Buck Sold Agressively Early On; Sustainability of Moves Now in Question

• Bernanke leaves door open for additional stimulus
• Moody’s threatens downgrade to US
• New Zealand GDP comes in much stronger than expected
• Two new trading positions established following the volatility
• Intervention speculation swirls as Yen reaches uncomfortable levels
• Macro funds question Aussie strength at current levels

A lot has gone on since the New York close on Wednesday, with three completely separate developments resulting in a surge in volatility, and strangely enough, none of which having anything to do with the Eurozone or Eurozone contagion fears. First off was the fallout from the Bernanke testimony on monetary policy to Congress. The Fed Chair left the door open for additional stimulus measures if growth in the second half of the year disappointed, and this unsurprisingly had a damaging impact on the US Dollar which was sold quite aggressively as a result.

Relative Performance Versus the USD on Thursday (as of 11:00GMT)

1. NZD +0.60%
2. CHF +0.33%
3. EUR +0.09%
4. GBP +0.04%
5. JPY -0.03%
6. CAD -0.11%
7. AUD -0.15%

With the buck already under pressure across the board heading into the New York close, Moody’s was out yet again, this time threatening a potential downgrade to US credit ratings should the country not be able to raise the debt ceiling in time. The key language from Moody’s on the subject was the following:

[The review of the US government's bond rating is prompted by the possibility that the debt limit will not be raised in time to prevent a missed payment of interest or principal on outstanding bonds and notes. As such, there is a small but rising risk of a short-lived default.]

[Moody's considers the probability of a default on interest payments to be low but no longer to be de minimis. An actual default, regardless of duration, would fundamentally alter Moody's assessment of the timeliness of future payments, and a Aaa rating would likely no longer be appropriate. However, because this type of default is expected to be short-lived, and the expected loss to holders of Treasury bonds would be minimal or non-existent, the rating would most likely be downgraded to somewhere in the Aa range.]

I[f the debt limit is raised again and a default avoided, the Aaa rating would likely be confirmed. However, the outlook assigned at that time to the government bond rating would very likely be changed to negative at the conclusion of the review unless substantial and credible agreement is achieved on a budget that includes long-term deficit reduction.]

This had an even greater negative impact on the buck against the alternative safe-haven currencies, with Usd/Chf collapsing to fresh record lows, and Usd/Jpy dropping back below 79.00. Meanwhile, the Euro and other risk correlated currencies were also well bid in reaction to the day’s events, with Eur/Usd reclaiming the 1.4200 barrier and Aussie rallying back above 1.0800. Other notable price action in response to this news was a drop in Eur/Chf to yet another record low below 1.1500, and an explosion in Kiwi through massive barriers by 0.8500 to fresh post-float record highs.

The spike in the New Zealand Dollar was not all from the events mentioned above, with the antipodean finding a good deal of relative strength on a blowout GDP print showing extremely robust growth in the local economy. Not only was the headline print significantly better than forecast, but an upwardly revised previous number made the result all the more substantial. As a result, markets have now priced in a 50% chance of a rate hike from the RBNZ at the next meeting.

Nevertheless, from a strategy standpoint, we continue to question the valuation in the FX commodity bloc and other currencies like the Swiss Franc and Yen at current levels, and are determined to look for opportunities to counter-trend any additional strength in these markets. One needs to be careful and pick good spots, but opportunities to profit from fading these trends do exist and we have gone ahead and sold both the NZD and CHF against the buck following the latest market craze at the end of Wednesday trade and into Thursday. We are SHORT Nzd/Usd from 0.8485; stop 0.8615, and LONG Usd/Chf from 0.8100; stop 0.7970. Our entry on these positions came with both market’s respective hourly RSIs breaking above 80 and below 20 on the hourly charts. We have already seen some decent follow through in our favor and the overnight consolidation coupled with some other offsetting Kiwi data (PMIs and consumer confidence) has certainly helped.

According to a recent article in the Wall Street Journal, even some of the large macro investors who may have been supporting the drive higher in these commodity currencies, are now questioning the sustainability of this trend with a particular reference to the Australian Dollar. The investors have either scaled back on long Aussie positions in recent months or even established fresh short positions. The main concern expressed in the article is the exposure to China, with a combination of higher Chinese interest rates and a slowing economy seen as a very bad mix for the risk correlated Aussie Dollar.

Price action in European trade was largely consolidative, with markets seemingly content on pausing for a breather following the latest sharp USD declines. Euro bids above 1.4200 were well absorbed as investors were reminded of an equally troublesome situation in the Eurozone. Data and events in the session were a non-factor with Eurozone inflation prints coming in more or less in-line with expectation and the Italian auction failing to inspire any significant moves.

Elsewhere, the topic of intervention was quite active in Europe, with most of the talk on the subject centering on the Yen which saw some violent intraday whipsaw price action. A quick jolt just ahead of the European open and immediate retreat fueled speculation of official action. While the MOF gave fair warning that intervention was certainly possible, it did not seem like there was anything official behind the move. Still, the risks for intervention have certainly intensified at current levels and FinMin Noda backed this up earlier today after saying that the Yen moves were one sided and did not reflect economic fundamentals.

Looking ahead, the economic calendar picks up into North America, with US retail sales, producer prices, initial jobless claims and business inventories all due out. US earnings could also influence direction, and JP Morgan has already come out beating street expectations. Meanwhile, expect to see more unscheduled official remarks, particularly with the currency markets starting to get a bit out of control, with the Franc, Yen and Kiwi all vulnerable to such commentary in light of their latest moves. US equity futures and oil prices are tracking slightly lower into the North American open, while Gold remains very well bid, ascending to yet another record high.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: Overall, price action remains quite bearish and we continue to like the idea of selling into rallies in anticipation of a more sizeable pullback below the 200-Day SMA. The longer-term moving average resides by the 1.3900 figure and a clear break below will open the door for a test of next key support in the 1.3750. In the interim, look for the formation of a fresh lower top somewhere ahead of 1.4400 ahead of the next drop.

USD/JPY: The latest daily close below 79.50 certainly compromises our constructive outlook with the market breaking down below some solid multi-day range support in the 80.00 area and dropping into the 78.00’s thus far. This now puts the pressure back on the downside and opens the door for a retest and potential break below the record lows from March by 76.30. At this point, a daily close back above 80.00 would be required at minimum to relieve downside pressures.

GBP/USD: 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 through next key support at 1.5750 further down. In the interim, look for any rallies to be well capped ahead below 1.6250 on a daily close basis.

USD/CHF: Despite the intense downtrend resulting in recently established fresh record lows below 0.8100, 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. Aggressive bulls may want to look to establish fresh long positions ahead of 0.8000, while conservative counter-trenders will want to wait for a daily close back above 0.8330 at a minimum.

Written by Joel Kruger, Technical Currency Strategist

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