FX - Markets Pressured in Early Trade But FT Draghi Interview Sheds some Light

• Euro short positions reach highest level since December 2007
• European finance ministers to hold more debt crisis talks Monday
• Rating agencies continue to swirl with downgrade threats
• Geopolitical uncertainty elevated on news of Kim Jong Il death
• ECB President Draghi sits down with FT and comments are enlightening
• Markets expected to lighten dramatically into final 2 weeks of year; sidelines good place

Risk sentiment is back under pressure into the early week with the Eurozone crisis still very much unresolved, and market participants growing decreasingly optimistic with the prospects for any sound and effective resolution. Net Euro short positions have reached their highest levels since December 2007, and the market is now focused on a break in EUR/USD below the 2011 lows from all the way back in January by 1.2870. European finance ministers will be holding more debt crisis talks on Monday in an effort to draft a new fiscal pact, figure out the size of bilateral loans to the IMF, and discuss ESM voting rights, but again, we are not very confident that these talks will do anything to alter damaged global sentiment.

Instead, the focus could be more fixated on the rating agencies with Fitch already placing many European sovereigns (including Italy and Spain) on review for potential downgrades by the end of January, and at the same time lowering France’s outlook to negative. Meanwhile, investors haven’t forgotten about recent threats from S&P of downgrades to many European countries (including France), and it seems as though some form of a response from this rating agency is right around the corner. Elsewhere, the death of North Korea’s Kim Jong Il has been getting headlines, with the news elevating geopolitical concern and adding to the broader risk off market environment, and weighing most heavily on the risk correlated Australian Dollar.

If there have been any positive developments at all, they could actually be coming from the ECB President who shared his views on the current debt crisis with the FT. ECB president Draghi came off sounding more accommodative than the central banker has been given credit for after leaving a lot of doors open for the use of alternative non-standard monetary policy measures. Although Draghi says he does not want the sole purpose of the long term refinancing operation (LTRO) to be used as a means to purchase sovereigns, he is not opposed to the strategy. Additionally, while Draghi does not commit to additional bond buying as most would expect, it worth noting that at the same time, he also does not rule out the possibility for additional bond buying and does not consider the practice to be illegal. The article is certainly enlightening and perhaps can be construed as Euro positive, with the central banker perhaps not as closed minded on certain key issues as markets might have thought.

Still, we are in the final two weeks of trade for the year and trade is likely to lighten up significantly making for more unpredictable and potentially volatile trade. While we concede that there are often big moves during this time of year, it is certainly not a market for the conservative, and we recommend that most of you stay on the sidelines until things return to normal into the beginning of January. Our core outlook remains grossly currency bearish and US Dollar bullish, but at this point, we can be certain as to whether the US Dollar will sell off a bit into year end before resuming its uptrend into 2012, or whether Dollar gains will accelerate in the final days of 2011.

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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