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Forex: Dollar Traders Hold their Breath as the Masses Look for Conviction in this Strong Risk Aversion Move

Forex: Dollar Traders Hold their Breath as the Masses Look for Conviction in this Strong Risk Aversion Move

2011-02-22 05:48:00
John Kicklighter, Chief Currency Strategist
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  • Dollar Traders Hold their Breath as the Masses Look for Conviction in this Strong Risk Aversion Move
  • Euro Fundamental Outlook will Grow More Complicated as ECB Talks Rates, Weber Voices Warnings
  • Japanese Yen’s Gain from Risk Aversion Flows Complicated by a Moody’s Outlook Downgrade
  • New Zealand Dollar Plunges as Risk Move is Exacerbated by Christchurch Earthquake
  • British Pound Inflation Run may have the Wind Knocked out of it by a Change in Market Interests
  • Canadian Dollar Pulled between its Association to Oil and Link to Risk Appetite Trends

Dollar Traders Hold their Breath as the Masses Look for Conviction in this Strong Risk Aversion Move

Risk appetite trends are under tremendous pressure. And, when investor sentiment starts to tremble; the effort to unwind leverage, risky positioning and seek safety in liquidity sends capital flowing back into US dollar’s awaiting arms. However, it is worthwhile to be patient and confirm that the fuse on fear has been lit before diving into a full-fledge thematic position. Taking stock of the initial signs of a genuine risk aversion move, we find evidence in all corners of the financial market (an indication that concern is wide-spread). From the currency market, the traditional lines of the carry trade are once again defining direction. The US dollar and Japanese yen as funding currencies as well as debated safe-havens have seen significant gains while the high-yield (Australian and New Zealand dollars) and fundamentally-scrutinized (euro and British pound) have begun to ease off recent highs. Making this particularly interesting, the commodity markets are not yet reacting as the speculative assets that they are often portrayed as being and are rather standing in as one of the causes of fundamental stress. As for equity markets, European shares tumbled and US futures slid.

It is an interesting coincidence that the US markets were closed Monday for the Presidents Day holiday. This offers an innate test for conviction in this still-tentative risk aversion move. Naturally, the S&P 500 and equities at large will correct to the move that futures made in electronic trading. Yet, from there, one the primary hubs for speculation will weigh in with its outlook. Follow through beyond the initial adjustment will feed the trend while a quick stabilization could help drain all momentum in the building drive. There are many reasons why investor confidence can falter; but the most important part of the equation is the catalyst. Once confidence is shaken, the level of the markets and its divergence from the fundamental backdrop will drive a self-sustaining dive as risk is unwound. Unrest in the Middle East is an unlikely driver when we consider that European financial concerns and ratings warnings on the US and Japan couldn’t undermine optimism. However, the dynamic nature of this situation and its painful influence on the global economy via commodity prices and credit availability can ensure that the poisonous roots of this threat run deep. In the meantime, keep an eye out of secondary troubles coming off the radar and truly undermining sentiment.

Related:Discuss the Dollar in the DailyFX Forum, John’s Analyst Picks: AUDUSD and EURJPY Ready to Drive on Risk Aversion

Euro Fundamental Outlook will Grow More Complicated as ECB Talks Rates, Weber Voices Warnings

Currency market traders were distracted Monday. With sentiment interests crowding the headlines and clouding speculators’ view; the euro would be sorted by its fundamental rigidity. However, there was considerably more going on behind the shared currency than mere price action may have accounted for. Should the move to withdrawal from risky positions intensify going forward, the euro’s financial troubles will come into deeper relief as investors once again grow concerned about policy officials’ ability to stabilize and balance the region’s extremely contrasting members’ performance. On that point, the ECB announced that it had purchased 711 million euros worth of government bonds last week; and they will almost certainly announce another round next Monday. Furthermore, exiting Bundesbank president and central bank member Axel Weber isn’t bowing out quietly. He commented that the most debt-laden EU members may not have seen their “most painful” period. Expect Weber to not pull any punches going forward. And, with this combined uncertainty, the questionable inflation and interest rate talk from various ECB members would be tersely pushed to the backdrop.

Japanese Yen’s Gain from Risk Aversion Flows Complicated by a Moody’s Outlook Downgrade

With the uncertainty in the Middle East leading the capital markets to the early stages of a meaningful reversal; the Japanese yen looks primed for a rally. As a funding currency for the carry trade, the necessary unwinding of yen-based loans established to take advantage of the stimulus-led climb in more yield-intensive markets stands to suffer a substantial reversal in flows. Should sentiment indeed slump, the Japanese currency will certainly show a considerable level of benefit. However, we should make more nuanced analysis of this particular unit. Early in the Asian session, Moody’s announced that it was downgrading the outlook for Japanese debt due to a lack of plan to reduce deficits. While this won’t touch the reversed carry flows that would boost the yen; it does throw into question its implied quality as a safe haven currency.

New Zealand Dollar Plunges as Risk Move is Exacerbated by Christchurch Earthquake

There is never a good time for a devastating earthquake to strike; but this particular natural disaster was particularly damaging to the New Zealand dollar’s position early in Tuesday’s session. A 6.3 magnitude earthquake struck Christchurch leading to significant structural damage as well as fatalities. With risk appetite trends already shaky, the high-yield kiwi dollar is doubly struck by this unfortunate development. This is the second earthquake to strike the Canterbury area; and we need to refer to the previous natural disaster for reference to how the new one will impact the currency fundamentally. Following the last event back in September, the government assessed a significant gouge to GDP was expected and RBNZ governor took a more neutral turn on policy. By initial estimates; this incidence seems much worse.

British Pound Inflation Run may have the Wind Knocked out of it by a Change in Market Interests

One of the sterling’s most bullish fundamental components is the heavy speculation assigned to interest rate expectations. In the past few weeks, expectations for a near-term rate hike hit a fever pitch as inflation surged to 4 percent and policy officials forecasted a peak of 4.4 percent. Yet, with the market only looking one step ahead (that first rate hike), there hasn’t been a lot of attention paid to the reality that there is a very low chance a true hawkish regime (a series of hikes). Should risk appetite trends fall apart, rate speculation will quickly fall apart.

Canadian Dollar Pulled between its Association to Oil and Link to Risk Appetite Trends

More often than not, when the Australian and New Zealand dollars fall, the Canadian currency takes notice and tumbles. This correlation is not born of actual interest rate potential but rather the risk appetite point of view shared by members of the Commodity bloc. However, this time around, with risk trends slipping; the loonie is holding up. A 6.1 percent rally in WTI oil flexes its muscle on another aspect of this picture.

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**For a full list of upcoming event risk and past releases, go to www.dailyfx.com/calendar

ECONOMIC DATA

Next 24 Hours

Currency

GMT

Release

Survey

Previous

Comments

AUD

0:30

NAB Business Confidence (4Q)

9

Actual number comes in at 5

NZD

2:00

RBNZ 2-Year Inflation Expectation (1Q)

2.6%

2.6% for three of last four months

EUR

7:00

German GfK Consumer Confidence Survey (MAR)

5.8

5.7

Moving higher to levels not seen since 07

CHF

7:00

Trade Balance (Swiss franc) (JAN)

1.26B

Strength in the Franc should boost imports and reduce exports, all else equal

CHF

7:00

Exports (MoM) (JAN)

4.2%

CHF

7:00

Imports (MoM) (JAN)

-4.1%

CHF

7:00

UBS Consumption Indicator (JAN)

1.841

Intermediate high in Aug ’10 at 1.935

EUR

9:00

Italian Consumer Confidence Index s.a. (FEB)

106

105.9

Confidence moving lower with stock market

GBP

9:30

Public Finances (PSNCR) (Pounds) (JAN)

-6.0B

25.5B

Borrowings have moved higher in recent months despite austerity measures. Expected to have pulled back in January, however

GBP

9:30

Public Sector Net Borrowing Ex Interventions (JAN)

-0.1B

16.8B

GBP

9:30

Public Sector Net Borrowing (Pounds) (JAN)

-0.3B

15.3B

CAD

13:30

Retail Sales (MoM) (DEC)

-0.1%

1.3%

Core retail sales expected to have risen for a fifth month in a row

CAD

13:30

Retail Sales Less Autos (MoM) (DEC)

0.6%

1.0%

USD

14:00

S&P/Case-Shiller Home Price Index (DEC)

143.85

Home prices are expected to have fallen for six months in a row as mortgage rates move higher

USD

14:00

S&P/Case Shiller 20 City (MoM) SA (DEC)

-0.5%

-0.54%

USD

14:00

S&P/Case-Shiller Composite-20 (YoY) (DEC)

-2.3%

-1.59%

USD

14:00

S&P/Case-Shiller US Home Price Index (4Q)

135.48

USD

14:00

S&P/Case-Shiller US Home Price Index (YoY) (4Q)

-1.51%

USD

15:00

Consumer Confidence (FEB)

65

65.6

Confidence is at highest since March ‘08

USD

15:00

Richmond Fed Manufacturing Index (FEB)

18

Regional surveys are not very influential

Currency

GMT

Upcoming Events & Speeches

USD

18:00

Fed's Kocherlakota Speaks in Pierre

SUPPORT AND RESISTANCE LEVELS

CLASSIC SUPPORT AND RESISTANCE - 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.4025

1.6420

89.00

1.0000

1.0922

1.0600

0.8230

127.60

146.05

Resist 1

1.3875

1.6300

86.00

0.9775

1.0750

1.0200

0.8000

120.00

140.00

Spot

1.3623

1.6061

82.36

0.9639

0.9961

1.0146

0.7743

112.20

132.28

Support 1

1.3425

1.5750

80.00

0.9300

0.9800

0.9600

0.6850

103.80

125.00

Support 2

1.2900

1.5315

75.00

0.9000

0.9700

0.9375

0.6585

100.00

119.00

CLASSIC SUPPORT AND RESISTANCE EMERGING MARKETS 18:00 GMTSCANDIES CURRENCIES 18:00 GMT

Currency

USD/MXN

USD/TRY

USD/ZAR

USD/HKD

USD/SGD

Currency

USD/SEK

USD/DKK

USD/NOK

Resist 2

13.8500

1.6575

7.4025

7.8165

1.4945

Resist 2

7.7500

5.7800

6.2750

Resist 1

12.5000

1.6300

7.2825

7.8075

1.4655

Resist 1

7.5800

5.6625

6.1150

Spot

12.0437

1.5754

7.1813

7.7826

1.2724

Spot

6.4370

5.4726

5.7748

Support 1

11.7200

1.5300

6.9900

7.7490

1.2700

Support 1

6.2850

5.2625

5.7030

Support 2

11.4400

1.4725

6.8000

7.7450

1.2500

Support 2

6.1250

5.1000

5.5200

INTRA-DAY PIVOT POINTS 18:00 GMT

Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist 2

1.3745

1.6219

82.83

0.9720

1.0045

1.0224

0.7834

112.75

133.60

Resist 1

1.3684

1.6140

82.59

0.9679

1.0003

1.0185

0.7789

112.47

132.94

Pivot

1.3628

1.6084

82.19

0.9602

0.9936

1.0150

0.7742

112.04

132.26

Support 1

1.3567

1.6005

81.95

0.9561

0.9894

1.0111

0.7697

111.76

131.60

Support 2

1.3511

1.5949

81.55

0.9484

0.9827

1.0076

0.7650

111.33

130.92

INTRA-DAY PROBABILITY BANDS 18:00 GMT

\Currency

EUR/USD

GBP/USD

USD/JPY

USD/CHF

USD/CAD

AUD/USD

NZD/USD

EUR/JPY

GBP/JPY

Resist. 3

1.3788

1.6228

83.24

0.9750

1.0057

1.0277

0.7845

113.61

133.87

Resist. 2

1.3746

1.6186

83.02

0.9723

1.0033

1.0244

0.7820

113.26

133.48

Resist. 1

1.3705

1.6145

82.80

0.9695

1.0009

1.0212

0.7794

112.91

133.08

Spot

1.3623

1.6061

82.36

0.9639

0.9961

1.0146

0.7743

112.20

132.28

Support 1

1.3541

1.5977

81.92

0.9583

0.9913

1.0080

0.7692

111.49

131.48

Support 2

1.3500

1.5936

81.70

0.9555

0.9889

1.0048

0.7666

111.14

131.08

Support 3

1.3458

1.5894

81.48

0.9528

0.9865

1.0015

0.7641

110.79

130.69

v

Written by: John Kicklighter, Currency Strategist for DailyFX.com

To receive John’s reports via email or to submit Questions or Comments about an article; email jkicklighter@dailyfx.com

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

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