Forex Market Could See A Return To Risk Aversion As Stocks Fall, US Dollar Rises

The US Dollar moved higher against the Euro and the British Pound while stock markets dropped in Asian trading, replaying the risk aversion dynamic that ruled the markets prior to mid-December. The economic calendar is virtually empty in European hours, with technical considerations likely to guide price action in the near term.

Key Overnight Developments

• US Dollar Rises as Stock Markets Fall, Signaling Possible Return of Risk Aversion
• Euro, British Pound Extend Friday's Loses in Overnight Trading

Critical Levels

The Euro moved lower against the US Dollar to start the trading week, testing past the 1.34 level. The British Pound followed suit, gapping to open below Friday's close and dropping to settle in a narrow range below the 1.51 mark.

Asia Session Highlights

A lack of substantial event risk led forex traders to pick up where they left off on Friday in the overnight session, sending the US Dollar higher against most top currencies (the Japanese Yen being a notable exception). Asian stock exchanges moved lower as markets reacted to Friday's dismal US Non Farm Payrolls report that showed the economy shed 524 thousand jobs in December. The sharp decline in US employment means Americans will not be a stable source of demand for producers worldwide, weighing on earnings and sending shares lower. Falling stocks accompanied by a rising US Dollar and Japanese Yen defined the risk aversion dynamic that ruled the markets prior to mid-December when the correlation inverse correlation between the MSCI World Stock Index and the greenback began to shrink. Seasonally, December tends to see counter-trend moves as most traders leave for the holidays, opening the door for knee-jerk price action in thin liquidity. The link between the US Dollar Index and global stock performance declined from 95.3% to a still-formidable 89.4% in the last month of 2008. If this was corrective, traders may see risk aversion return in the near term.

Euro Session: What to Expect

The economic calendar is virtually empty in European hours, with technical considerations likely to guide price action in the near term. The Euro is testing key support at 1.3409, with a daily close below this level opening the door for a selling opportunity targeting 1.3075, the range top that contained the pair from 10/22/08 - 11/10/08. The British Pound has added 3.61% against the US Dollar to date this month but looks to be running out of steam: GBPUSD traded up to resistance at a downward-sloping trend line connecting major swing highs since late October and put in a bearish Star candlestick and hinting at the possibility of a forming top. Near-term resistance is seen at 1.5096, the 23.6% Fibonacci retracement of the 10/20/08 - 12/31/08 decline. A daily close below this level conservatively targets 1.4650, the double bottom tested in mid-November and early December. A more ambitious target is 1.4350, the most recent major swing low.

DailyFX

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