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Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

2011-03-07 06:44:00
Joel Kruger, Technical Strategist
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The Euro remains well bid into the new week, with the single currency tracking just below 1.4000 and now contemplating a potential move above. The relative strength in the Euro comes on the back of a much more hawkish European Central Bank in the previous week, which has now signaled a move towards higher interest rates. Language from the ECB which included “strong vigilance” was seen driving the market towards 1.4000 on Thursday and things remained bid into Friday, with a slew of ECB officials confirming the need to start focusing on the normalization of rates in light of rising inflationary pressures. ECB’s Gonzalez Paramo was the firmest of the bunch after saying that “the risks to inflation are on the upside and it is the mission of the ECB to prevent those from materializing.”

Meanwhile, on the other side of the ocean, things have not been all that bad, with US economic data producing some impressive results including a drop in the unemployment rate back below the Fed’s late 2011 target of 9.0%. This could fuel some speculation of the need for the Fed to also start thinking about a reversal of monetary policy, which ultimately could help the Greenback mount a bit of a recovery. But at this point, the markets don’t appear to be taking this notion too seriously as the US Dollar remains under broad pressure.

We have however been seeing some relative weakness on the commodity bloc, with Kiwi, Aussie and Cad showing some offers in recent trade. The weakness in the New Zealand Dollar has certainly been the most prominent on the back of the devastating earthquake, but Aussie has also been offered on some softer local data, and weaker than expected results out of China. The Canadian Dollar is definitely the strongest of the bunch, but has started to show some solid sell interest over the past few days. We contend that a USD/CAD rate in the 0.9700’s is at an extreme, and the risks from here are for a sizeable upside reversal back above parity over the medium-term. Any additional setbacks should be limited from here and we do not expect to see a retest of the record lows by 0.9055 from November 2007.

Elsewhere, after showing some relative strength of late, the Pound has begun to cool off, with the market once again finding offers against the buck up by the 1.6300 figure. The one day close above 1.6300 in the previous week is proving to be a false break, and the market could once again be looking to carve out a top in favor of deeper setbacks towards 1.6000 over the coming sessions. The latest comments from Bank of England’ King are certainly not supportive, with the governor quoted in the Daily Telegraph as saying that imbalances in the banking system are beginning to grow again which may lead to another financial crisis unless reforms in that sector are undertaken.

Finally, geopolitical uncertainty and some elevated risk aversion have definitely helped to propel the Swiss Franc to record highs in recent trade, while somewhat hawkish comments from SNB’s Jordan in the previous week have also not hurt the plight of the Franc. There are no key data releases out of Switzerland on Monday, and we expect that these broader themes will continue to influence the direction. Nevertheless, we also contend that the strength of the local currency has now reached major levels of discomfort for the local economy and despite Jordan’s comments, we would not at all be surprised to see some major profit taking on Franc longs over the coming days. From a technical perspective, we are very bearish on the Franc at current levels and project major upside in USD/CHF over the coming months.

Looking_Beyond_Foreign_Exchange_body_Picture_5.png, Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

On the strategy side, we will depart from the normal currency talk and move to commodities which are arguably a little more compelling considering oil’s recent surge and gold’s ascent to fresh record highs. But as contrarians, we are always looking to fade excessive moves, and the latest surge in these commodities has been far too aggressive for our liking. While it may be a little too risky to short oil or gold straight up, we like the idea of pitting one commodity against the other and eliminating other variables. Technically, although gold is trading by record highs, it is oil that is more significantly overbought, and oil which has been the more volatile and less predictable of the two. As such, we recommend t considering a short OIL/GOLD position this week, as we see good risk for some relative weakness in the black gold.

Looking ahead, the economic calendar is exceptionally light in European trade, with things only picking up a bit more in North America. It seems like the markets might be more focused on official speak, with Fed Fisher and Fed Lockhart on the docket for Monday. US equity futures are tracking moderately lower ahead of the European open, while commodities remain well bid for now.

ECONOMIC CALENDAR

Looking_Beyond_Foreign_Exchange_body_Picture_6.png, Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

TECHNICAL OUTLOOK

Looking_Beyond_Foreign_Exchange_body_eur.png, Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

EUR/USD: The market has since stalled out after breaking above 1.4000 and the latest topside failure should not be taken lightly, with the market stalling around some key resistance at the 78.6% fib retrace off of the major November-January high-low move and by the psychological round number barrier. For now, we will use 1.4000 as our gauge for directional bias. A daily close above 1.4000 will open the door for a direct retest of 1.4280, while inability to establish above the figure on a daily close basis will open the door for a meaningful bearish reversal. A break and close back below 1.3940 helps to confirm short-term bearish reversal prospects.

Looking_Beyond_Foreign_Exchange_body_jpy2.png, Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

USD/JPY: Although the market has come under some intense pressure in recent trade back below 82.00, overall price action remains largely consolidative with the market once again very well supported in the 81.00’s. For now, 81.00 remains the key level to watch below, and only a close below this figure would negate the current range-bound price action and give reason for concern. As such, we like the idea of buying into the latest dips in favor of a bullish reversal back towards the key 84.50 multi-day range highs over the coming days. Intraday setbacks should now be well supported ahead of 81.50.

Looking_Beyond_Foreign_Exchange_body_gbp2.png, Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

GBP/USD: After failing to establish above 1.6300 over the past several weeks, the market finally managed to break and close above the level to suggest that a fresh upside extension towards 1.6500 could be underway. However, failure to hold above the figure once again leaves us doubting the latest move, and a break and close back below 1.6215 would confirm our suspicions and open the door for a key bearish reversal. For now we remain sidelined until a clearer opportunity presents.

Looking_Beyond_Foreign_Exchange_body_swiss1.png, Looking Beyond Foreign Exchange; We Propose A Compelling Commodity Play

USD/CHF: The latest break to fresh record lows by 0.9200 is certainly concerning and threatens our longer-term recovery outlook. Still, we do not see setbacks extending much further and continue to favor the formation of some form of a material base over the coming weeks in favor of an eventual break back above parity. From here, big figures become key support as we are in unchartered territory, while a weekly close back above 0.9330 would help to encourage bullish reversal prospects.

Written by Joel Kruger, Technical Currency Strategist

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