Markets Twisting In the Wind as Deleveraging Continues

11/17/2008 10:13 am EST

Focus: FOREX

Brian Dolan

Chief Currency Strategist, FOREX.com

Sustained relief in this environment does not seem likely, and rallies will remain selling opportunities over the next several weeks, at the minimum. This weekend's G-20 meeting in Washington is not expected to produce any concrete initiatives (see below), and the risk is that another spasm of despondency (i.e. selling) ensues in the aftermath. Fiscal stimulus packages have been announced in many individual countries, but their implementation is yet to occur, leaving any remedial impact likely months off. The US Congress is set to consider a second fiscal stimulus package as well as a bailout for the US auto industry in the next few weeks. But opposition may be fierce, and a comprehensive stimulus package may be delayed until the new Congress takes office in January, leaving markets and investors to twist in the wind until then.

In FX, the ongoing environment of asset sales (deleveraging) is likely to see the current correlations persist. Those correlations are that the USD and the JPY strengthen when stocks sink and weaken when stocks rise. The JPY crosses will continue to experience heightened volatility, but gains are likely to be capped by over-arching risk aversion, and my preference is to continue to sell them on rallies.

Key Levels to Watch in Stocks and Major FX Pairs

This past week reinforced the close relationship between stocks and currencies, and while the correlation will eventually break down at some point, it does not appear to be anytime soon. In the meantime, forex traders will need to be mindful of stock market technical levels as much as individual currency pair levels. I'll be closely watching the following levels next week:

  • S&P 500: Has likely formed a broad bear flag channel (countertrend consolidation) with the base at 850 and the top at 1015. Prices tested briefly below on Thursday, only to reverse and surge higher, producing a hammer on weekly candlestick charts. This is a potential reversal signal higher, but Friday's price action failed to sustain the gains, indicating uncertainty in relation to Thursday's rebound. Nearby resistance levels to gauge a further recovery are Ichimoku levels at 913 (Tenkan) and 931 (Kijun), and the 21-day moving average at 925. A daily close above may signal a rally up to the range top at 1015. A daily close below 850 signals a new wave lower.
  • EUR/USD: Three consecutive weekly doji candles (open and close are nearly identical) indicate uncertainty is high and that the likely resolution will produce an extreme movement. The 1.2450/70 area is the key support zone to watch, while the 21-day moving average (last at 1.2824) has managed to cap rallies. The Ichimoku Tenkan line at 1.2753 keeps the focus lower. The overall impression on the charts is of a descending triangle, with lower highs and a flat bottom at 1.2470/80, suggesting the downside remains the focus.
  • USD/JPY: Long-legged doji on weekly candles similar to EUR/USD suggest we are in a broad consolidation range and may see a violent resolution. The downside remains the focus while below 98.50 trend line resistance, and the 94.50/95.00 is the key support zone to watch on a daily closing basis. A daily close below 94.50 suggests fresh weakness down to the 92.00/50 area initially.
  • GBP/USD: The downside is clearly in focus while below 1.5000, but a daily close above 1.4800 may prompt a rebound. A daily close below 1.4700 should see a retest of this week's lows near 1.4550, which is just beyond a key Fibonacci extension level at 1.4580. A daily close below there would target a further wave lower to roughly 1.3300.

Low Expectations for the G20 Meeting This Weekend

Expectations that anything momentous will come out of the G20 meeting this weekend are fading fast. President Bush recently gave us an indication of what to expect. He noted that this meeting would be the first of many and that the problems facing the global financial system cannot be addressed in one weekend. So those looking for a silver bullet are likely to be disappointed and will probably have to wait until the Obama administration assumes control before any significant measures are implemented. Thus, talk of a ramp up in financial regulations is likely to go nowhere. While the Europeans favor more government meddling in markets, the US and Canada are likely to push back on this issue vehemently.

The most the market can expect is a pledge by the participating countries to continue to support their own economies via aggressive fiscal stimulus. This would be de facto coordinated support for the global economy as the linkages between countries are stronger than ever. Japan has gone a bit further by pledging $100 billion to the IMF earlier this week in support of a broader global stimulus. There is talk that China might follow suit with a pledge of their own and others might be compelled to do the same.

Equity markets are likely to be content with anything that surpasses already very low expectations. Positive headlines that show support for the global financial system and the real economy will probably elicit a rally in global stock markets. This adds confidence and a fresh piece of good news on the back of a pretty depressing week. For FX, this means higher JPY crosses and strength in other riskier currencies such as EUR and GBP initially. The potential for the return of risk aversion, however, is extremely high as the economic realities sink in and the weekend meeting is shrugged off. Thus, any knee-jerk pop in risk trades on the back of positive G20 headlines should be viewed as a good selling opportunity.

Key Data and Events to Watch Next Week

The US economic calendar is relatively busy next week and kicks off with NY Empire manufacturing and industrial production on Monday. Tuesday sees international capital flows and the NAHB homebuilder confidence index. Consumer prices and housing starts are due up on Wednesday, and initial jobless claims and the Philly Fed round out the week for data on Thursday. There are plenty of Fed speakers on deck as well next week, with Hoenig, Kohn, and Lacker, to name a few. Also look for the minutes of the October FOMC meeting, which are due out on Wednesday.

Europe's calendar is less busy but has some important top-tier data lined up nonetheless. French business sentiment starts off the week on Monday, along with the euro zone trade balance. Thursday has German producer prices. Friday is important, with French consumer prices and euro zone PMI manufacturing and services indexes. Plenty of ECB speakers are scheduled as well, with Weber, Stark, and Steinbrueck the highlights.

Japan has a busier week than usual and kicks off in a big way with GDP and the tertiary industry index on Sunday. Tuesday sees the leading index and nationwide department store sales. Wednesday has the trade balance due up, while Friday sees the all-important BOJ rate decision. Look for the Cabinet Office Monthly Economic Report on Friday as well.

The UK calendar is on the light side. Monday sees Rightmove home prices, and Tuesday has consumer prices lined up. The Bank of England meeting minutes are up on Wednesday, along with the November CBI industrial trends survey. Retail sales close out the week on Thursday. Look for some BOE speakers next week as well, including Besley, Gieve, and Bean.

Canada is also pretty uneventful. International security transactions and leading economic indicators kick off the week on Wednesday. Wholesale sales are on deck Thursday, and Friday sees consumer prices. Look for a speech by the Bank of Canada's Carney on Wednesday of next week as well.

Finally, it is a modest week down under. Australian retail sales kick it off on Monday. Tuesday sees the Australian leading index and New Zealand producer prices. Thursday has RBA foreign exchange transactions, and New Zealand credit card spending closes the week out on Friday.

By Brian Dolan of Forex.com

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