Currency Setbacks Accelerate As Uncertainty and Panic Escalate

• Safe-haven currencies outperforming in risk off environment
• Fallout in Italy fuels contagion fears
• China also making headlines on local debt worries
• Kiwi price action continues to confound
• Eur/Chf cross to record lows; Hildebrand not helping
• Short Aud/Usd from 1.0780
• Bernanke testimony on Wednesday in focus
• Geithner warns that debt ceiling must be raised before August deadline
• US Q2 earnings set to kick off

Currencies remain under broad pressure into the new week following Friday’s awful US NFP print, and speculation that today’s emergency European Council meeting was related to increased fallout from Italy has not helped matters. Although officials have attempted to mitigate and deny this speculation (including China’s reaffirmation of support for Eurozone), market participants have not been buying into this and fears of contagion in the region are becoming even more of a reality. Bond spreads on the EMU periphery have widened out yet again to fresh record levels, and the Euro has been the hardest hit currency on the day as a result.

Relative Performance Versus the USD on Monday (as of 11:25GMT)

1. JPY -0.04%
2. CHF -0.05%
3. CAD -0.49%
4. NZD -0.53%
5. AUD -0.64%
6. GBP -0.73%
7. EUR -1.24%

Meanwhile, developments out of China have also not been helping to mitigate investor concern, with uncertainty over local government debt creeping in. China’s audit office has attempted to allay fears after saying that they see no systematic risk from local government debt, but with market nerves already on edge, these comments have not done much to help. Additionally, the much higher than expected inflation data out of China over the weekend also continues to threaten global recovery prospects.

The US Dollar has therefore been broadly supported, while the Franc and Yen have emerged as the biggest gainers. Eur/Chf price action is perhaps the most compelling, with the market dropping all the way back to fresh record lows below 1.1800. Weekend comments from SNB Hildebrand have only exacerbated the situation for the cross after the official ruled out any possibility of intervention to curb Franc strength.

But if Eur/Chf price action has been the most compelling, price action in Kiwi is perhaps the most astonishing, with Nzd/Usd rallying to yet another post-float record high beyond 0.8350 despite the broader wave of risk selling. The relative outperformance in the antipodeans in general has been rather perplexing in the current market environment, with risk off developments failing to significantly weigh on these traditionally risk sensitive currencies. It seems as though demand for attractive yield differentials is still outweighing any risk associated concerns when it comes to these currencies, but we continue to support the view that this will soon come to an end and both the New Zealand and Australian Dollars will be highly exposed going forward.

Last week we established a short position in Aud/Usd at 1.0780 (also long Eur/Aud 1.3260) and will look for some good downside follow through in Monday trade. A break back below 1.0650 in Aud/Usd sets up a technical double top formation that will initially expose 1.0500 further down. Only back above 1.0800 would ultimately give us reason for concern here. We have also just now established a fresh long position in Eur/Chf (see “Trade of the Day” below).

Although Monday’s anemic economic calendar has hardly factored into the day’s volatility, there has been enough going on that a quiet economic calendar has been welcome. As far as the week ahead is concerned, the highlight of the week, and especially after Friday’s disastrous jobs report in the US, will be the testimony of Fed Chair Bernanke in front of Congress on Wednesday. While the Fed has little room to implement any additional accommodative measures going forward, it will be interesting to see just how dovish the Fed Chair sounds in this post QE2 economy. Also out this week is the start to second quarter earnings, with Alcoa, Citi, JPM and Google amongst some of the big names scheduled to report.

Meanwhile, let us not forget about the other pressing topic of the US debt ceiling which could also generate a good deal of market volatility. US Treasury Secretary Geithner was on television over the weekend warning Congress that the debt ceiling must be raised before the August 2nd deadline or risk shock to the US, and global economic confidence. Although Geithner reassured that the US would not default on its obligations, he also stressed that failure to get a deal done would open the door for the first time ever downgrade in the US government’s AAA debt rating. On the subject of Geithner’s position which has come into question in recent weeks, the Treasury Secretary said that he would be around for the “foreseeable future.”

Looking ahead, the calendar is nearly empty, with the only notable release coming in the form of Canada housing starts. US equity futures and oil prices are already a good deal lower and looking to extend declines from Friday’s setbacks, while gold tracks marginally higher and remains well bid overall as the ultimate portfolio hedge in the flight to safety environment.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: Overall, medium-term price action remains quite choppy and we continue to like the idea of selling into rallies in anticipation of a more sizeable pullback below 1.4000. From here, look for the formation of a fresh lower top by 1.4580 ahead of the next downside extension to be confirmed on a break back below 1.3970 over the coming days. In the interim, look for intraday rallies to be well offered ahead of 1.4400.

USD/JPY: After undergoing a fairly intense drop off from the 85.50 area several days back, the market looks to have finally found some support in the 80.00 area and could be in the process of carving out some form of a base. Look for setbacks to continue to be well supported around 80.00 with only a close back below 79.50 to give reason for concern. From here we see the risks for a fresh upside extension back towards the recent range highs at 85.50 over the coming weeks and the latest break and close back above 81.00 helps to confirm. Look for a test of next key short-term resistance by 82.20 over the coming sessions.

GBP/USD: Although the short-term structure remains bearish, setbacks seem to be well supported in the 1.5900’s for now. However, we classify the latest price action as some bearish consolidation ahead of the next major downside extension with the market now looking to establish back below the 200-Day SMA and extend declines below next key support at 1.5750 further down. In the interim, look for any rallies to be well capped ahead below 1.6150 on a daily close basis.

USD/CHF: Despite the intense downtrend resulting in recently established fresh record lows below 0.8300, short/medium/longer-term technical studies are looking quite stretched to us, and we continue to like the idea of taking shots at buying in anticipation of a major base. The latest break back above the 20-Day SMA is encouraging while a push beyond 0.8550 will ultimately be required to officially relieve immediate downside pressures and accelerate gains. In the interim, look for intraday setbacks to be well supported above 0.8350 on a daily close basis with the potential for the caring of an inverse H&S base. A close below 0.8275 negates.

TRADE OF THE DAY

EUR/CHF: Although the fundamental picture on Monday is screaming against taking this trade with uncertainty running rampant and SNB Hildebrand recently dismissing the possibility for any form of central bank intervention, we can not ignore the severely oversold hourly technical studies, with the daily ATR already well exceeded and the hourly RSI tracking by 20 with the market dropping to fresh record lows below 1.1800. Quite often, the time when things don’t look like they can get any better is precisely the moment when trend shifts occur and we will take comfort in the fact that our entry for the trade has been appropriately timed on the quantitative side, at least for today. Should the position fail to show any follow through by the close on Monday, we will look to exit. We would however stress that this is a highly risky short-term trade and only recommended for those with the inclination to take such positions. We are also already short Aud/Usd from 1.0780 and view this as somewhat of a hedge. POSITION: LONG @1.1795 FOR OPEN OBJECTIVE; STOP ONLY ON A DAILY CLOSE (5PM NY TIME) BELOW 1.1695.

Written by Joel Kruger, Technical Currency Strategist

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