Sunday, December 12, 2010

Weekly Review and Outlook: Dollar Stabilized after Compromise on Tax Cut Extension, But Remains ...

Dollar's selloff halted last week and the greenback recovered after US President accepted to extend the tax cuts on higher income individuals, dividends, capital gains and multimillion dollar estates for the next two years, which was a compromise with the Republicans. The news was a boost to the greenback in two ways. First, it's believed that the tax cut extension will provide additional boost to economic recovery, which will in turn ease the burdens on Fed to complete its $600b QE2 program, as well as the need for QE3. Secondly, the fear of worsening budget deficit prompted selloff in US treasuries which pushed yield sharply higher. USD/JPY is the move sensitive pair to yields and rebounded strong from intraday week low of 82.33 and is back pressing 84.39 resistance.

Dollar's outlook is less bearish than a week ago. But there is no convincing sign of strength yet. Firstly, EUR/USD's fall from 1.3437 last week looks corrective and rebound from 1.2969 is in favor to continue. On next rise, EUR/USD should take out 1.3447 resistance, which will confirm near term reversal and would push the pair through 1.3785 resistance. USD/CHF's recovery from 0.9725 to 0.9914 looks corrective and might have finished. GBP/USD has taken out 1.5838 resistance and is in favor to rise further to 1.6093 resistance and above. 

AUD/USD engaged in sideway consolidation for most of the week and rebound from 0.9536 will likely continue towards 1.0181 high sooner or later. USD/CAD did recovered but momentum was weak. USD/JPY is this only one that clearly look bearish, yet there wasn't enough buying to send it through 84.39 resistance. After all, we are not convinced to turn bullish on dollar again yet.

Though, three developments worth noting in the coming weeks before year end. Firstly, a turn in risk sentiments could be around the corner. S&P 500 did make new recent high last week but the rise from 1173 might be the final wave in the five wave sequence from 1010.91. If that's true, we should seen strong resistance between 1246/1291 projection level to limit upside and bring reversal. Fundamentally, investors should be deeply worried of interest rate hike from China after data released over the weekend showed much worse than expected inflation outlook with CPI jumped to 5.1% yoy in November, highest reading in 28 months. China raised bank reserve requirement ratio on Friday but that shouldn't be viewed as enough by anyone for curbing inflation.

Second development to note is any further rally in treasury yield. 4.508 and 3.330 might be near term tops in TYX and TNX respectively (yield on 30 years bond and 10 year note). However, rebounds from 3.463 and 2.334 are clearly not over yet. In particular, TNX, yield on 10 year note, is indeed accelerating higher. The solid 30 year bond auction and the mediocre but non-disastrous 10 year note auction last week helped stabilized the bond markets temporarily. But we'll expect sellers to jump in again sooner or later. Further rally in yields should finally send USD/JPY through 84.39 resistance and help the greenback recovers against other major currencies.

Thirdly, while gold did make another record high at 1432.5 last week, recent up trend looks over-stretched. Upside momentum has been diminishing for a while with bearish divergence condition in daily MACD and RSI. Reversal should be imminent. Another rise cannot be ruled out yet but strong resistance should be seen well ahead of 1500 psychological to complete the diagonal triangle pattern and bring medium term reversal.

So to conclude, while we're still mildly bearish in the greenback, we'd be cautiously watching the above three areas and the greenback's fortune would likely reverse if the above three developments materialize together.
In other news, four central banks met last week. BoE was a non-event. BOC left its target for the overnight rate unchanged at 1% and delivered a modestly dovish statement as domestic economic growth slowed and sovereign crisis in the Eurozone may dampen global recovery. The decision was widely expected by us as well as the market. Policymakers acknowledged that economic activity in 2H10 was weaker than the central bank's projections released at the October MPR. Yet, they believed the recovery continued to progress at a 'moderate' pace and there were some pleasant surprises. More in BOC Kept Policy Rate Unchanged for a Second Consecutive Time.

The RBA left the cash rate unchanged at 4.75%. There were few surprises from the accompanying statement and the central bank sent no signal on when the next rate hike will be. Yet, it continued to warn of the high level of commodity prices and the effect on investment and incomes. The RBA did not show any concerns about the disappointing GDP growth in 3Q10, suggesting it remains confident toward the country's economic outlook. We retain our views the next rate hike will be in 1Q11, probably March. More in RBA Left Policy Rate At 4.75%.
RBNZ was the most market moving one. The RBNZ left the OCR unchanged at 3% in December as domestic economic growth was slower than previously expected. The central bank expects interest rates will rise to a 'more limited extent over the next 2 years than signaled in the September Statement'. In the latest set of economic forecasts, the RBNZ revised lower GDP forecasts for 2010/11 while upgrading growth in 2011/12. We view the statement as more dovish that the previous one and the schedule of tightening may be pushed later. More in RBNZ Left OCR Unchanged. Future Rate Hikes Limited.

Technical Highlights
Dollar index's recovery from 79.07 extended further last week and is back pressing 80 psychological level. Prior break of 79.46 support was taken as a sign that whole rebound from 75.63 is finished at 81.44 already and a short term top is at least in place. While recovery from 79.07 might extend further high, overall risk will remain on the downside as long as 81.44 resistance holds and we'd still expect another fall in near term towards 77.97 support. Make or break there will determine whether rise from 75.63 is totally finished, or is still in progress for upper side of the larger range near to 88 level.
The Week Ahead
Two central bank meetings are featured this week. FOMC has just unveiled its much anticipated QE2 program in November and this week's meeting could be much quieter. SNB is widely expected to leave rates unchanged. Though, the bank will issue 2011 growth outlook after this week's meeting and that could set markets' expectation of any chance of policy accommodation removal in 2011. EU summit at the end of the week will also be watched. Nevertheless, last Friday, German and France have already made clear their joint position against setting up of eurozone bonds and expanding the current crisis fund. It's doubtful if the summit will end up with anything significant.
  • Monday: Swiss PPI; UK PPI input; New Zealand retail sales
  • Tuesday: UK CPI; German ZEW; US retail sales, PPI; FOMC rate decision
  • Wednesday: Japan Tankan survey; UK job data; Swiss ZEW; US CPI, Empire State manufacturing, TIC capital flow; industrial production, NAHB housing market index
  • Thursday: SNB rate decision; Eurozone flash PMIs, CPI; UK retail sales; US new residential construction, jobless claims, current account, Philly Fed survey
  • Friday: UK nationwide consumer confidence; German Ifo, Eurozone trade balance; US leading indicator
EUR/USD engaged in choppy retreat from 1.3437 last week. The corrective structure suggests that rebound from 1.2969 is not over yet and another rise is in favor. Above 1.3437 will bring rise resumption. In such case, 1.3447 resistance should be taken out and that would confirm that fall from 1.4281 has completed with three waves down to 1.2969, just missing 100% projection of 1.4281 to 1.3447 from 1.3785 at 1.2951. EUR/USD should then target 1.3785 and then 1.4281 high. We'll favor this bullish case as long as 1.2969 support holds.
In the bigger picture, the three wave structure of the fall from 1.4281 to 1.2969 argue that it's merely a correction only. Also, it raises the possibility that whole rise from 1.1875 is indeed impulsive in nature, with a small fourth wave from 1.4150 to 1.3733. Break of 1.3785 resistance will bolster the bullish case that rise from 1.1875 is resuming for another high above 1.4281 and revive the case that medium term correction from 1.6039 is already finished at 1.1875. On the downside, a break below 1.2969 again will in turn solidify the case that correction from 1.6039 is still in progress for another low below 1.1875 before completion.
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.
EUR/USD 4 Hours Chart
EUR/USD Daily Chart
EUR/USD Weekly Chart
EUR/USD Monthly Chart

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