Weekly Review and Outlook

Forex Markets in an Highly Uncertain State after a Violent Week

The forex markets are in a highly uncertain state after all the violent moves seen last week. Dollar is weak without a doubt when you saw the dollar index dropping more than 7% from 83.64 to intra week low of 77.69 after Fed cut the federal fund rates more than expected to a target range of 0-0.25% and formally entered into quantitative easing. But is it that weak? We doubt so as GBP/USD, AUD/USD, USD/CAD are still kept in range while the USD/JPY was just mildly lower.

The weakness of dollar was mainly manifested in strength in Euro and Swiss Franc which saw both currencies surging across the board. Euro was boosted by ECB's comments that suggested it will pause the rate cut cycle in Jan to wait-and-see the effect of prior rate cuts first. EUR/GBP accelerated to a record high of 0.9554. EUR/CAD took out key resistance at 1.7 and reached as high as 1.7499 while EUR/AUD is also back pressing 2.1126 high. EUR/JPY did rebounded strongly and breached 131 level briefly. But is the common currency really that strong? Yes against Sterling and commodity currencies, but in doubt against dollar, yen and swissy.

Euro gave back much gains after ECB announced to widen the so called rate corridor and that's viewed as intended to discourage banks from parking money with the ECB. After all, EUR/JPY is still bounded in range of 113.63 and 131.03 and there is no change to the view that it's merely in consolidation. More importantly, such consolidation could have ended at 131.03. EUR/CHF, only other hand, as mentioned during the week, reversed after hitting an important resistance level and could have peaked at 1.5880. EUR/USD's rally, though strong, was still limited by 1.4867 structural resistance.

What about the yen? Markets had little reaction to BoJ's rate cut to 0.1%. Despite all the intervention talk, the Japanese currency was just mixed. GBP/JPY even managed to take out prior low of 133.09 during the week while USD/JPY's rebound clearly lacked momentum. EUR/JPY retreated sharply after hitting 131.03 on initial strength.

After all, the markets are in a highly uncertain state and here are some points to note for the rest of the year and probably in early Jan too to clear out the messy picture.

1. Dollar index's sharp decline from 88.46 was supported by mentioned 61.8% retracement of 71.31 to 88.46 at 77.86, inside key support zone of 75.88 and 80.38. Based on the fact that most dollar pairs are still viewed as in consolidation, we favor the case that such fall is merely a correction in the larger up trend only. To solidify this case, we'd like to see the dollar index breaks 83.11 cluster resistance (50% retracement of 88.46 to 77.69 at 83.07) without making a new low below 77.69. That will significantly increase the odds that fall from 88.46 to 77.69 is in corrective 3 wave structure and thus, retain the long term bullish scenario. Ideally, the break of 83.11 should be accompanied by at least a retest of 1.4466 in GBP/USD, 1.3015 in USD/CAD and 0.6008 in AUD/USD.

2. However, failure below 83.11, followed by a break of 77.69 will argue that fall from 88.46 is impulsive in nature. If accompanied by a break of 1.4867 in EUR/USD, that will suggest that the greenback's trend has totally reversed and it's indeed developing another long term down trend.

3. So far, we're still favoring the case that EUR/USD's rise is merely a corrective rebound. A break of 1.3629 support will add much credence to this case. Meanwhile, attention will also be paid to 118.07 in EUR/JPY as well as 1.5163 in EUR/CHF and break of which will add much doubts to Euro's general strength.

4. Again 118.07 in EUR/JPY will be an important level for yen traders. Break of which will significantly increase the chance then yen in staging another round of massive rally.

5. 1.5163 in EUR/CHF will also be important in a way that even if Euro could maintain strength in generally, break of this support will argue that the focus is indeed shifting from Euro to the Swissy.

Currency Heat Map Weekly View

Suggested Readings:

• This Week's Market Outlook
• Weekly Foreign Exchange Insights
• FX Briefing: Dollar Collapse at the End of the Year
• Forex Follies
• Dollar May Be Relegated to Ranges Amidst Holiday Trading
• Weekly Economic and Financial Commentary
• The Weekly Bottom Line
• Financial Markets Review: Sterling Approaches Parity vs the Euro

Fed

• Reaction to Federal Reserve's Radical Medicine
• Fed Fights to Weaken Dollar
• USA: Fed Pulls All the Plugs
• FOMC Officially Announces Policy of Quantitative Easing
• FOMC December Meeting: To Boldly Go...
• Fed Embraces Quantitative Easing: Lessons from Japan and Implications for the Dollar
• U.S.: The FOMC Cuts to Zero and Changes Gears
• Fed Cuts Funds Rates; Sets Target Range of Zero to ¼%
• Fed Sets Policy In A Range Between 0.00% And 0.25%
• Zero-Bound Fed Breaks Dollar
• Fed Cuts Interest Rates to 0.25% and Formally Enters QE
• Comparative Analysis of Current vs. Oct 29 FOMC Statements
• Fed Cuts Rates by 75bps to a New Record Low
• FOMC Cuts Key Interest Rate by 75 Basis Points to 0.25% (Update)
• (FED) FOMC Statement December 16, 2008

BoJ

• Bank of Japan Announces Several Steps to Ease Credit Conditions
• Japan: BoJ Cuts Leading Rate by 20bp and Turns to Quantitative Easing "Light"
• Returning To ZIRP, BoJ Slashed Policy Rate To 0.1%.
• BoJ Cuts More Than Expected, Increases Outrights
• Bank of Japan Buckled Under Pressure to Bring Rates to 0.10%, Economist Says
• Bank of Japan Cuts Rates to 0.10%, Will Buy JGB's and Commercial Paper

The Week Ahead

Volatility will likely continue to increase in the holiday shortened week as liquidity decreases further. Initial focus will be on markets' reaction to Bush administration's $17.4b emergency lending to automakers. Economic data to watch include US Q3 GDP finalized, new home sales and existing home sales, consumer confidence, Nov personal spending and income, durables, Germany Gfk consumer sentiments, import price index, UK Q3 GDP. Japan BoJ report, trade balance, CSPIF, housing starts, CPI, unemployment rate, retail sales, New Zealand Q3 GDP, Canadian Oct GDP.

Suggested Readings

• Economic Calendar Summary 12/21 - 12/26
• US Dollar, Japanese Yen to See Slight Event Risk, Low Volumes This Week
• US Economic Indicators Preview
• EMU Economic Indicators Preview
• Next Week
• Weekly Focus: All the Best for 2009
• The Week Ahead Canada & U.S.: Look for Thin Trading Over Christmas Holidays
• Week Ahead UK & Europe: German GfK Consumer Confidence
• The Week Ahead Japan and Australia: Japanese CPI, Retail Trade

EUR/USD Weekly Outlook

EUR/USD's rise from 1.2549 accelerated to as high as 1.4719 last week, meeting mentioned 61.8% retracement of 1.6038 to 1.2329 at 1.4621 but retreated sharply since then. From a short term angle, a top should be in place at 1.4719. Initial bias will remain on the downside this week as long as 1.4306 minor resistance holds. Further fall should be seen to 4 hours 55 EMA (now at 1.3682). Below 1.3629 cluster support will turn short term outlook bearish for decline towards 1.2329 low. On the upside, above 1.4306 will indicate that fall from 1.4719 has completed and flip intraday bias back to the upside for 1.4719 and above.

In the bigger picture, a medium term bottom no doubt in place at 1.2329 and fall from 1.6038 should have completed. Such decline could either be viewed as being a three wave sequence that's completed at 1.2329 or a five wave sequence that's completed at an orthodox low at 1.2423. In either case, as long as 1.4867 resistance holds, such fall from 1.6038 is still in favor to resume. Though, some larger scale consolidation could be seen first. However, above 1.4867 will dampen the bearish view and argue that stronger rally would be seen to retest 1.6038 record high.

In the long term picture, outlook is rather unclear for the moment. While 1.6038 is no doubt an important long term top, there is no clear answer on whether subsequent price actions from 1.6038 are unfolding as sideway consolidation, deep correction, or a reversal in trend. Nevertheless, note that another fall is still in favor as long as 1.4867 resistance holds and in such case, EUR/USD should at least have a test of 1.1639 long term support.

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