EUR/USD: The latest break and daily close above 1.3325 ends a recent bout of multi-session consolidation and now opens the door for the next upside extension towards the 1.3600-1.3700 area over the coming days. While our broader outlook remains aggressively bearish with a downside target by 1.2000 in 2012, the 2012 correction within the broader downtrend off of the 2008 record highs is still in play, and shows potential for additional gains. Still, we prefer to remain sidelined as our bearish bias has us looking for opportunities to sell rather than attempting to buy into a corrective rally within a broader downtrend. We would also not rule out the possibility for a topside failure ahead of 1.3600-1.3700, but given the latest break, the risk for additional gains seems like a very real possibility that needs to be considered and anticipated. Back under 1.3350 will be required at a minimum to alleviate immediate topside pressures.

--- Written by Joel Kruger, Technical Currency Strategist

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• Dollar Stumbles as S&P 500 Notches 3 Year High, Euro Awaits Stimulus
• Euro Absorbs IMF Refusal to Up Bailout Contribution, Greek Selective Default
• Japanese Yen Suffers its Biggest Hit in a Month – Trend Changer?
• British Pound Traders Speculate on Further BoE QE and UK Bank LTRO Participation
• Australian Dollar Ignores Gillard’s Win to Retain the Reins on the Country
• Swiss Franc: Will SNB’s Jordan Update Monetary Policy at His Upcoming Speech?
• Gold Tests 1,760 Floor as European Stimulus, Questions of Risk Trends in Focus

Dollar Stumbles as S&P 500 Notches 3 Year High, Euro Awaits Stimulus

While we haven’t broken to fresh two-week lows just yet, the US dollar is struggling to keep its head above water; and risk trends are applying pressure on the safe haven. The S&P 500 put in for another bullish performance Monday (albeit one that forged little progress on a close-over-close basis), which ushered the benchmark for risk appetite to a three-and-a-half year high close. The drive behind risk taking is tame, and therefore so too is dollar selling. Nevertheless, it is too consistent to ignore. And, with the trend in place, all that is needed is another catalyst to shake hesitance and generate momentum. What would clear the air this week? The ECB’s second long-term refinancing operation (LTRO).

Euro Absorbs IMF Refusal to Up Bailout Contribution, Greek Selective Default

The euro was dealt two discouraging updates Monday, and yet it managed to hold back the selling tide. Most influential for the troubled currency was the news over the weekend that the IMF was refusing to boost its contribution to the Greek bailout effort to match the European Union’s recent second bailout package. This wasn’t exactly a surprise, but it was said by a few Euro-area players that a matching move by the global fund would be key to the process (they will surely back off of any such claims now). Further trouble for the Greek problem was Standard & Poor’s downgrade of the country to Selective Default (SD). Despite what it sounds like, this is not actually the kind of default that would call an abrupt end to the rescue effort. The bond swap can boost the rating - though the S&P says only to CCC. And, that is when we start to discuss majority private sector investment (PSI) participation and forced restructuring through collective action clauses (CAC). Regardless of what temporary stays are put into place, uncertainty seems the order of the day. So why is the euro climbing? That is the stimulus (LTRO) effect.

Japanese Yen Suffers its Biggest Hit in a Month – Trend Changer?

Having rallied 10 of the previous 14 trading days and covering 7.4 percent over that time frame, the USDJPY’s correction Monday didn’t come as much of a shock. A correction after such a remarkable run is only natural. What really matters is what happens when the pullback runs its course. At that point, the market will need to decide whether it was simply an opportunity to take profit - and thereby temporary - or a genuine change in trend. A quick analysis says the trend of daily lows is still pushing higher and the benchmarks for risk appetite (S&P 500) are hovering just off their highs. If we wanted to, we could dig up a wealth of ‘reasoning’ to justify a quick return to yen dumping; but actual selling depends on concern that anti-carry or safe haven holdings need to be reversed. As long as volatility is high for the yen, this balance of risk will be tilted.

British Pound Traders Speculate on Further BoE QE and UK Bank LTRO Participation

We often talk about the fundamental and financial connections between the Euro-area and the UK. It is a general relationship that can be followed without much reference, but we should not a few particular links in this vein that will help prepare us for possibly large moves a little later down the line. The more immediate threat is in the upcoming ECB refinancing operation. While we it may seem that the European Central Bank would only open up the flood gate for Euro Zone financial firms, British banks are able to tap the fund for euros as well. In the first go around, there was supposedly little demand from UK players; but there is expectations of a larger take this go around. And not to distract ourselves with just the immediate future, we were given guidance by BoE member Fisher that the next decision on bond purchases would likely be made in May. The decision to hold at £325 billion or increase will very likely hinge on the Euro Zone’s spill over troubles by then.

Australian Dollar Ignores Gillard’s Win to Retain the Reins on the Country

Through the opening trading day of the week, the Australian dollar advanced against all its liquid counterparts – that is except for the Japanese yen. The slide from AUDJPY is particularly unusual given the general risk-positive consensus that the markets followed Monday. Nevertheless, risk appetite trends climbed through the London and New York trading sessions, and the high-yield currency benefited for it. Looking beyond the simple correlation between currency and risk trend, however, it is further interesting to note that the Aussie dollar would also post notable gains against fellow carry currencies in the kiwi and loonie. Offer an edge is the greater yield as well as a 12 month rate forecast that is at a seven month high (recovering to an outlook for a 50bp cut). Where does Gillard’s win come in? For FX traders, it is last-page news.

Swiss Franc: Will SNB’s Jordan Update Monetary Policy at His Upcoming Speech?

If you were to plot an intraday chart of USDCHF and overlaid it with USDEUR (EURUSD inversed) price action, you’d see an incredible correlation between the two. The same would be true between AUDCHF and AUDEUR along with nearly any combination of Euro and Franc-based pairs that switch out for a common third component. This shouldn’t exactly surprise us given EURCHF’s anchor to 1.20, but it still helps us to reset our expectations when analyzing any Swissie pair. When there is nothing actively driving the traditional safe-haven currency, it simply follows its more liquid counterpart. Though while we keep one eye on stimulus speculation surrounding the upcoming Euro-area banking system injection, we should also take in what acting SNB President Jordan says in his upcoming speech on the economy. Any stray into monetary policy suggestions (buying euros before 1.20, introducing capital controls, etc) and the franc could start moving on its own.

Gold Tests 1,760 Floor as European Stimulus, Questions of Risk Trends in Focus

Bullish ambitions for gold continue to moderate despite the renewed concerns for a clean Greek solution and clear pressure on the US dollar. That said, bulls don’t seem to be giving back much ground as the previous range high for December and early February at 1,760 held the line. News over the weekend that the IMF wouldn’t boost their contribution to the Greek bailout is clearly a destabilizing threat for an already fragile situation (which subsequently represents a clear boon for the metal’s safe haven appeal). Yet, the medium-term sustainability of the Euro Zone’s most rooted financial problem didn’t seem to spark much of a flight to safety. Such stubborn buoyancy from the euro comes on account of expectations of the mid-week LTRO. That said, in injection of stimulus diminishes the general appeal of government backed assets (currency, government bonds) and thereby leads right back to gold. Therefore, we may just be biding our time until the next bullish catalyst.

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ECONOMIC DATA

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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

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• End of month flows could influence trade
• Euro risks still tilted to upside with focus on establishment above 1.3500
• Yen stabilized after bout of intense selling
• Global equities remain very well supported but still see risks for pullback
• ECB LTRO on Wednesday remains in focus

We are in the final days of February and markets always have an added tendency of additional volatility on the end of month flow-related activity. This aside, the Euro remains very well supported on dips and continues to focus on the establishment above next key barriers by 1.3500. While we retain a broader bearish bias in EUR/USD, we still see risks for additional gains into the 1.3600-1.3700 area before the market finally relents.

Elsewhere, the Yen has found some renewed bids, albeit most of these bids are probably related to profit taking on short positions, with Monday’s Yen rally seen as a necessary development given how well offered the currency had been, trading to multi-month lows against the buck. Still, we continue to see the risks for the Yen tilted to the downside from here, with every indication that the currency is carving out a major top against many of the major currencies.

Moving on, the ability for global equities and risk sentiment to remain so well supported has us frustrated at the moment, as technical signs continue to warn of a near-term pullback which should be rather sizable. Inability for equities to roll over to this point has once again helped to put the bid back into the higher yielding, risk correlated commodity currencies which managed to outperform on Monday. Also seen supporting the commodity currencies on Monday was news that Singapore’s Wilmar will be taking a 10.1% stake in Australia’s Good man Fielder. But at this point we will not waver from our convictions and will continue to be on the lookout for the expected bearish shift in global sentiment.

Simmering geopolitical tensions between Israel and Iran represent a risk to market sentiment and stand to impact oil prices. Additionally, IMF Lagarde has been on the wires warning that the global economy is “still not out of the danger zone,” and these comments could invite more uncertainty to the marketplace on Tuesday. Looking ahead, Wednesday’s ECB LTRO remains in focus and the results will surely have an impact on directional movement in the markets.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: The latest break and daily close above 1.3325 ends a recent bout of multi-session consolidation and now opens the door for the next upside extension towards the 1.3600-1.3700 area over the coming days. While our broader outlook remains aggressively bearish with a downside target by 1.2000 in 2012, the 2012 correction within the broader downtrend off of the 2008 record highs is still in play, and shows potential for additional gains. Still, we prefer to remain sidelined as our bearish bias has us looking for opportunities to sell rather than attempting to buy into a corrective rally within a broader downtrend. We would also not rule out the possibility for a topside failure ahead of 1.3600-1.3700, but given the latest break, the risk for additional gains seems like a very real possibility that needs to be considered and anticipated. Back under 1.3350 will be required at a minimum to alleviate immediate topside pressures.

USD/JPY:The market is doing a good job of showing the potential for the formation of a major cyclical bottom after taking out the 200-Day SMA and now clearing psychological barriers by 80.00 for the first time in 6 months. This further solidifies basing prospects and we could be in the process of seeing a major bullish structural shift that exposes a move towards 85.00-90.00 over the coming months. At this point, only back under 77.00 would delay outlook and give reason for concern. However, in the interim, it is worth noting that gains beyond 80.00 over the coming sessions could prove short-lived with technical studies rolling from their most overbought levels in over 10 years and warning of some additional corrective declines towards previous resistance now turned support by 78.00 before bullish continuation.

GBP/USD: Overall, the market remains locked in a choppy consolidation with setbacks more or less supported by the 100-Day SMA and rallies well capped towards the 200-Day SMA. The market has been bid in recent sessions to open a test of the 200-Day SMA, but a break and close above the longer-term SMA will be required to force a directional shift in the structure. Best to stand aside now and wait for a clearer signal while the market chops around.

USD/CHF: The market remains under some intense pressure since topping out by 0.9600 back in late December/early January, and risks from here are for deeper setbacks over the coming sessions, potentially towards the 200-Day SMA by 0.8800 before eventually stalling out. However, our broader outlook remains bullish and we will be on the lookout for the formation of the next medium-term higher low ahead of a fresh upside extension back through 0.9600 and above parity. Ultimately, only a break back below 0.8550 would compromise outlook and give reason for pause.

--- Written by Joel Kruger, Technical Currency Strategist

. Follow me on Twitter @JoelKruger

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Major Currencies vs. US Dollar (% change)

20 Feb 12 – 24 Feb 12

Talking Points

• Euro at Risk as LTRO Feeds Dilution Bets, Greece Struggles with Bailout Terms
• Japanese Yen Selling to Resume if Bernanke Testimony Unravels QE3 Outlook
• British Pound Vulnerable vs. Dollar if US Yields Jump on Shift in Fed Posture
• Comm Dollars Aiming Higher as Risk Appetite Improves on LTRO, US Growth

A week packed with fundamental event risk begins with the second 3-year ECB long-term refinancing operation (LTRO). Banks will begin to tap the facility on Tuesday and the results are set to be unveiled on Wednesday. Median forecasts call for a take-up of €470 billion this time around after a €489 billion outing in December. Taken together, this would amount to a firewall of close to €1 trillion containing the market-wide impact of a sovereign default within the Eurozone. In fact, taking OECD data as a basis, it would be close to enough to offset the hit from losses incurred by defaults in Greece, Spain and Portugal to banks’ balance sheets such as to prevent a significant retrenchment in lending or an asset selloff.

While markets are far from perfectly rational – meaning some reflexive risk aversion is likely if either of the aforementioned countries actually goes into outright default – it also hints an uptake broadly in line with expectations will prompt a significant downgrade the threat of a Eurozone-driven credit crunch in the eyes of investors. Needles to say, this is net-positive for global economic growth expectations. As such, it is likely to boost the sentiment-linked Australian, Canadian and New Zealand Dollars. The impact on the Euro itself may prove more nuanced. A significant correlation with the benchmark 2-year German bond yield hints that while a larger uptake may be good for risky assets, the single currency may see it play out as a significant dilution of the money supply that produces selling pressure.

From here, the spotlight shifts to the US where the Federal Reserve will deliver its Beige Book survey of regional economic conditions while central bank chairman Ben Bernanke gives his semi-annual testimony to Congress. If Mr Bernanke appears to soften his dovish rhetoric in line with we heard from other policymakers last week against a backdrop of firmer regional growth cues and otherwise stronger data, QE3 bets will probably take a significant hit. This will pressure Treasury bond yields higher and in turn seems likely to weigh on the Japanese Yen (see chart below). It remains to be seen how risk trends respond to a reduced probability for further Fed easing.

Given a likely parallel downgrade in Eurozone-driven credit crisis risk however, we suspect it is likely to prove supportive at least in the near term as traders see the accelerating US economy as an offsetting force to the oncoming growth contraction in the currency bloc. Expectations for another broadly positive set of US data releases – most significantly the ISM Manufacturing gauge – stand to reinforce this dynamic. Needless to say, this too bodes well for commodity currencies. Meanwhile, such a scenario may weigh on the British Pound, where the focus is also returning to yields. Homegrown catalysts are fairly limited, with a relatively flat February Manufacturing PMI expected to be the only data point of note. This means UK yields will likely remain relatively steady while those in the US are pressured higher, which stands to weigh on GBPUSD.

The EU leaders’ summit closes out the week. The focus here will be on the mechanics of implementing the second Greek bailout agreement. Athens has a long checklist of requirements to complete before the sit-down, and it is not at all clear that it will deliver. EU policymakers have allowed Greece to miss ample deadlines before, the downgrade in credit market risk posed by a disorderly default there following two LTRO operations means their tolerance is far thinner than before. This opens the door for a testy outing that may reflexively spook markets and weigh on the spectrum of major currencies to the benefit of the greenback (and potentially the Yen) if the release of the first tranche of the second bailout is delayed.

EURO

Source: Bloomberg

BRITISH POUND

Source: Bloomberg

JAPANESE YEN

Source: Bloomberg

CANADIAN DOLLAR

Source: Bloomberg

AUSTRALIAN DOLLAR

Source: Bloomberg

NEW ZEALAND DOLLAR

Source: Bloomberg

--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

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