FX - Markets Supported by US Data, Spanish Auction and Healthy Correction

• Currencies find support into end of week
• Solid US data and well received Spanish auction factor
• Healthy technical bounce also welcome following large sell-off
• Looking at US equities in 2012

A combination of solid data out of the US and well received Spanish auction results could be attributed to the latest mild bounce in risk correlated assets, but we contend the price action is most likely some healthy consolidation before a fresh wave of risk liquidation kicks in. The European debt crisis is still far from resolved, and the risk of downgrades to European countries is as high as ever. Key support for the Euro comes in by the 2011 lows from January at 1.2870 and we would expect for this level to be tested over the coming week.

However, we continue to warn that trade is going to lighten up dramatically over the coming days as market participants race from their desks into the holiday season. This does not normally make for ideal trading conditions, and as such, we recommend taking to the sidelines until things pick up again into early January. With that in mind, I would like to segue into my outlook for opportunities in 2012 and offer one strategy that I feel could be extremely attractive.

Foreign Investment in US Equities

While on the surface, the strategy appears to be non-currency specific, we view this as an extremely attractive opportunity for a portfolio hedge in 2012 and potential arbitrage. Currencies have been broadly outperforming against the US Dollar in recent years and it finally appears as though this trend could be on the verge of some form of a reversal back in favor of the buck. However, long USD positions have also been quite risky and exposure to the Greenback might bring with it some unwelcome stress. As such, our recommendation for non-US residents is to instead, put their money into US equities. What does this mean?

Here is how we see this playing out. Should current correlations stand, if US equities are to head higher, then the investor will benefit from the US equity return, but at the same time, likely have their investment offset by the sell-off in the US Dollar and appreciation in their local currency on the resurgence in risk appetite and outflow from the safe-haven US Dollar. If on the other hand US equities head lower, then the risk off market environment will allow the investor to offset their loss in US stocks through the appreciation in the US Dollar on its safe-haven flows (remember – the investor in invested in US equities and thereby has USD exposure).

So if this is the case, then where is the benefit in this trade, and why even do it? Well, what if we see a break down in familiar correlations where the US equity market rallies and the US Dollar also rallies at the same time? What if we see a situation where US equities and the US Dollar become positively correlated? In this scenario, the investor stands to benefit a great deal and will not only make money from his investment in US equities, but will also enhance returns on the appreciation in the US Dollar.

The global recession appears to be moving in phases, and with the markets now dealing with phase two of the crisis in Europe, we can start to anticipate the transition to phase three, where we believe that China, the commodity bloc economies and emerging markets will all be exposed. At the same time, we see a first in and first out type of situation, with the US economy the first to emerge from the global recession which should translate into a more upbeat outlook on low valuation US equities, and the US Dollar as well, with the Fed to signal a reversal of ultra accommodative monetary policy.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The market has finally taken out the key October lows at 1.3145 to confirm a lower top by 1.3550 and open the next downside extension towards the 2011 lows from January at 1.2870. Daily studies are however looking a little stretched and at this point we could see some corrective action before the market resumes its downward trajectory. Look for any rallies to be well capped in the 1.3300 area from where the next lower top will be sought out.

USD/JPY:The market has managed to successfully hold above the bottom of the daily Ichimoku cloud to further strengthen our constructive outlook and we look for the formation of a inter-day higher low by 76.55 ahead of the next major upside extension back towards and eventually through the recent multi-day highs by 79.55. Ultimately, only a close back below the bottom of the Ichimoku cloud would negate outlook and give reason for pause, while a daily close back above 78.30 accelerates.

GBP/USD: Rallies have been very well capped ahead of 1.5800 and it looks as though a lower top has now been carved out by 1.5780 ahead of the next major downside extension back towards the October lows at 1.5270. Key support comes in by 1.5400 and a daily close below this level will be required to confirm bias and accelerate declines. Ultimately, only back above 1.5780 would negate bearish outlook and give reason for pause.

USD/CHF: The recent break above the critical October highs at 0.9315 is significant and now opens the door for the next major upside extension over the coming weeks back towards parity. A confirmed higher low is now in place by 0.9065 following the recent break over 0.9330, and next key resistance comes in by 0.9785. Ultimately, only back under 0.9065 would delay constructive outlook.

--- Written by Joel Kruger, Technical Currency Strategist

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