The USD Surge Continues; No End In Sight

09/08/2008 12:00 am EST

Focus: FOREX

Brian Dolan

Chief Currency Strategist,

So much for the period of consolidation I was expecting last week. The USD surge has continued and the persistence of USD price gains remains as forceful as the early phase of the USD rebound. Price action continues to point to massive position liquidations, as USD pullbacks remain exceptionally shallow and new highs occur with little seeming relationship to data releases or other time-specific events. In simpler terms, asset managers are still looking to unload long EUR, GBP, AUD positions and ultimately get short those currencies, preferably on bounces in those pairs. When better levels to sell at fail to materialize, these funds are forced to go to market and sell into weakness at successively lower levels.

Many analysts are continuing to look for some slowing to the USD rally or some consolidation to develop and I fell into that trap last week. Instead of trying to anticipate a bottom in EUR/USD or a top in the USD, I'm going to operate on the basis of "I'll know it when I see it." And right now, I'm seeing very little in the way of signs of a USD top. The best that I can see are some doji patterns on daily candlesticks from Friday in the US dollar index and USD/JPY. But doji patterns (where the daily open is nearly identical to the daily close) are neutral and only potential warning signs of a reversal; traders need to wait for confirmation signaled by a daily close beyond the doji extreme point in the opposite direction of the trend. For example, in the USD index, the trend has been up, so a daily close below the low of the doji candle could confirm a reversal.

Key inter-market relationships continue to support the USD advance, which in turn reinforces some of those markets' moves. Oil prices are below the 200-day moving average at 111.51 and remain at risk of dropping below the $105/bbl level, setting up potential to take out the psychologically significant level of $100/bbl and decline further. Gold has dropped back below the daily Tenkan line (fastest moving line) in daily Ichimoku charts and is closing below the cloud on weekly Ichimoku charts, highlighting the prospect of more significant declines ahead. US Treasuries were bought on flight-to-quality desperation as asset managers dumped overseas assets and looked to park money in the most secure bond available. Also, this past week saw significant market talk that hedge funds were paring asset holdings in anticipation of large redemptions, a Street euphemism for withdrawals, for the September quarter end. It seems unlikely that such asset sales have already run their course in the first week of September and I would expect more to come.

New levels to watch in EUR, GBP, and AUD.

In last week's update, I highlighted key levels to watch in EUR/USD, GBP/USD and AUD/USD for signs that further declines were unfolding. In each pair, those key levels were broken and the targeted declines were met or exceeded. Below are snapshots of those same currency pairs with new levels to watch.

EUR/USD: Broke below the key 1.4500/50 level and losses exceeded my projected target of 1.4300. Importantly, EUR/USD is closing below weekly trendline support at 1.4470/80, marking that area as the new 'sell on rally' level. The 100-week moving average at 1.4192 looks to have contained the downside for the time being and a break below that level will likely trigger further weakness to the 1.4000/50 zone of round-number, psychological support. Below sees even longer-term weekly trendline support at 1.3850/70. Additionally, EUR/USD is closing below 1.4358, which is the 38.2% retracement of the move higher from Nov. 2005 lows at 1.1640 to the recent all-time highs at 1.6038. The close below the 38.2% level ultimately targets a drop to the 61.8% retracement at 1.3319, but the 50% level (1.3838) happens to coincide with weekly trendline support at 1.3850/70, so that level may prove more significant as support.

GBP/USD: Collapsed below the supports I highlighted last week and reached the measured move objective from the 'head and shoulders' pattern at 1.7530 (Friday's low was 1.7538). Cable is below any moving average or retracement you would care to think of. The next downside objective is simply a zone of support between 1.7200/80. This area is marked by trendline support of lows from late 2005/early 2006 and a symmetrical decline equivalent to the drop from 1.9750 to 1.8520, which would target 1.7280. The 1.7850/7900 area is key trendline resistance that offers potential selling levels.

AUD/USD: Succumbed below 0.8500 and exceeded my projections to 0.8280 and nearly reached the next target at 0.8000 (Friday's low was about 0.8030). Perhaps significantly, AUD/USD is closing above the 200-week moving average at 0.8090. Also, Fibonacci support comes in at 0.8103 (61.8% retracement of the rise from March 2006 low of 0.7016 to the recent all-time high at 0.9861), making this area the trigger to a likely decline below 0.8000. Weakness below these levels likely signals further declines to the spike low of August 2007 around 0.7680 next. Key trendline resistance in the 0.8300/30 area offers potential selling opportunities.

Expect some Kiwi volatility with RBNZ on deck:

Before I get to the RBNZ outlook, beware that RBA Governor Stevens is set to give his semi-annual economic testimony on Sunday evening at 23:00 GMT and his comments could have significant spillover impact on Kiwi. Now, the Reserve Bank of New Zealand is due to announce next Wednesday at 21:00 GMT and the market expectation is that the bank will reduce the benchmark interest rate by -25bp to the 7.75% level. We agree with the market outlook but would also note the risk that the bank decides to cut a more aggressive -50bp in an attempt to nip the economic slowdown in the bud. Retail sales have slowed to an annual rate of just 2.4% in 2Q 08 after running at 6.5% last year.

Meanwhile, the housing market remains in the dumps and this is weighing heavily on consumer confidence. The Westpac Banking consumer confidence index plunged to 81.7 in 2Q from 96.5, to the lowest level since September 1991. Inflation does remain high at 4.0%, though this still leaves the real benchmark interest rate well in positive terrain and gives the RBNZ a great deal of room to take rates lower at a relatively quick pace. One way or the other, we expect some good price action in Kiwi to result.

Technically Kiwi looks poised for further downside. Indeed NZD/USD looks to have formed a classic hourly bear flag pattern. The 0.6880/0.6580 flagpole suggests a 300 pip measured move objective on a break below channel support (currently ~0.6630), with weakness towards the 0.6350/30 area. That said the pair looks likely to find support at the 0.6530/20 area initially, which is around the daily close back in late September 2006, right before Kiwi's long-term move higher. We would expect this area will be firmly in play if the RBNZ surprises the market with a -50bp cut. The risk to the upside would come from a -25bp cut coupled with a relatively hawkish statement which focuses on inflation risks and tones down the risks to economic growth. Though unlikely, this scenario should see NZD/USD make a try for 0.6750 initially, with further upside to 0.6800 next. Stay tuned!

Hurricanes and 9/11 anniversary may roil markets:

Besides the usual key economic data reports next week, the market is also likely to be keenly focused on the hurricane activity in the Atlantic. While Hanna is set to dissipate over the weekend, Ike still looms as a present danger. Projections are that Ike will end up anywhere from the east coast of Florida to the Gulf by Wednesday morning. The forecast is that by then the hurricane will still be a very potent category 3 storm with roughly 115 mph winds. The key for oil prices will be whether the storm does indeed make a move towards the Gulf where it has the potential to impact oil production facilities. If such a risk becomes highly probable, this should send oil prices rocketing higher towards $111.50 initially and $117.00 on the follow. Should Ike avoid the Gulf, look for oil prices to breathe another sigh of relief and test lower.

The anniversary of the September 11, 2001 terrorist attacks could also add some extra volatility to markets as terrorist organizations in the past have used this day to release threatening statements. While statements of the sort would eventually be shrugged off, the potential still exists that such an event could create some extra market uncertainty.

Key data and events to watch next week:

The US data calendar is pretty heavy next week with pending home sales and wholesale inventories kicking things off on Tuesday. Thursday has the usual initial jobless claims along with the trade balance and import prices due up. Friday is a big top-tier data day with producer prices and retail sales the highlights. Also released will be the University of Michigan consumer sentiment index and business inventories. Fed speakers next week include Fisher on Monday, Bernanke on Tuesday, and Kohn on Thursday.

The Euro-zone will see only a handful of data reports but has a busy week lined up nonetheless. The German trade balance starts off the action on Tuesday. Wednesday has French industrial production and French trade on deck. Thursday sees German wholesale prices and French nonfarm payrolls while Friday has French business sentiment, French CPI and Euro-zone employment. ECB speakers abound next week with Stark on Monday, Weber and Mersch on Wednesday, and Trichet on both Thursday and Friday. The European Commission is set to release economic growth forecasts on Wednesday and it looks like they will be reducing expectations on this front. Lastly, Euro-zone Finance Ministers are due to meet on Friday. Expect this group to highlight economic growth risks more than upside risks to inflation.

Japan has a relatively light week coming up. The Eco Watchers consumer sentiment survey kicks off the week on Monday. Tuesday is busier with machine tool orders, domestic corporate goods prices, current account and trade balance all due. The leading index is scheduled for Wednesday while Thursday has the 2Q final GDP read. Friday rounds out the week with industrial production data.

The UK calendar sees modest action as well. Monday starts with producer prices and the BRC retail sales monitor. Tuesday has industrial production while Wednesday has trade balance data. The Bank of England releases the quarterly inflation attitudes survey on Friday. Finally, Friday also has several Bank of England MPC members due to testify before Parliament and they are likely to be grilled.

Canada's calendar is characteristically light with building permits starting things off on Monday. Housing starts are on tap for Tuesday and productivity data is due on Wednesday. Thursday rounds out the data week with international trade and new home prices. Finance Minister Flaherty is due to speak on Wednesday as well.

The data calendar down under has a plethora of data coming up. Sunday starts things off with RBA Governor Stevens giving the semiannual economic testimony and New Zealand home price data. Tuesday follows things up with Australian business confidence and New Zealand trade. On Wednesday we have Australian consumer confidence and the RBNZ rate decision. Thursday rounds out the week with Australian employment, New Zealand business PMI and New Zealand retail sales.

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