Dollar strengthened broadly last week on Eurozone debt crisis and Korean geopolitical tension and some important technical levels were broken. Firstly, dollar index has taken out 80 key resistance and it's accompanied by break of 1.3330 support in EUR/USD. The relatively resilient GBP/USD has also taken out 1.5649 support to confirm near term reversal. Even the strongest AUD/USD has completed a head and shoulder top reversal pattern. The greenback is possibly building up a medium term rally that would last for a few months. But it will need to get through tough tests of a number of events this week first. Also, another key focus will be on whether gold would fall back to below 1300 level to fuel more buying in the greenback.
The boost from Ireland's bailout was rather brief. Moody's said in a note last week that rescue package from EU/IMF would "crystallize more bank-contingent liabilities on the government balance sheet, and increase the Irish sovereign's debt burden". Previously, Moody's put Ireland on review and said it would likely cut the grade by one level. However, the increase in state debt would now exceed original expectations and a multi-notch downgrade" is "now the most likely outcome." Also, S&P lowered Ireland's long-term sovereign rating by two notch from AA- to A while short term rating was cut from A-1+ to A-1. S&P also assigned a negative outlook to the rating. S&P said in a statement that "the Irish government looks set to borrow over and above our previous projections to fund further bank capital injections into Ireland's troubled banking system." There are also much political uncertainties in Ireland after Ireland's Green Party called for a January election, saying the prime minister "misled" voters about the need for aid.
Ireland is in the final stage of the bailout as EUR Finance ministers will conclude an agreement on Sunday. Irish Prime minister Cowen estimated that the deal would amount to EUR 85b. The terms for the bailout will also be nailed out, including interest rates on the loans an debt restructuring. The announcement will be the biggest event risk for early part of this week.
In addition, there are numerous speculations on Eurozone. Firstly, German Chancellor Merkel said that the prospect of serial bailouts was "exceptionally serious." Merkel reiterated the call for a permanent rescue system that will have bondholders sharing the responsibility from 2013 and tough conditions to be imposed on nations that seek bailouts. Secondly, there were speculations that EU finance chiefs are trying to force Spain and Portugal to seek bailout from EU/IMF even though these rumors are denied by various parties. Thirdly, there are also speculations that ECB would delay exit of the stimulus measures. In any case, the story is not close to an end yet and would likely continue to pressure Euro for a while.
Geopolitical tension in Korea weakened yen against dollar last week and pressured risk sentiments. North Korea fired over 200 artillery shells at a South Korean island and there were exchange of firing. Later in the week, North Korea warned that they're "greatly enraged at the provocation" from South Korea, and any "escalated confrontation", including planned US-South Korea naval exercises, would bring the peninsula closer to war.
There were also some support for the greenback as FOMC minutes revealed disagreement among policy makers on launching the $600b QE2 program. The vote was near unanimous by 10-1. However, while most members expected the program to "help promote a somewhat stronger recovery in output and employment while also helping return inflation, over time, to levels consistent with" Fed's mandate, "some participants noted concerns that additional expansion of the Federal Reserve's balance sheet could put unwanted downward pressure on the dollar's value in foreign exchange markets." This is seen as signal of deep concern on the depreciation of dollar as an impact of the QE2 program. Meanwhile, Fed also released latest projections with GDP estimated to rise at 3-3.6% in 2011 versus prior forecast of 3.5-4.2% released in June. Unemployment was projected to be at around 9% by end of 2011, higher than prior projection of 8.5%. Inflation is expected to stay below the informal target of 2% through 2013.
Aussie was sharply lower on risk aversion last week. Also selling accelerated after speech from RBA Governor Stevens that imminent rate hike is unlikely. He qualified current rates as "a little tighter than average", and expects a strong Aussie would help curb inflationary pressures. Kiwi, on the other hand, was the worst performer as New Zealand's credit rating outlook was lowered to negative by S&P on "a significant weakening in the credit quality of New Zealand's banking sector." New Zealand is current having AA+ rating, second highest grade. S&P expects New Zealand's current account deficit to widen and average 5.9% of GDP over three years, which raises the need for external financing. New Zealand Finance Minister Bill English said in response to the move that "this is a long-standing problem for New Zealand and has left us vulnerable as a country...... the government is taking steps to reduce this external vulnerability and to move the economy towards savings and exports."
Technical Highlights
Dollar index's strong rally and break of 80.08 resistance indicates that that whole decline from 88.70 is finished at 75.63 already. The less bullish scenario suggests that price actions from 2009 high of 89.62 are developing into sideway pattern in form of triangle. In such case, current rise from 75.63 would still extend further towards upper trend line resistance above 88 level.
In any case, we'll stay bullish as long as 77.97 support holds and next near term target is 100% projection of 75.63 to 79.46 from 77.97 at 81.80.
One of the key factors to determine whether dollar could sustain its rally lies in commodities. CRB index continued to draw support from 55 days EMA as well as 38.2% retracement at 292.43 last week. But recovery was so far mild and unconvincing. We'll continue pay close attention to 292/3 support level to determine whether CRB's trend has reversed or it's merely turning sideway.
The Week Ahead
Initial focus of the week will be on any solid announcement on the rumored EUR 85b bailout from EU/IMF on Sunday, as well as the terms tied to the bailout. Onwards it a week full out higher important economic data. The question of whether Fed will complete the $600b QE2 and whether there will be QE3 are still in investors' mind even though they're on the back seat in the past two weeks. The job report on Friday, plus other data including ISM indices would continue to trigger adjustments on such expectations. Also, China will also released manufacturing PMI, which should trigger some volatility in Asian equities and risk sentiments.
Also, ECB meeting will be an important event of the week. Unlike prior meetings, markets' opinions on whether ECB will make another U turn and soften its hawkish stance are quite divided. In addition, there are some speculations that ECB might somewhat hint at delaying stimulus exit, or at least slowing the pace.
- Monday: New Zealand trade balance; Japan retail sales; Canada current account, IPPI/RMPI; UK pre-budget release
- Tuesday: Japan manufacturing PMI, unemployment rate, household spending, industrial production, housing starts; Australia building approvals, current account; German unemployment, Eurozone unemployment rate, CPI; Canada GDP; US house price, consumer confidence
- Wednesday: Australia GDP; German retail sales, Eurozone manufacturing PMI; UK nationwide house price, manufacturing PMI; Swiss SVME PMI; US ADP job report, productivity and unit labor costs, ISM manufacturing, Fed Beige Book
- Thursday: Australia retail sales, trade balance; Swiss GDP, retail sales; UK construction PMI; Eurozone GDP, PPI, ECB rate decision; US jobless claims, pending home sales
- Friday: Swiss CPI; Eurozone services PMI, retail sales; UK services PMI; Canada job data; US non-farm payroll, ISM non-manufacturing, factory orders
EUR/USD dropped to as low as 1.3200 last week and the strong break of 1.3330 support indicates that whole rebound from 1.1875 is already finished at 1.4281. Initial bias remains on the downside this week for 100% projection of 1.4281 to 1.3447 from 1.3785 at 1.2951. On the upside, above 1.3386 minor resistance will turn intraday bias neutral and bring consolidations. But break of 1.3784 resistance is needed to indicate that fall from 1.4281 is finished. Otherwise, outlook will stay bearish.
In the bigger picture, the break of 1.3330 resistance turned support indicates that whole medium term rally from 1.1875 is possibly finished at 1.4281 already after failing below falling trend line resistance from 1.6039. More importantly, the development suggests that whole correction from 1.6039 (2008 high) is still in progress. Such correction might develop into a falling triangle pattern, with the fifth leg just started at 1.4281. In other words, decline from 1.4281 could now head towards another low below 1.1875. In any case, we'll stay bearish as long as 1.3784 resistance holds.
In the long term picture, considering the five wave impulsive structure of the long term up trend from 2000 low of 0.8223 to 2008 high of 1.6039, price actions from 1.6039 are viewed as a correction only. Hence, firstly, we'd expect strong support between 61.8% retracement of 0.8223 to 1.6039 at 1.1209 and 1.1639 to contain downside. Secondly, we'd expect another high above 1.6039 eventually, after correction from 1.6039 is confirmed to be finished.
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