FX - Euro Looks Ready for Next Drop Towards Key October Lows

• Euro poised to establish below key 1.3420 support
• Aussie weighed down by softer China PMI data
• Short Aussie positions performing exceptionally well
• Pimco’s El Erian on the wires with disturbing comments
• Chatter making rounds of bailout for Dexia bank
• US equity futures weighed down significantly

With the Euro unable to take out 1.3420 in the early week, we had warned of a potential corrective rally towards 1.3700 before the selling resumed. However, the correction never really played out and the Euro remains well offered on even the shallowest of rallies to suggest that we could soon see a fresh downside break below 1.3420 to expose the key October lows at 1.3145. Look for a sustained break below 1.3420 on Wednesday to confirm and accelerate declines. The EUR/USD 1.3420 will be a key level to watch in the FX markets and perhaps the broader markets, with the major currency pair attracting most of the attention in recent months due to the escalation in the Eurozone crisis.

While the Euro is the most influential in terms of gauging directional bias and overall risk appetite, it will not be the hardest hit should the 1.3420 level be taken out. Instead, the downside break will expose the higher yielding commodity currencies, which have relatively outperformed in recent years and are now at risk for major liquidation as market participants realize that the global recession even extends to these markets. The Australian Dollar is the strongest candidate for relative underperformance going forward, as we continue to project that a third wave of the recession will spread to China, which ultimately will weigh heavily on the correlated Australian economy. China’s latest HSBC flash PMIs came in below the critical 50 boom/bust level, and this in conjunction with a generally downbeat market environment should continue to weigh on the Australian Dollar going forward, even against the Euro.

We have been very short Aussie over the past several weeks, both against the USD, where we are short from 1.0550, and against the Euro, where we are long EUR/AUD from 1.3300. While most have understood the logic behind the short AUD/USD trade, many had questioned the motivation for a long EUR/AUD position with things so bad in the Eurozone. As we explained back then, and as appears to be now materializing, the fact that we still see a third wave of the global recession spreading towards Australia, and the fact that we perceived the worst case scenario to already be priced into the Eurozone, was the primary driver for this strategy. While we have booked some profit on both our short AUD/USD position and long EUR/AUD position, we continue to project major Aussie weakness against both of these currencies over the coming weeks and months.

Other headlines seen negatively influencing risk sentiment on Wednesday have been chatter of a Dexia bailout and comments from Pimco’s El Erian that US economic conditions are “terrifying.” Moving on, Wednesday will be the last full day of trade for the week, with the US markets lightening up significantly for the Thanksgiving Day holiday. Markets are always unpredictable in these times of lightened volatility, so the best place to be could very well be on the sidelines until normal market conditions resume next week.

Technically, we continue to defer to the EUR/USD monthly chart, which has been extremely useful this year. The market looks like it has been in a steady downtrend since positing record highs in 2008, and is now in the process of a carving out the next major lower top below 1.5000 ahead of a retest of some multi-month range lows in the lower 1.2000’s. Once the lower 1.2000’s are tested, it is entirely possible that we see further acceleration towards parity, but at this point, it is way too premature to make such calls and we will have to step back an reassess when the market gets down to our lower 1.2000 area objective.

Looking ahead, key releases in the European session include German and Eurozone manufacturing PMIs, the Bank of England Minutes, and Eurozone industrial new orders. The calendar is also quite busy in North America, with durable goods, personal spending, personal consumption, personal income, initial jobless claims, and Michigan confidence all due. On the official circuit, ECB Constancio, EU’s Rehn and Van Rompuy, and Bank of Canada Carney are all slated to speak. US equity futures and oil prices are tracking a good deal lower on the day, while gold is managing to generate some bids.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The latest break below 1.3480 should now open a fresh downside extension which ultimately exposes a retest of the key lows from October at 1.3145. Look for any rallies to be well capped below 1.3700, while ultimately, only back above 1.3870 would negate outlook. Once 1.3145 is taken out, it will negate the corrective October price action and should result in a more aggressive bout of selling into the 1.2000’s. We continue to project weakness over the coming weeks into the lower 1.2000’s as per the monthly chart.

USD/JPY:Although the market has come back under pressure following the recent surge to 79.55, we retain a constructive outlook with the price still holding above the bottom of the daily Ichimoku cloud. The bottom of the cloud currently comes in just under 77.00 and so long as the market continues to hold above the bottom of the cloud, we recommend looking to be long this market in anticipation of a more significant bullish trend shift from record lows. A close back below 76.80 would however give reason for concern.

GBP/USD: The latest daily close below 1.5870 confirms our bearish outlook and should now open the door for a bearish resumption back towards the key October lows at 1.5270 over the coming days. Next key support comes in at 1.5525, while any intraday rallies are expected to be very well capped below 1.6000.

USD/CHF: The pair looks like it is in the process of carving a major base ahead of some significant upside over the coming weeks and months. The latest rally seems to be gaining momentum, and we anticipate that the market will soon clear the key October highs at 0.9315. Above 0.9315 should then accelerate gains and open the next major upside extension towards parity. Any setbacks from here should be very well supported above 0.8900.

--- Written by Joel Kruger, Technical Currency Strategist

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