FX Developments…

  • July 7, 2004
  • Dave Floyd

Logic and The FX Market

We all know that conventional wisdom, a.k.a.
logic, does not go very far in the marketplace.  This was illustrated quite
clearly in the FX market yesterday.  You will recall that last Friday the Dollar
took it on the chin as traders reacted to the much weaker job numbers.  In this
case, logic prevailed; there were lots of expectations built into not only the
bond market regarding Fed tightening, but the FX market as well.  The Dollar
finished the session just short of breaking key support at 88.04.

At this point, traders are very anxious to know
if the Dollar is about to commence another down leg; the recent data certainly
suggest that.  However, the reaction to the ISM Number on Monday was
rather interesting.  Within minutes of the release, the Dollar dipped, then shot
up 25 points.  Bad data does not necessarily mean a sell-off is at hand,
especially when you have most traders heavily lopsided short Dollars.

The bigger story here is that markets have
nothing solid to sink their teeth into.  A few weeks ago it was the prospect of
higher rates; the dollar rallied.  Last week the whole Fed tightening was
seriously questioned.  The odds of a rate hike in August are looking slim. 
There is no clear path for the second half of 2004 – the growth outlooks are
doubted,  FED credibility questioned.

Nonetheless, the charts have begun to show some
signs of solid trade set-ups. 

The Euro

While the Euro has been range bound lately,
Friday’s break has set the stage for a re-test of the Wave high from early June
(1.2354).  A break through that level should allow for a move towards 1.2435.

Added to this technical
backdrop is the apparent inability for the US economy to consistently put up
economic data that warrants not only the big sell-off in bonds but also the
solid rise of the Dollar in the last 3-4 months.  Going forward it seems clear
that the US economy is in a position where the economy may well be peaking,
while

inflation pressures continue to mount.  This
will not be good for the Dollar if in fact this scenario plays out.  The market
has priced in far more rate hikes than are likely to occur by years end. 
Without this, the attractiveness of the Dollar will abate.

Additionally, hawkish comments
from select ECB members indicate their concern with rising inflation.  At
present, inflation stands 20% above the ECB’s self-mandated target ceiling.

The data going forward in both
Euro land and the US will fill in the missing pieces as to how each economy
unfolds.  However, when considered from a technical and macro perspective, the
Euro looks increasingly attractive.

Deutsche Bank had this to say
regarding the EUR:  “According to the most recent EUR-Sentiment surveys*,
this group has been a net seller of the single currency for the last fortnight.
Two surveys ago, we noted that they sold near the mid-$1.21’s in the belief that
the euro was at the upper end of a narrow trading range. Our latest deduction is
that they sold even more sometime after the release of Friday’s payroll data,
probably near to $1.23.  As this latest action followed what is widely viewed as
a bad number for the dollar, one can only assume that their motivation for
buying it was also a belief that the euro was at the upper end of a (presumably
wider) trading range. The result of this medium-term range-betting was the
lowest EUR-optimism reading in over a year.”

^next^

The Yen

It appears that despite the
BoJ remaining on the sidelines regarding intervention since March 16th,
the rumors and apparent price action indicates that they are uncomfortable with
the recent appreciation in the Yen.  What is ironic is that speculators have
increased their long positions in the Yen recently:

“Data
from the Commodity Futures Trading Commission’s Commitments of Traders report
show that in the latest week, speculators grew the net long JPY position to
8,416 contracts from 5,495 a week earlier. It was the largest net long position
since the April 12 report.”

 
Source:  Bank of New York

 
Technically, the USD/JPY is beginning to look like a
solid short as key resistance levels remain:

 
–         
109.52, 50 day ema

–         
110.60, 200 day ema

However, with the bear
trend channel breached (109.05) and daily and weekly stochastics turning up, it
would be wise to avoid going short USD/JPY at present. 

This begs the question;
if the technical picture looks solid, why not go long USD/JPY?  The trend is
still clearly down, and while there may be a brief bounce in here, there is far
more upside in the Yen than downside at present.  With the disparity between the
overall health of the Japanese economy versus the US, it is only a matter of
time before the Yen breaches 105.

The Week Ahead

While summer trading conditions
may continue to persist, there are simply too many variables in this market at
present to simply discount range trading.  The soft US data, hawkish comments
from the ECB, June economic data from China due out, and rising oil prices all
have the possibility of stirring up the pot quite a bit going forward.

I invite you to join me
this afternoon for my FX Webcast.  A forum where I discuss developments
in the FX market, current trades and technical analysis.  To sign up for this
free 30-minute presentation,
click
here.

As always, feel free to send me
your comments and questions.


Dave