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Sentiment Poised for Favorable Short-Term Reversal in Early Week

Sentiment Poised for Favorable Short-Term Reversal in Early Week

2011-09-26 11:02:00
Joel Kruger, Technical Strategist
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  • Weekend Telegraph article could gain traction
  • IMF comes out with comments that support our core outlook
  • Emerging markets at risk for major depreciation
  • Looking for opportunities to fade Yen strength
  • Buying USD on dips against currencies is preferred strategy

An article in the weekend Telegraph could start to gain more traction as the day progresses, with the piece highlighting the first discussion of a detailed plan to prevent contagion to Spain and Italy should Greece move to a restructuring. The article also talks of the need for a recapitalization of European banks, and could help to offset some of the downbeat sentiment seen in the markets in recent sessions, with some form of an official response potentially bolstering confidence. However, there is still a good amount of work that ultimately needs to get done to really force a shift in the overall negative outlook in the region, and investors are expected to remain cautious.

Relative performance versus the USD on Monday (as of 10:55GMT)

  1. GBP +0.42%
  2. JPY +0.31%
  3. NZD +0.15%
  4. AUD -0.03%
  5. CAD -0.04%
  6. CHF -0.10%
  7. EUR -0.13%

One good reason for caution is the fact that this global downturn has yet to fully play out and could still enter a third phase. Those of you who have been reading my research over the past couple of years know very well that we have been anticipating such a scenario and see the global recession as a three stage recession starting in the United States, spreading to Europe, and then finally rippling into China, the commodity bloc economies and emerging markets. Comments out from the IMF over the weekend have been reinforcing our view after the fund came out and warned of the potential spread to China and the emerging markets.

From our perspective, these markets have been outperforming in recent months on a backwards logic where funds have been flowing into these markets as safe-haven plays with attractive yield differentials. But the reality is that you can’t be both and these markets should not be treated as safe-havens. Ultimately, if the global deterioration continues, then we would expect to see a major depreciation in these markets which have benefited and relatively outperformed throughout the crisis.

On the strategy front, currencies remain under pressure against the US Dollar and Yen, with market participants continuing to shift money into the lower yielding and safe haven options. However, we continue to warn against the accumulation of additional Yen at current levels, and see this market at a serious risk for major weakness going forward, even in the event of additional strain on the global macro economy. Japanese officials have been actively warning of intervention, and the Bank of Japan has more than enough at its disposal to be able to buy a significant amount of US Dollars.

As such, just as we have already seen with the Franc, the Yen will also be at risk for a major sell-off should the current stat of affairs continue (ie risk liquidation). We therefore hold firm in our broad based USD bullish outlook and continue to like the idea of looking to fade any additional Yen strength against the major currencies. As far as the other major currencies are concerned, short-term technicals have been warning of some corrective rallies, with the markets showing oversold. The best strategy would probably be to look to be buying USDs against these currencies on dips.

ECONOMIC CALENDAR

Sentiment_Poised_for_Favorable_Short-Term_Reversal_in_Early_Week_body_Picture_5.png, Sentiment Poised for Favorable Short-Term Reversal in Early Week

TECHNICAL OUTLOOK

Sentiment_Poised_for_Favorable_Short-Term_Reversal_in_Early_Week_body_eur.png, Sentiment Poised for Favorable Short-Term Reversal in Early Week

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. The latest inter-day rally off of the 1.3500 area lows has stalled out within our projected lower top region between 1.3835 and 1.4055 and Thursday’s break back below 1.3500 confirms the lower top at 1.3940 and should accelerate declines down towards 1.3000 over the coming days. Still, with daily studies looking slightly stretched, look to sell into a rally towards 1.3700 rather than attempting fresh shorts on downside breaks. Ultimately, only a close back above 1.3940 delays outlook and gives reason for pause.

Sentiment_Poised_for_Favorable_Short-Term_Reversal_in_Early_Week_body_jpy2.png, Sentiment Poised for Favorable Short-Term Reversal in Early Week

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. From here, we look for the establishment back above the 50-Day SMA to reaffirm our recovery outlook and accelerate gains towards next key resistance by 80.25 further up. Ultimately, only a daily close back under 76.00 delays.

Sentiment_Poised_for_Favorable_Short-Term_Reversal_in_Early_Week_body_gbp2.png, Sentiment Poised for Favorable Short-Term Reversal in Early Week

GBP/USD: The market has now extended declines to our objective by 1.5350, with the setbacks matching the December 2010 lows. While we continue to project additional weakness over the medium-term, short-term technical studies are quite stretched and as such, we see risks for a potential corrective rally before the underlying downtrend resumes. Look for a bounce over the coming sessions back towards previous support now turned resistance by 1.5780 where a fresh lower top will then be sought ahead of the bearish resumption.

Sentiment_Poised_for_Favorable_Short-Term_Reversal_in_Early_Week_body_swiss1.png, Sentiment Poised for Favorable Short-Term Reversal in Early Week

USD/CHF: Although daily studies are showing overbought and warn of the potential for a short-term corrective pullback, the recent daily close back above the 200-Day SMA is significant and now opens the door for the next upside extension towards 0.9500 further up. Medium-term and longer-term studies still show plenty of room for upside ahead, while the short-term outlook also remains constructive above 0.8645. Ultimately, only back under 0.8645 delays short-term outlook and would open the door for a more sizeable corrective decline. Still, even at that point, buying into dips would be the preferred strategy. Any intraday dips back towards the 0.8900 handle are viewed as solid short-term buy opportunities.

Written by Joel Kruger, Technical Currency Strategist

If you wish to receive Joel’s reports in a more timely fashion, email jskruger@dailyfx.com and you will be added to the distribution list.

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