Rallies in Response to Coordinated Central Bank Action to be Short-Lived
- Market rallies from latest coordinated intervention efforts should be met with resistance
- Central bank response brings haunting feel after coming on 3 year anniversary of Lehman
- Additional deterioration expected in Eurozone economy with expectation of spread to Asia and EM
- Still waiting for major depreciation in Yen over coming days with the BOJ expected to aggressively intervene
If we have learned anything since the onset of the global macro crisis in 2008 it is that any rallies on the back of efforts from central bankers and government bodies to artificially prop the markets have often been met with very solid resistance. The pattern is one in which market participants react positively on news that officials won’t let things get worse, before a reality sets in that the initial response from these officials was because things were so bad, and investors are once again panicked and look to head for the exits to more than offset any favorable initial reaction from the response.
While we are not against coordinated interventions and other measures to help prop and stimulate the global economy, we also feel quite strongly that these actions should not be taken as a sign that everything is now great and we are out of the woods. The rally in the global equities markets from the lows of 2009 and into 2011 was a perfect example of such an unwarranted reaction from investors and we are finally seeing the fallout from these aggressive moves which had US equities only some 20% off of their pre-crisis highs from 2008.
As such, this latest coordinated intervention from the Fed, ECB, SNB, and BOJ in which the central banks announced the revival of USD swap lines, should be taken with a grain of salt. The move which is aimed at relieving escalating USD funding pressures on European banks is also somewhat haunting as it comes on the 3 year anniversary of the day Lehman filed for bankruptcy, the very event which triggered the onset of the global crisis.
From our perspective, we continue to see downside risks to the global economy, with the European market crisis still at risk for additional deterioration. We project that the spillover and contagion from this crisis will soon ripple into the third and final phase of the global recession which ultimately exposes the Asian continent and emerging market economies.
On the strategy front, with the Swissie short trade now well on its way, we look to the next potential major mover, and this leaves us staring squarely at the Yen. We are now waiting for the currency to undergo a similar bout of selling ahead and have a hard time seeing how things won’t play out this way. A few months back very few would have been able to anticipate that the more active central bank would have been the SNB. Given the super aggressive measures taken by the Swiss central bank to depreciate their local currency, we can only expect to see similar measures taken by a Bank of Japan whose economy might arguably be even more at risk to currency appreciation than Switzerland.
The Bank of Japan name is synonymous with currency intervention and the central bank has plenty of ammunition to throw at the problem when they feel it is necessary. Given that the Yen is also trading just off record highs against the buck and some other major currencies, we do not suspect that the central bank will welcome the additional spillover flows into the Yen resulting from the Swiss depreciation. While it is true that the current deteriorative state of the global economy should funnel more money into the Yen on the liquidation of risk correlated assets, the Japanese Yen is by no means a safe haven currency given the equally uncertain Japanese economic outlook and natural benefit to the economy in having a weaker currency.
As such, we predict that any additional appreciation in the Yen will open the door for a major central bank reaction that equals or exceeds the one we have just seen from the SNB. The Euro/Yen cross is trading by multi-year lows and has dropped back below levels even seen at the onset of the crisis in 2008. We think that any additional upside pressures on the Yen will soon escalate pressures for the newly appointed Japanese officials to speak out on the unwanted currency strength and set the stage for a strong central bank campaign of aggressive currency intervention. We may not see this play out over the coming sessions, but keep a close watch for our outlook to materialize over the coming days and weeks.
EUR/USD: The sharp pullback below the July lows and establishment below the 200-Day SMA solidifies the prospects for the carving of a major lower top on the monthly chart which now ultimately projects additional declines down towards the 1.2000 area over the coming weeks and months. However, with technical studies looking stretched on an inter-day basis, we see the RSI taking time to unwind from oversold levels to allow for the price to correct before once again resuming a downward trajectory below 1.3500. From here, look for additional gains over the coming sessions back into the 1.3835-1.4055 region, with the market seen elevating into this previous support now turned resistance zone (July low, 200-Day SMA, and August low) before once again finding some solid offers and the formation of a shorter-term lower top. Ultimately, any additional gains beyond 1.4055 should not be sustainable and only a break and close back above this level would delay our bearish outlook.
USD/JPY:This is a market that looks like it trying very hard to establish some form of a base after recently setting fresh record lows just under 76.00. Although the downtrend remains intact and has been fairly intense, longer-term studies welcome the prospects of the formation of a material base and shift in the overall structure. Price action over the past several days has been confirming, with the market very well supported in the 76.00’s and unable to extend the downtrend to fresh record lows. Instead, the break back above 77.00 is looking more and more constructive, with the weekly chart also showing bullish tendencies after quietly putting in three consecutive positive closes. From here, we look for the establishment back above the 50-Day SMA at 77.90 to reaffirm our recovery outlook and accelerate gains towards next key resistance by 80.25 further up. Ultimately, only a daily close back below 76.50 would give reason for concern.
GBP/USD: Overall price action seems to suggest that this market could once again be looking to roll over in favor of some fresh medium-term declines. Any gains in recent months have proven to be very well capped above 1.6500, and this latest break back below 1.6000 opens the door for a pick-up in bearish momentum. Next key support by 1.5780 has just been broken and a daily close below the level will confirm bias and accelerate declines for a retest of 1.5345 further down. Any interday rallies are expected to be well capped below 1.6100, while ultimately, only back above 1.6500 would give reason for concern.
USD/CHF: A recent acceleration of gains beyond critical resistance and a previous lower top at 0.8550 confirms bullish bias and from here, we see room for fresh upside above 0.9000 and towards 0.9500 over the coming days. Look for any setbacks to be well supported above previous resistance now tuned support at 0.8550 on a daily close basis, while ultimately, only back under 0.8200 would delay. A break and close back above the 200-Day SMA for the first time in several months will provide more ammunition for our highly constructive outlook.
Written by Joel Kruger, Technical Currency Strategist
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