• EU draft proposal well received; Euro surges
  • Technical studies warn of lower top
  • Fundamental concerns still abound
  • US debt ceiling discussions linger on
  • German IFO, Canada inflation and retail sales due up

The EU Summit draft proposal has been released and the initial reaction has been risk positive and very Euro positive with the single currency surging on Thursday to easily clear topside barriers by 1.4300 and 1.4400. Although many of the terms in the draft agreement had been expected, the overall feel of the agreement seems to have been even more generous than anticipated. Nevertheless, we would still recommend taking this latest development with a grain of salt, and we still contend that the Euro may now face some headwinds both technically and fundamentally which could offset any of the gains seen in recent trade.

Technically, the market has been carving out a series of lower tops since stalling shy of 1.5000 in early May, and the latest rally still maintains the integrity of this broader downtrend. If the market is to adhere to this broader downtrend, a fresh lower top could take form somewhere below the previous lower top from July 4 at 1.4580. At this point, 1.4580 becomes the key level of resistance, and only a break above this level will officially relieve downside pressures and open the door for a bullish shift in the structure. Until then, we are still in a broader downtrend and would therefore be looking for opportunities to fade the move.

Legitimacy_of_Euro_Rally_Still_in_Question_Looking_to_Fade_Strength_body_nzdtradeofday.png, Legitimacy of Euro Rally Still in Question; Looking to Fade Strength

Fundamentally, our colleague and friend, the global head of G10 FX strategy at a major US bank, has outlined some of the potential reservations market participants should have with the strength of the Euro on the back of this latest EU draft proposal, and we have listed them below:

1) “We have had such announcements of major policy initiatives in both the US and euro zone, only to see them fall apart in the details, in the implementation or because growth was to meager….There is nothing to prevent slippage from all of the targets announced today.

2) Similarly whether in CDS or market spreads, the peripherals and Italy have unwound a relatively small proportion of this month's deterioration. A more significant EUR rally requires a much bigger unwinding of spreads.

3) Private investors are likely to continue to avoid playing EURUSD. There is simply too much political uncertainty to make positioning attractive. Central banks would love to buy the EUR, if they were convinced of its stability, but the recent episode may have approached disaster too closely for them to feel complete confidence in the policy making structure.”

4) “The big winners in G10 FX are neither the USD nor the EUR but the G10 smalls. What this tells is that investors are relieved that neither the US nor the euro zone will derail growth in more attractive [economies], rather than [sending a message that investors are convinced that either [USD or EUR] is out of the woods.

5) There is a potential moral hazard issue, since [the EU] are [now] counting on all States to follow-up on their commitments.

Yet another source for the relative underperformance in the US Dollar on Thursday has come from the other major theme this week in the form of the US debt ceiling discussions. While a draft resolution has been put forth in the Eurozone, things have not gone the same over in the US, with the debt ceiling debates still lingering on and any rumors of a formal resolution being dispelled.

Additionally, there is still some contention about which specific areas of spending should be cut and which taxes should be raised, and still a good deal of uncertainty to whether the US can even meet the deficit reduction requirements of the major rating agencies. As such, with so much still in the air on this front, here has been an added weight on the Greenback in recent trade. Still, we would expect that just as with the Eurozone, a resolution will soo be reached, and the US government will successfully raise the debt ceiling by the determined deadline. This also should help to restore some confidence in the buck.

Looking ahead, we would expect traders to continue to digest the latest developments, and this is likely to influence a good deal of price action in Friday trade. However, there are still some economic data releases which are worth keeping an eye on, and these include; German IFO, Eurozone industrial new orders, Canada inflation and Canada retail sales. US equity futures are consolidating the latest impressive gains, while on the commodity front, oil is decently bid, while gold is finally showing some relative weakness off record highs as risk is priced back into markets.

ECONOMIC CALENDAR

Legitimacy_of_Euro_Rally_Still_in_Question_Looking_to_Fade_Strength_body_Picture_6.png, Legitimacy of Euro Rally Still in Question; Looking to Fade Strength

TECHNICAL OUTLOOK

EUR/USD: (SEE FUNDAMENTAL SECTION ABOVE)

Legitimacy_of_Euro_Rally_Still_in_Question_Looking_to_Fade_Strength_body_jpy2.png, Legitimacy of Euro Rally Still in Question; Looking to Fade Strength

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.

Legitimacy_of_Euro_Rally_Still_in_Question_Looking_to_Fade_Strength_body_gbp2.png, Legitimacy of Euro Rally Still in Question; Looking to Fade Strength

GBP/USD: Despite the latest rally back above 1.6300, the market still remains locked in a broader downtrend off of the April highs, and a fresh lower top is now sought out somewhere ahead of 1.6550 ahead of the next downside extension back towards the recent range lows at 1.5780. Ultimately, only a break back above 1.6550 would delay bearish outlook and give reason for pause.

Legitimacy_of_Euro_Rally_Still_in_Question_Looking_to_Fade_Strength_body_swiss1.png, Legitimacy of Euro Rally Still in Question; Looking to Fade Strength

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. The latest declines have stalled ahead of major psychological barriers at 0.8000, and we look for a break back above 0.8280 to reaffirm basing outlook and accelerate gains to even more significant resistance by 0.8550 further up. Ultimately however, it will take a break above 0.8550 to officially relieve downside pressures and force a shift in the structure. Any additional declines to record lows below 0.8000 are viewed as an excellent counter-trend opportunity.

Written by Joel Kruger, Technical Currency Strategist

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