Market may have overreacted to Spain's downgrade

	SPOT	CURRENT POSITION	SIGNAL STRENGHT	OPEN DATE	OPEN RATE	POSITION GAIN/LOSS
USD/JPY	84.03	LONG USD	WEAK	11/15/10	82.51	1.81%
GBP/USD	1.5583	LONG GBP	WEAK	12/14/10	1.5870	-1.81%
EURO/USD	1.3224	LONG EURO	WEAK	12/14/10	1.3459	-1.75%
EURO/JPY	111.11	LONG EURO	WEAK	12/15/10	111.71	-0.54%
EURO/GBP	0.8484	LONG EURO	WEAK	12/15/10	0.8466	0.21%
GBP/JPY	130.89	SHORT GBP	WEAK	11/24/10	131.33	0.34%
USD/CHF	0.9696	SHORT USD	STRONG	12/14/10	0.9624	-0.74%
USD/CAD	1.0058	SHORT USD	WEAK	12/13/10	1.0086	0.28%
AUD/USD	0.9878	LONG AUD	WEAK	12/14/10	0.9993	-1.15%
AUD/JPY	83.00	LONG AUD	STRONG	12/09/10	82.55	0.55%
USD/MXN	12.4501	LONG USD	WEAK	11/30/10	12.5035	-0.43%

Outlook

If we see Europe making the EFSF bailout institution a permanent feature of the landscape, as expected, this is euro-favorable even if the funding amount is not raised. Refusal to raise the amount or to authorize e-bonds becomes a problem only if it looks like Spain needs a bailout, and so far that looks like a less than 50-50 proposition. Lack of clarity on raising the ECB’s capital would be a more serious shortcoming, although central banks have a lot of tricks up their sleeves and nobody lacks confidence in Mr. Trichet. The market may have overreacted to the Spain downgrade yesterday because the market is thinning ahead of the holiday or for other  reasons, but not because there is a universal judgment that EMU is failing. EMU is not doing well and management leaves a lot to be desired, but it’s not failing. At a guess, blundering along and muddling through will work to prevent a real crisis. As for street riots, they seem not to be affecting markets much. The indifference implies a real sense of confidence in the durability and capability of existing governments, somewhat like a vote of confidence in the sovereign.

As for the outlook for the US, today we get the usual Thursday weekly jobless claims, which traders like when they are feeling uncertain even though most of the time, weekly data is of almost no use whatever. A drop in claims is expected so it’s conceivable that a rise instead might be dollar negative. Now that at least some analysts are seeing 10-year yields headed down off an overbought level, that’s a dollar-negative, too. Today we also get Wehousing starts and building permits, hardly likely to be nice numbers given the season, the current account deficit and the Philly Fed. Of these, the Philly Fed could be important if it shows a robust recovery.

Most of all, traders will be starting to pare back positions ahead of settlement next Monday, which marks the week before Christmas and certain additional thinning.

Despite the giant dollar rise yesterday, we continue to think the chart work is correct and the new  buy signal in the euro is the right one. We need to see the euro rise to the previous high at 1.3380 from early yesterday to confirm. That might not happen in a single day since the EU summit will not report until tomorrow. But don’t be in a hurry to buy into more dollar rally—it’s just a one-day reversal, not a trend change.

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