FX - Euro and Currencies At Risk for Accelerated Declines Against Buck

• Euro break below 1.3420 opens direct test of October lows
• Risk for more broad based currency weakness against the US Dollar
• Yen also seen exposed against the Greenback going forward
• IMF, S&P and local Japanese officials out with downbeat Japan comments
• Germany, France and Italy to meet to discuss major crisis
• German IFO business climate reading could be a big mover today

Technically, Wednesday’s break and close below 1.3420 in EUR/USD is significant and now opens the door for a full retracement back to the critical October lows by 1.3145. The downside break is also important on a broader scale, as it sends a message to the rest of the markets that risk liquidation is likely to continue, which ultimately exposes all risk correlated assets and should benefit the US Dollar. But, price action for the remainder of the week could be a little tricky, and we recommend taking to the sidelines, with the US markets closed for the Thanksgiving holiday. It is difficult enough to trade in normal market conditions, and trading in illiquid holiday markets is therefore not advisable.

Moving on, we have also been projecting USD upside even against the Yen, and as per our analysis, we recommend looking to buy USD/JPY at current levels, and so long as the market continues to hold above 76.80 on a daily close basis. The 76.80 level represents a major point in a very powerful Japanese trend indicator, and while above this level, we retain a constructive outlook and look for the market to carve a major base off of record lows. On the fundamental front, the IMF and S&P have both been out with separate warnings that Japan could be in trouble if its JGB yields were to rise from current levels, as this would result in unsustainable public debt and potential downgrades. Meanwhile, Japan’s EconMin Furukawa has also been on the wires warning that the Eurozone’s debt crisis could harm the Japanese economy by way of trade flows and FX movement.

Overall, the crisis in the Eurozone appears to have intensified on realized fears of contagion to the core economy and beyond, and the latest disastrous German bund auction and warnings from Fitch of a potential downgrade to France, have not helped matters. Economic data in the Eurozone has also been quite soft, and EU leaders remain under intense pressure to come up with some effective resolutions. The EFSF relief is clearly not enough and today’s meeting between German, French and Italian leaders in Strasbourg will be watched closely for any progress or lack there of.

Looking ahead, market participants should be paying very close attention to today’s German IFO business climate reading which is a major sentiment indicator and could very well influence price action. While the indicator is generally smooth and not subject to major deviations from expectation, those close to us have issued warnings that there are risks for a more significant letdown today in light of the ongoing crisis. Our colleague, a leading currency strategist at a major bank highlights these risks in his report today:

“The market is short EUR, but not massively short, with the big shorts concentrated among the CTAs and high frequency traders. If the drop takes IFO below 104.0, the FX market will see it as reinforcing the recession fears that have intensified in recent weeks. This is Euro negative, and could fuel a significant move. The big downside for the Euro is that a major downward revision to German and Eurozone growth prospects will make achieving fiscal targets less likely in peripheral and semi-peripheral euro zone countries. This may galvanize the ECB to some degree, but investors are generally very skeptical that the ECB is ready now to make a move at the long end, where it is needed. Net, net, even 104 would be bad for the Euro, but if the risk is for an even lower number, we may see significant downward pressure on the currency well before the mini-summit (German, French, Italian meeting mentioned above) results later in the day.”

On the strategy front, 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.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The latest break below 1.3420 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 1.5625 further 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 1.5400, while any intraday rallies are expected to be very well capped below 1.5800.

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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