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New China Concerns Hit the Currency Market

New China Concerns Hit the Currency Market

Boris Schlossberg, Technical Strategist

The sharp decline in Chinese equities and weak economic data from Australia and the UK have risk currencies on the ropes in early trading, and both EURUSD and GBPUSD have tested key price levels.

Most major currencies are enduring a down opening at the start of the trading week in response to a swoon in Chinese equities and a smattering of weaker-than-expected economic data which have put pressure on risk once again. The Australian dollar (AUD) fell to fresh year-to-date lows in Asian trade, hitting 1.0114 against the US dollar (USD) before rebounding slightly in Europe. The AUDUSD pair was heavy from the open, as weak Chinese stocks and a miss in Australian building approvals revived concerns about the economy down under.

Chinese stocks fell hard in the wake of new curbs on real estate lending. The CSI 300, representing the nation's biggest companies in the Shanghai and Shenzhen stock exchanges, fell 4.6 percent, to 2,545.72 at the close, the most since November 2010, while the Shanghai Composite Index slid 3.7 percent to 2,273.40, the most since August 2011. The drop unnerved investors in Australia, which is very vulnerable to any possible downdraft from China.

Meanwhile, Australian economic data offered little solace to the bulls, as building approvals dropped to -2.4% from 2.8% expected, indicating that the housing market is starting to weaken as overall demand remains tepid.

On Tuesday, all eyes will be on the Reserve Bank of Australia (RBA), as the central bank will issue its statement following the monthly meeting. The RBA has been relatively sanguine about the state of the Australian economy, signaling that it believes the current policy is enough to stimulate demand down under.

The market does not expect any rate cuts tomorrow, but a change in language that would acknowledge the recent weakness could push the Aussie through the 1.0100 barrier, with currency traders assuming that the central bank is laying the groundwork for a rate cut next month.

British Pound Facing “Last Glimmer of Hope”

In the UK, the data continues to signal a deepening recession, as the PMI Construction report—much like last week’s PMI Manufacturing report—missed its mark, printing at 46.8 versus 49.2 expected. This was the lowest reading since October 2009, effectively destroying any expectations of a rebound in the UK housing sector.

In response, GBPUSD touched the psychologically important 1.5000 figure for the second time in as many sessions, but quickly rebounded off that level as bargain hunters again swooped in.

Tomorrow's UK PMI Services report looms even larger than usual, as it remains the last glimmer of hope for the bulls. Services represent more than 70% of UK economic activity, and the forecast is for a reading of 51.5. If the data misses, however, or even worse, dips below the 50 boom/bust line, then sterling is very likely to give up the 1.5000 level for good.

Italian Calamity Remains the Top Story

In the Eurozone, the action was relatively subdued, with little economic data on the docket, although EURUSD did drift lower, dropping below the 1.3000 level as the night progressed. The situation in Italy remains unresolved with little prospect of a coalition government as Pier Luigi Bersani now tries to focus on forming a ruling minority that will likely be very unstable. Italian bond yields continue to inch higher as investors grow increasingly nervous while Beppe Grillo muses on the possibility of Italy leaving the Eurozone.

With no economic reports from North America due today, risk FX could continue to drift and consolidate for the rest of the day. The Eurogroup and Ecofin meeting tomorrow could produce some market-moving rhetoric, but the primary market driver is still Italy. The longer the political quagmire lasts, the greater the pressure on the euro. Specifically, EURUSD would look very vulnerable if it drops below the 1.2950 support level.

By Boris Schlossberg of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.