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Risk Aversion Kicks In and the Dollar Tumbles, Fundamental Connections are Bending

Risk Aversion Kicks In and the Dollar Tumbles, Fundamental Connections are Bending

2010-07-15 15:50:00
John Kicklighter, Chief Currency Strategist
Correlations are starting to shift. We have seen the dollar deviate from its standard role as a safe haven currency for some time; but the gap between currency and driver seems to be growing wider each week. This morning's price action is evidence of that. However, the unusual developments don't stop there. While the euro and pound would rally through the early trading hours, the most risk-sensitive currencies were actually retracing - and doing so against the pummeled greenback. What does this mean? Well, considering equities were down on the morning, we see that risk appetite is still holding in most areas. The disconnect therefore is coming through the European currencies. News that a Spanish bond sale found significant demand seems to work on the speculative principal that the euro's drop through the first half of the year has been overdone. Will the dollar and European currencies fall back into line or are things permanently loosening their correlations? Time will tell.

For my positions, I have cut the NZDUSD long off at break even. The immediate lack of follow through on a breakout is leading me to further doubt the upside objective this could reasonable meet over time. Also, there is a descending trendline from the 11/16 swing high that is now working on its fourth test at 0.7250. Best to step back and reassess. As for long risk-based AUDCHF, a sharp tumble has put me back on track; but this is going to be a medium-term setup. Siding with its funding component and playing on the weak dollar, USDJPY is falling towards 87 and pushing my long deeper into the red. I won't add at the next even level as I want to keep it lower risk. Also, deviating from the general strong performance of the sterling elsewhere, GBPCHF has fallen back after the progress made in a medium-term reversal. I have set a stop at 1.5950.

As for potential setups, we are seeing some very attractive ones develop. AUDNZD is once again threatening a bearish break from its congestion of the past two months. A close below 1.2150/25 would be a good signal to start building a position. AUDCAD is questionable given its bearing; but I still consider it a potential short opportunity. CHFJPY is still holding to its rising trend channel; but 83 is my signal level just in case. For EURGBP, I am cautious ahead of the EU stress test results; but 0.84 and 0.83 are levels to watch for a potential technical move. Finally, CADJPY has retraced sharply and is once again within striking distance of a very high-profile rising trend channel. A break of this technical level would be an excellent entry effort.

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