FX - EU Leaders Under Increased Pressure After ECB Draws Line

• EU Summit to influence price action on Friday
• Investors shaken by failure of ECB to deliver more accommodative response
• Commodity bloc currencies hit hardest on recent risk liquidation
• EUR/USD focusing once again on retest and break of October lows

Any hopes for a firmer response from the European Central Bank on Thursday were seriously disappointed after the ECB cut rates by an as expected 25bps and announced additional measures to enhance liquidity in the Eurozone. Market participants had undoubtedly been looking for a more accommodative response, and when ECB President Draghi announced that the ECB would not be stepping up purchases of government bonds and that it would not be forced to fund governments as a lender of last resort, a massive bout of risk liquidation ensued, opening the door for some broad based appreciation in the US Dollar.

Interestingly enough, the Euro was not the hardest hit of the major currencies on the day, with the commodity bloc underperforming on its tight correlation to risk and the potential realization that these economies are also very much exposed to the threat of global contagion. Also seen weighing on these currencies was a softer than expected inflation print out of China.

The move by the ECB now puts much more pressure on EU leaders at today’s Summit and all will be focused on developments at the meeting. Aggressive action needs to be taken to address the Eurozone crisis and investors will be much less patient with any promises of budget stabilization, austerity measures or fiscal integration. Anything short of an immediate injection of ample liquidity into the markets to alleviate some of the stress will likely be viewed as a failure and open the door for yet another wave of broad based risk liquidation and buying of the US Dollar.

Overall, while we are quite pleased with the price action as it reaffirms our core USD bullish bias, we continue to recommend that traders proceed with caution in the month of December. The final weeks of the year are often very difficult to trade, and throw in the added uncertainty surrounding the Eurozone, and we are even more unnerved with the idea of establishing short-term positions. Technically, we recommend keeping a close eye on EUR/USD as a gauge for broader directional bias, and a break back under 1.3200 or above 1.3460 will help to provide added insight.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The latest corrective rally appears to have stalled out by 1.3550 and the market looks poised for a bearish resumption to challenge the critical October lows at 1.3145. A break below 1.3145 is significant and will open the door for deeper setbacks over the coming weeks and months into the lower 1.2000 region. Ultimately, only a daily close back above 1.3550 will negate outlook and give reason for pause.

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: The market correction out from the recent lows at 1.5420 appears to have finally stalled out and we will be looking for a daily close back under 1.5560 to confirm bias and accelerate declines. A close below 1.5560 should accelerate declines towards 1.5420, below which will open an even deeper setback to retest critical support by the October lows at 1.5270. Ultimately, only back above 1.5800 would delay and give reason for concern.

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. Daily studies are looking slightly stretched at current levels, so we would not rule out the potential for some corrective selling, but ultimately, look for any setbacks to be well supported in the 0.9000 area, where a fresh higher low is sought out.

--- Written by Joel Kruger, Technical Currency Strategist

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