_Power_of_27_body_eur.png, Euro/Dollar: A Closer Look at the Power of 27; Why Today Could be the Day

EUR/USD: It should be no surprise that this is our trade of the day, and we like the idea of taking a shot at fading the current strength in anticipation of what appears to be a much needed short-term correction. The daily RSI is quite stretched, but has already started to role over despite fresh highs in the price. This negative divergence is bearish and would suggest that the market is at risk for a pullback over the very near-term. Although we conclude that a close back below the previous daily low is required to trigger an official reversal, we still like the idea of fading into strength as it offers a more ideal entry point. While it is also much riskier, we are looking for a retest of Thursday’s highs before the market eventually reverses sharply into North American trade and ideally closes back below Thursday’s 1.3955 low. This would set up a very strong bearish outside day and solidify our outlook. STRATEGY: SELL @1.4120 FOR AN OPEN OBJECTIVE; STOP 1.4260. RECOMMENDATION TO BE REMOVED IF NOT TRIGGERED BY NY CLOSE ON FRIDAY.

Written by Joel Kruger, Technical Currency Strategist for DailyFX.com

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15 October 2010 08:12 GMT