The 15 Year Swing

Swing traders are probably the most patient breed of Market players. Rather than taking part in a short, medium, or long term trend, they wait with extreme discipline for price to reach a level that previously proved to be a substantial turning point. Commonly referred to as Support and Resistance or Demand and Supply levels, these price levels mark the origin of a past sharp and sustained move in price.Price may drift above or below such levels for hours, days, weeks or months before returning to test them. Once they identify a quality turning point in price, swing traders will wait for the price to re-test that level, using it to define risk and potential reward.

Taking a look at the USDJPY pair, we can see a swing trade that, like a good Single Malt, is 15 years in the making. The Japanese yen has recently reached levels against the USD not seen in more than a decade and a half. On its last visit to this multi-year low, USD turned around and pushed higher against the yen for more than 3 years. This can be clearly observed in following monthly chart:

Zooming in on a 4 hour chart we can see that price is indeed finding some support at this important and broadly watched level:

This current level is an appealing long entry with a clearly defined risk (80.85) and an excellent chance for price to move up at least far enough for us to move a trailing stop comfortably above the entry level (80.12).

Looking Ahead

Last week was a busy one for financial markets in general and FX markets in particular. The dollar staged  another advance across the board and the DXY notched a new high. The euro broke to new lows and the British pound remained under pressure. Yen lost ground across the board as stocks continued to rise alongside yield differentials.

One of the most important and most interesting developments is the rise in Treasury yields, esp. the 10 Yr notes. There are at least two relevant questions to be asked: What is driving the yields? and what are the possible effects. One possible explanation for the yield rise is that the market is pricing in a continued recovery which will, eventually, contribute to rising interest rates. Another possible explanation is that buyers of treasuries are simply bloated. With growing deficits (trade and budget) a huge supply of notes, and concerns over the future of US credit rating, the market may simply be asking for a higher risk premium to hold US debt. In either scenario, the short term expectation is bullish for the dollar.

Greece is expected to issue new bonds this week. The result of this auction will be telling and we will get a better idea as to whether or not the market puts any stock in the recently announce rescue deal for Greece.Either way, we should still expect euro rallies to serve traders as opportunities to reload their shorts rather than a trend reversal. Same goes for the British pound.

Yen was weaker across the board and this is expected to continue as long as we don't get into risk aversion mode. I have been using the S&P 500 as one measure of risk appetite and for the time being, it seems due for a pullback. I know I have been cautious since the middle of March and I also realize the danger in adopting a bearish bias  - the more time passes, the more liable I am to become entrenched in my position, waiting for a correction which may only come much, much later. Having said that, I still maintain my view that a short term pullback in the stock market is immanent and may have already started last week. The market climbed a wall of worry and it will descend a wall of reassurance. This is how the game is played. The S&P COT report also shows large speculators being net short for the first time in month - another red flag. The only positive for stocks at this time are the rising yields in bonds. If bonds loose their luster because the marker is pricing in a sustained recovery, we may witness a major capital reallocation from bonds to higher yielding assets like stocks and commodities.

Traveling today so no charts with this post.

Rising Yields Cement Dollar's New Highs

Positive developments yesterday (Thursday) sent stocks and the USD higher. While stocks gave up their gains during the last hour of trading, the dollar remained strong. The greenback gained against all its major counterparts, including the commodity currencies, aided by rising Treasury yields. Here's a quick recap of yesterday's news:

1. Unemployment numbers came in slightly better than expected.
2. Strong earnings/guidance from Best Buy and Qualcomm.
3. Citi gained on news suggesting the Treasury will unveil a plan to sell its stake in the bank.
4. Bernanke gave the market another fix of its favorite drug - commitment to keeping easy, cheap money flowing.
5. France, Germany find common grounds for Greece assistance package involving the IMF (but euro makes new lows)

Perhaps the most important development is the sharp rise in 10yr Treasuries which soared after a less than stellar demand for the notes during recent auctions. Would be buyers are already bloated with US government debt and concerns over sovereign debt do not make T notes any more appetizing. Add the potential of inflation to the mix and you have a market demanding higher yields. Higher yields on Treasuries may entice new buying which could keep the yields in check. However, if buyers remain reluctant and demand even higher yields, the Fed may be forced to raise rates sooner than later. Any way, this scenario is largely bullish for the dollar but may or may not be bullish for stocks and commodities (for example, premature rate hikes may hinder the recovery and therefore be negative for stocks and commodities. Likewise, rising yields may push mortgage rates up. Couple that with the Fed ending its MBS purchase program and the eventual demise of the home buyers tax credit - and you might have a recipe for double-dip in housing).

 The potential Greece rescue deal continues to expose deep divides within the EU. It's getting pretty clear at this point that the clock is ticking and something must be done to prevent contagion. After all, the EU cannot afford to let Greece go down the path of Lehman Bros. Therefore, it is safe to assume that under pressure, EU leaders will announce a detailed deal within the next 48 hours. Depending on its conditions, the deal may provide a short relief to the euro but any rally is likely to fade quickly. Greek/German spread have actually come down since late January as the euro continued its precipitous decline. So a fix for Greece may not be a cure for the euro. So much of Europe's destiny is riding on perception. There will be buyers for Greek (Italian, Portuguese, Spanish) debt. The question is, at what cost? If risk perception is high, the cost of borrowing will be high - perhaps high enough to actually drive some of these sovereign nations to the brink.

As noted in previous post, 1175 was seen as the next resistance for the S&P and, indeed, the broad market index was unable to sustain this level. It is important to mention that this was more of a "psychological" level rather than a purely technical resistance/supply zone. The S&P finished the day with a very bearish candle formation, suggesting more downside may follow. After a nearly two month wild rally, and a rising VIX we should not be surprised to see a 1%~2% pullback to the 1150-1130 area. Falling stocks should weigh on commodities and commodity currencies and we may continue to see the Aussie and loonie lose more ground to the almighty (for now) dollar. AUDUSD chart indicates downside risk:

Blame it on the Weather

So, it was a really amazing weekend in New York and I was out and about, which explains the absence of my weekly summary/forecast post on Sunday. I have been pretty disciplined about writing my weekend review so I almost forgot how important it was. It is absolutely imperative to review the week that was, study the weekly and monthly charts, take into account recent fundamental developments and anticipate the markets direction based on the charts and calendar of economic events. Then, it is important to take all of that and formulate a working hypothesis for the week - a set of assumptions to frame our trading decisions. Personally for me, it is also important to do all of this on the weekend, when the market is closed and after spending at least 24 hours away from my monitor.

Well, better late than sorry so in lieu of the Sunday review, here's a little mid-week recap - a sort of Tuesday night quarterbacking, if you will. Here we go:

S&P 500 
The S&P finished last week above 1150. This was largely seen as a bullish sign with a Friday confirmation close above a strong resistance level. However, until today (Tuesday) the S&P was not able to close above 1166, the resistance level we've identified days ago. Today's break above 1166 was decisive and happened toward the end of the day. It definitely looked like a good number of stop entries triggered on a break above 1170. At any rate, the next short term support/resistance levels for the S&P are 1175 and 1150. A break below 1150 might accelerate selling pressure with support seen at 1130 and 1115. This means that we are currently just a fraction of a point from another resistance level. A pullback at this point is all but certain. But hey, I could be wrong. The question is, what is the catalyst to push the market up or down. For sure, the Fed's commitment to keep rates low is a major factor. On the other hand, the Fed will end its MBS (mortgage backed securities) purchase program this month. No one knows for sure how it will impact mortgage rates and, in turn, real-estate prices but we already know that uncertainty and risk appetite do not go hand in hand. At any rate, if I set my bearish bias aside and just look at the chart, it looks like S&P is set to drift higher to 1200.

USD Index (DXY)
The strong inverse correlation that dominated the relationship between the USD and the S&P for much of 2009 seems like a distant memory. The relatively strong  US recovery stands in stark contrast to the situation in the EU and the UK. This macro environment allowed US equities to rise to new monthly highs in tandem with the US dollar. One can only imagine that in a risk aversion scenario, the gap between the USD and the euro/GBP would be even greater - arguably, in such environment, the USD will stand to gain not only against the weak euro and GBP but also against the strong loonie, aussie, and Swiss franc.
As previously noted, the euro and GBP make up nearly 70% of the basket of currencies against which the DXY is calculated. This means that most of the recent strength in the DXY is due to weakness in the euro and pound, both of which face lingering issues and may suffer further weakness.

Euro - Greece
Germany's Merkel changed her stance a couple of days ago when she asserted that the IMF may be the only way to extend help to Greece. At the time the news came out, I thought a good chance for some relief to Greece and the euro was on the cards but that was not the case. A new round of political bickering commenced which helped push the euro even lower. The euro declined to new monthly lows against the Aussie and Swiss franc. As I write these lines, EURUSD is flirting with its 1.3450 support. A break below this level will most certainly trigger some stop sell orders waiting to be activated and send the euro even lower.
Only a clear plan for Greece and a cohesive EU stance can save the euro from sliding further. Euro sentiment remains bearish until then.

British Pound
The GBP suffered a massive slide on the backdrop of a weak UK economy coupled with an upcoming elections and accented with dovish BoE comments. At one point the pound even weakened against the euro. New economic data released today didn't help. Technically speaking, the pound looks the most vulnerable for further decline. At this very moment (3/24/09, midnight), GBPUSD seems well on its way to retest recent support at 1.4880 - 1.4800.

Japanese Yen
The yen maintained most of its strength despite the new highs in equities. As previously noted, at least some of the yen's strength should be attributed to repatriation which should abate by the end of the month, leaving the yen (risk appetite permitting) vulnerable.

Commodity Currencies
The loonie and Aussie continued to dominate the scene, with the loonie outpacing its Australian counterpart. The thought her is that the Aussie is vulnerable to further Chinese tightening but the Canadian dollar is less so. In addition, BOC has yet to raise interest rates while the RBA may not be willing to go much higher at this point.

OK - That's all for the time being. To be continued tomorrow....

Beware the Ides of March

 -------------Weekly Summary-----------
1. Greece bailout and FOMC statement to set the tone for the week - hawkish "surprises" will set the stage for stronger dollar and pullback in risk appetite.
2. S&P500 at major resistance level. Break above 1150 expected to be capped at 1166. The more likely scenario, is sideways consolidation or a pullback to key support (1130, 1112).
3. Expect a limited euro rally but capped at 1.3850 or 1.4000.
4. GPB priced in for a worst case scenario - as such, counter-trend bounce should not surprise but capped at 1.5550
5. Japanese hints of intervention and easing concerns over Greece, should keep yen on the decline. Any yen rallies should be limited.
6. Canadian dollar set for another swing at parity with USD.
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 Beware the Ides of March
OK - clearly not the most original headline for a blog post on March 14 but a fitting one nonetheless. As we enter the second half of March, we find the Market in a precarious position and the bulls and the bears at an impasse. This time last year was fortuitous for market participants holding long positions in stocks and high yielding bonds and currencies. After a seven month free-fall, the downside risk was limited, if only by the end-of-the-world sentiment that was baked into cake. When perception changed and market participants realized the end of the world was not quite ready to manifest itself, a dramatic rally in "risky" assets ensued fueled further by massive, unprecedented amounts of cheap money pumped into the global economy.

But after twelve months of remarkable gains, the stock market rally is more mature and its momentum has waned due to lingering concerns over sovereign debt, commercial RE, tentative consumer demand, the eventuality of monetary tightening and the uncertain consequences of central banks' exit strategies. Clearly, this year the risk is more to the downside or, at least some sideways consolidation. Even a breakout above 1150 is no guarantee for extended rally. In fact, strong resistance zones loom just above the 1150 level. And 1225 is a major resistance zone marking a confluence of technical analysis elements (resistance lines, 68.8% Fibonacci retracement level, major moving averages). The combination of technical resistance and questionable fundamentals will no doubt keep risk appetite at bay.

Whether or not we will see the S&P break decisively above 1150 is impossible to predict. However, it is safe to assume that a major move will not take place prior to the FOMC statement on Tuesday. From the data we have, we can expect a more hawkish remarks that may spook the market. We will find out if others at the Fed adopted Mr. Hoenig's hawkish views.  Actually, we should expect some hawkish "surprise".

Of course, hawkish remarks from the Fed could be interpreted as a sign of strength and a validation of the recovery - but this is the least likely scenario. Over the past months one could have observed on numerous occasions the close link between the risk trade and loose monetary policies. So where does that leave us?

S&P 500 - The Trend is Your Friend (until it ends)
To get a better understanding, we must zoom out and look at the bigger picture. First, let's look at the weekly chart. Despite a slight negative divergence with the RSI, the chart still looks bullish and a break above 1150 is still within reach.

But what if we break above 1150? For that answer, we must look back to September 2008, the last time the S&P held such lofty levels. We can see from the chart below (the image is spliced to fit the screen) that the real supply zone looms at the 1166 level - the origin of a huge move down. 1166 is as critical (if not more) as 1150 and we are only a few points away.

Bottom line, the S&P is still in "the mouth of the dragon" with sideways consolidation and/or limited pullback to key support areas (1130, 1112)being the most likely scenario. Any upward moves are likely to be capped at 1166.

USD - Time to Move
As expected, the DXY pulled back slightly, stopping just shy of our 79.50 target. After 34 days of sideways consolidation, we can expect the dollar to choose a clear direction. The dollar index COT graphs reveal sustained elevated levels of net long positions. This is inline with the sustained extreme net-short positions for the euro and GBP. In recent weeks, we referred to the USD as win-win on the notion that both highly positive or highly negative economic readings could send the dollar higher. In the short term, we can expect the dollar index to pull back on better than expected economic readings which may ease fears in the EU and the UK while worse than expected readings and/or hawkish Fed statement will send the dollar higher against all but the yen. Key support level for the DXY remains at 79.50

Euro - Shelter from the Storm?
FT reported this weekend that a EU bailout for Greece was in the works. Details are still scarce but we should know more by tomorrow (Monday). A bailout for Greece may provide the euro brief reprieve but rallies expected to be shallow and capped at 1.3850-1.4000. Obviously any bailout from Germany will be contingent upon austerity measures which have already stirred massive strikes and demonstrations across Greece. Euro sentiment remains bearish and the high probability trades would be to short the euro against the US dollar at key resistance levels (1.3850, 1.4000)

GBP - 
The worst performing major currency seems to be priced for a worst case scenario. As such, it will not be surprising to see the pound staging a little bounce - especially if we get a dovish Fed statement. GBPUSD could be a good long if it comes back to test 1.4880 or on a break above 1.5230. Just like the euro, GBP sentiment is still bearish and rallies are likely to meet renewed selling pressure. 1.5550, 1.5350, and 1.5200 look like decent levels to short GBPUSD

Yen - Deja Vu All Over Again
Last week we noted our expectation for the yen to weaken against the strong aussie and loonie. That scenario played out nicely. Surprisingly, the yen decline vs. the US dollar was a lot milder as USDJPY finished the week only slightly up. Also, we noted surprising net-long positions among the Commercials both in the recent COT report and last week's. This could be reflecting expectations for temporary yen strength due to repatriation or a bet on a risk aversion sentiment. Whatever the case may be, going long yen may be perilous. Japanese officials already made commented on the yen's recent strength. Any hints of intervention may be enough to cause temporary but sharp declines in the yen.

And the Oscar Goes to....the Loonie!
The Canadian dollar finished another impressive week with gains across the board. Similar to the Aussie, the Canadian dollar has enjoyed the surge in commodity prices (namely, gold and oil). But unlike Australia, Canada's interest rates have yet to be tightened. In addition, further Chinese tightening are perceived to pose greater risk to Australia than to Canada. USDCAD broke a major support last week (1.0200) and is well on its way for parity, its next resistance level.
 

A Market Climbs a Wall of Worry

 -----------------Weekly Summary------------------
1. S&P to retest 1150 - expected to consolidated sideways from 1150 or pullback to the 50 day MA.
2. USD - expect a pullback to 79.55-78.62 on easing concerns over Greece and a milder than expected NFP report.
3. Yen - expect to see continued weakness, especially against the Aussie and Canadian dollars.
3. Euro - may see a limited move to the up side but expected to be capped at 1.3850-1.4000
--------------------------------------------------

The S&P 500 finished the week up 34 points (3.1%) after rising six days in a row. Stocks climbed despite widespread concerns over Greece (and other "Club Med" nations), unemployment and dismal housing sales reports (new, existing, pending). But now what? well, we're about to find out.  The S&P has rallied straight into it's January resistance level. A confirmed break above 1150 is needed in order to see the S&P advances to new highs. But a retest of the 1150 level is more likely to end in sideways consolidation or a pullback to the 50 day MA.

DXY - USD Due for a Pullback
We repeatedly stated here that for the dollar, the worst case scenario is a lackluster, slow economic recovery with mild inflation. That is to say, a scenario in which risk levels are contained, but so are rate hike expectations. Last Friday's NFP number, although better than expected, was still negative. It was exactly the kind of "less worse" reading that is negative for the USD - enough to dissipate some fear, but not strong enough to invoke serious thought about interest rate increases.
Technically, the dollars bull run that started late in 2009 seems ready for a pullback. We should expect a pullback to at least 79.55 (10 day EMA) or 78.62 (38.2% retracement). A record number of short positions against the euro and GBP created the perfect set up for a short squeeze in either or both currencies. Any positive news coming out of either the UK, the EU or both, should prove negative for the US dollar, at least in the short term.

 

Japanese Yen

As usual, the biggest loser in a "risk on" environment is the Yen. The Japanese currency has several good fundamental reasons to weaken. You can check out Marc Chandler's blog for more information. If risk appetite prevails, and we see the market continuing to fade bad news, we can expect the yen to continue to weaken, especially against the loonie and Aussie.

Euro - licking the wounds

The Euro may finally get a few days of rest to lick its wounds as tensions over Greece ease a bit. But look at the following headline: 

"Greek crisis deepens as S&P downgrades sovereign debt" 

Sounds familiar, right? But consider this: the story is dated January 14th 2009 - more than one year ago! so what is my point? the point is that sovereign debt issues cannot and will not be resolved over night. It took months for the Greek crisis to peak but it was already well in play by early 2009. We can only assume that Dubai, California, and more relevant to the euro, Spain, Portugal, Italy, and Ireland will continue to dominate the headlines with a fresh supply of debt crises. Sovereign debt problems in the EU have had a more severe affect on the single currency due to the political and financial complexity of the EU. Neither German nor French citizens want to see their tax euros used to bailout Greece - and this is causing extra pressure on Merkel and Sarkozy. However, they cannot leave Greece completely neglected as inaction will undoubtedly increase the risk of contagion. The point is, again, there is no simple solution and euro rallies will be subjected to selling pressure. We should expect to see any upward moves capped at 1.3850-1.4000 level.

Wild Card Friday

The S&P 500 has been trading in a narrow, 10 point range (1116-1125) since Tuesday. For the most part, the stock market has treated both good and bad economic reports with the same indifference. But Friday promises to end the week with a crescendo: US non-farm payroll report. The results of the much anticipated report and its subsequent interpretation are anyone's guess. Wednesday ADP report showed a loss of about 20,000 jobs in February, definitely not a good number but in line with a declining trend of job cuts. The NFP, which is calculated differently than ADP's, is expected to be adversely impacted by February's snow storms.

The S&P's daily chart looks bullish and a retest of January's 1150 high seems closer than ever. Still, signs of risk aversion are apparent, most notably in a stronger yen.

There are 3 possible outcomes for tomorrow's NFP report:
1. Inline with expectations  -should be positive for the stock market but potentially damaging to the US dollar and yen.
2. Better than expected - should, obviously, be positive for the stock market and negative for the yen. A slightly better NFP number could prove negative for the dollar while a much better than expected could lift the dollar higher (recall Dec 4 2008 NFP report).
3. Worse than expected - a slightly worse than expected report is somewhat anticipated and is already factored in. So if the number is only slightly worst than expected, the market might breath a sigh of relief and charge forward. In this case both the yen and the US dollar might pair gains. Having said that, a MUCH worse than expected will surely be negative for the stock market and support stronger US dollar and yen.

Another Friday wild card, with a potential for an upside surprise, is the Papandreou/Merkel meeting. The German Chancellor was quick to point out the meeting was largely symbolic in nature and not intended to discuss a possible bailout for Greece. Still, we should expected them to come out with some reassuring statements regarding the strength of the EU and its resolve to stick together in tough times.

In short, it's almost impossible to predict what will happen tomorrow. One thing for sure, it will not be boring!

What Bad News?

Weekly Summary:
1. S&P - uptrend still intact but under pressure (note recent yen strength, weak economic reports).
2. USD - DXY showing signs of fatigue as it struggles in its current congestion level. Expect further sideways consolidation with chances for a limited down move.
4. Euro and GBP - continue to be under pressure. Even if we get to see some USD and/or yen weakness, euro and GBP gains expected to be limited.
5. In case we get a break to the upside on the S&P, the Aussie and Canadian dollars stand the most to gain, especially against the Japanese yen.

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Despite ending the week five and a half points lower, the S&P, in an act of defiance, faded one piece of bad news after another. And they just kept on coming - consumer confidence, new home sales, core durable goods orders, unemployment claims, existing home sales - all came in worse than expected. And let's not forget Greece! Yet despite the barrage of negative economic readings and contrary to reason, the S&P managed to erase most of its losses for the week. The S&P's tight range indicates a market searching for direction while evidence of buying pressure indicates the higher probability direction is still up. Market veterans are often quoted saying that when the market is going up for no apparent reason, don't try to fight it. It's the "don't-catch-a-falling-knife" logic - only in reverse.

What's Wrong With This Picture?
I think the image below captures the market's lack of direction perfectly. Look at the head line - future fall as investors remain cautious about consumer led recovery. Yet right underneath we see that Target's profit rises 53.7%, Sears' profit more than doubles, and Home Depot beats estimates. Not too shabby.

Yen Strength - Still a Red Flag
The Japanese yen has been one of the best fear indicators in recent months. Therefore we must take note of the fact that many yen pairs slid to levels not seen since Feb 5th - the recent S&P low. In fact, Euro/Yen and Pound/Yen made fresh lows. The recent yen strength is indicative of risk aversion but the recent COT report shows that traders commitment for supporting a stronger yen is weakening. If that happens, we can expect to see a strong recovery of AUDJPY and CADJPY and a more modest one for EURJPY and GBPJPY. However if the yen continues to strengthen, we can certainly expect to hear comments from the BoJ about it and hints of interventions will once again resurface, curbing further yen advances.

British Pound - an Untold Story
Hidden in the shadows of the EU, Greece, and the euro, the British pound quietly but surely slid to new lows against its major counterparts. It has even lost ground against the embattled euro. Concerns over the UK's recovery and the possible need for further QE, combined with a looming general election and dovish statements by the BOE have sent the GBP on a downward spiral with no end in sight. As overextended as it may seem, we must not catch this falling knife as most analysts see further loses ahead. We are staying bearish on the pound.

Euro - Greece, the Never Ending Story
Last week we concluded that Greece will reemerge to take center stage after falling off the radar for a few short days. As expected, it did. Once again, the mess looks too big to overcome and renewed doubts over the fate of the EU resurfaced in force. We have to stay bearish on the euro at this point. Counter-trend moves are to be expected considering the record short positions but they will be short lived and capped below 1.38

DXY - Uptrend Showing Signs of Fatigue
Weekly chart for the USD reveals an inside bar for the week of Feb 22-26. This could signal further pause for the dollar's rally. Sideways action with limited moves to the downside are to be expected at this point:

New Home Sales Drop to a Record Low But Market Cries "Bull"

Despite a dismal number of new home sales in January, the stock market managed to stage a bounce after a two day decline (with 3 hours until closing bell, this could still change). The rise in stocks is largely attributed to Bernanke's congressional testimony in which he reiterated the need for zero rate policy for an "extended" period. In addition to the gains in stocks, we see the dollar and the yen hold on to most of their recent gains. So what does it all mean?

1. Equities - the market's muted reaction to the new home sales report is very bullish but it must be taken in context, namely, zero rate policy. For sure, cheap money supply has supported the recovery efforts. But it also had the undesirable affect of carry trades. We should not think of carry trade just in the sense of using dollars to buy other currencies. Instead, think of it in a broader sense where cheap US dollars are used to fund any number of riskier assets like stocks, bonds, real-estate, etc. Basically, with a zero  rate policy, one has no incentive to keep one's money in the form of (depreciating) cash. The stock market is showing clear signs of severe addiction to zero interest rates. We are sure to experience some sobering days in the future when the economy checks into rehab.
2. Strong dollar - How is it possible for the dollar and the stock market to rally at the same time? the answer, to a great extent, is the way we measure dollar strength, namely, the dollar index. The dollar index is a weighted index which tracks the dollar's strength against a basket of currencies, of which the euro alone accounts for more than 57% and the combination of euro+pound+yen accounts for more than 80%. This means that it's enough for the dollar to show strength against the euro and British pound in order to send the DXY higher. And there's good reason for the dollar's strength vs. the euro and the pound. While Bernanke is laying out his exit plans, the UK and the EU are knee deep in trouble with no end in sight to loose monetary policy.
3. Strong yen - We are used to seeing  a strong inverse-correlation between yen pairs and equities. When equities rise, yen eases (risk on) and when the stock market falls we normally see the yen rise (risk off). So it is important to note here that while stocks nearly regained their highs for the week, the yen stayed relatively strong, relenting only some of its recent gains. This price action is indicative of a shaky market sentiment.

Filling In the Gap

No, not the price gap - the blog gap!
It's been a while since my last post so it's time to fill in the gap. Luckily the themes we've touched upon in the last several posts have played out nicely over the last couple of weeks. They are: (1) Dollar strength, (2) Euro weakness, (3) Equities weakness. So let's examine each theme in light of recent events. Since so much of the market's action has been determined by the Greek crisis, let's begin with taking a look at Greece and the Euro.

EU - On the Horns of a Dilemma
We've already discussed the issues in Greece so a detailed intro is not needed - but here's a brief recap anyway. Grave concerns over Greece's sovereign debt have been at the center of an unfolding drama as of late 2009. The Greek story has dominated headlines and opened the floodgates of fear that came gushing into the markets. Not long after Greece hit the spotlights, concerns over sovereign debt spread like wildfire to Spain, Portugal, Italy (and let's not forget Ireland), wrecking havoc in the "Club-Med" nations' bond and equities markets.

When Greece first made the headlines in November '09, EU leaders and the ECB chose to distance themselves from the center of attention, as Greek officials struggled to reassure nervous markets that everything was under control and that swift austerity measures could rein in a runaway deficit. However, as hopes for quick fix vanished and fears of contagion arose, it became obvious that EU leaders had to step in. But what to do? Each options seemed worse than the next. Letting the IMF step in was just too humiliating. Not doing anything was just too dangerous. Outright bailout posed a moral hazard and opened the door for more bailouts (Portugal, Spain, Italy). The unique structure of the EU, a monetary union with no fiscal or political unity, made the uncertainty even worse. For the first time, the EU was being put to a test for which the Euro was punished severely as traders piled in record numbers to short the single currency.

OK - so much for the "brief" recap. Fast forward to Thursday, Feb 11. European leaders at an EU summit meeting finally spoke up. During a much awaited press conference EU leaders served the markets a big dose of disappointment saying they stand ready to take coordinated action to protect the stability of the EU if such action was needed. At the same time, they insisted Greece did not need external help at this point.

The lack of clarity and conviction projected by EU leaders weighed heavily on the Euro as it plunged to test its recent lows against the dollar and the yen and made fresh, multi-year, lows against the aussie. After its massive slide following the press conference, the Euro managed a small bounce against the dollar and the yen but remained largely in the bears' hands. And in overnight trading, the Euro slid further against the dollar to break yet another level, this time stopping just shy of 1.3500.

Euro sentiment remains largely bearish. So long as uncertainty concerning the Club-Med nations lingers, the Euro will remain under pressure. With so many piled on the short side, it is likely we see some contrarian move to the upside, a move which may provide a profitable opportunity to re-short the Euro.

USD - Raging Bull
US dollar reversed its multi-week slide late last year and has been on tear since then. The initial strength in the dollar was due to signs of a recovering US economy. Since then, however, the rise in the dollar was strongly associated with flight to safety as fears over Greek debt, China's monetary tightening, and pending US banking regulations contributed to risk aversion among traders and investors. In the land of the blind, the one-eyed man is king. And so it is in the forex markets where the USD was the least worse of a pretty bad bunch.

The USD is approaching another congestion area which may act as a temporary roadblock. In the chart below, you can see the DXY reaching a resistance zone between the blue and red lines:

A major milestone for the US economy and the US dollar went almost unnoticed this week as Chairman Bernanke's testimony got canceled due to a heavy snow storm in the DC area. Bernanke's prepared testimony was released to the media. It outlined the Fed's exit plan for withdrawing the emergency measures it had put in place in the early days of the financial crisis. While repeating the Fed's mantra of "exceptionally low for an extended period" referring to the near zero interest policy, Bernanke's testimony definitely sets the stage for tightening. The question is, how will the market interpret tightening moves when they are finally announced? Depending on many factors, markets are likely to have one of two reactions: 1. interpret tightening as a sign of strength (risk back on) or 2. devastating blow to a fragile economy (risk off). A third and least likely scenario is a mixed reaction somewhere in between. Given a mildly positive parade of economic data and earning reports, option one (interpretation of strength) seems the most likely - but not by much.

S&P - a Long Awaited Correction
Most market participants were caught off guard in March of 09 as a massive rally in equities emerged from the rubble of the financial disaster. By the time it became evident that the rally was real, traders were faced with two options - chase the market or wait for a pullback. Well, for those who opted for the latter, a generous amount of patience was needed. The much anticipated pullback stubbornly refused to arrive - that is, until January 2010, when The S&P 500 climbed back to 1150 and finally met a resistance strong enough to send stocks lower.

Concerns over sovereign debt provided a perfect backdrop the S&P's decline. However, it would seem that other forces were in play, specifically, large market participants booking profits for 2009. A quick look at the charts reveals that 09 market leaders such as financials and materials, actually turned lower before the broad market sell off, suggesting profit taking and sector rotation.

Keeping Things in Perspective
With all the gloom out there, one must keep things in perspective. For example, fourth quarter earning season has been, thus far, quite positive with most companies meeting or beating expectations. Jobs, unemployment, and inventory numbers also continue to show signs of improvement. Greece is unlikely to default on its debt. And China's monetary tightening is a response to a booming economy - not exactly a bad thing! Moreover, companies have reduced bottom line costs and are well positioned to show bigger net income gains as top line   revenue streams return to normal levels. That is not to say everything is rosy. Of course there are lingering concerns (record foreclosures, commercial RE, weaker consumer demand, to name a few) but on the whole, a double-dip recession seems a less likely scenario than a moderate recovery and a range bound equity market.

A quick look at a weekly chart of the S&P 500, shows that the weekly uptrend, while losing momentum, is still intact and that the 1250 (generally accepted) target is still in sight.

Thoughts for the Week Ahead
Subtle disparities in market action on Thursday and Friday, may hold some clues for the week ahead:

1. Euro pummeled as US equities rise - we are used to seeing US equities and the Euro trade in tandem. However, last week saw a rise in US equities and a slumping Euro. 
2. Yen easing against the Canadian and Aussie dollars and, to a lesser extent, against the USD- this is another sign of risk abating to some degree.

Given last week's market action and news coming out Europe, we may begin to see Greece's problems contained within the EU, keeping the Euro depressed. In this scenario, we should continue to see the S&P basing around its recent levels and the yen easing further against the Aussie and Loonie. The US dollar is likely to see some consolidation this week as it hits a new level of resistance. Any further comments from the Fed regarding its exit strategy should help maintain dollar strength, especially vs. the Euro and British pound. 

USD Index Notches a New High

Last week, we covered the USD and concluded it was poised for gains. The Dollar did, in fact, gain against most of its major counterparts and the DXY notched a new high, breaking slightly above its December highs. The DXY is a weighted average and its heaviest component is the Euro. Therefore it should come as no surprise that the previous week was rather rough on the common currency. Greece is still very much in the news and not in a good way, dragging the Euro lower.

Last week's post mentioned that the USD was a win/win situation where either strong economic reports or very poor readings could send the dollar higher on expectations for higher interest rates or a flight to safety respectively. Unfortunately, it was a flight to safety that sent the dollar higher. So long as uncertainly and concerns cloud the economic skies, we are likely to see the USD trend higher. This week, however, the dollar will have to push a little harder to be able to maintain its momentum as it approaches new resistance levels. The first resistance level is right where the dollar made its new high on Thursday around 78.80-79.00. The next level the USD will need to overcome in order to march higher is 79.50. A clear break above the 79.50 level could send the dollar as high as 81.00.

An upward move for the USD this week is likely, though not as likely as it was last week. The higher probability is for some sideways consolidation while uncertainties in the economy clear and earning reports shed more light on the state of affairs.

USD Poised for Gains in the Week Ahead

While the US dollar index (DXY) retraced some of its December gains, it is still noticeably stronger than it was in the beginning of December 2009. Here are some signs we may see the dollar index advance in the coming week:

1. DXY failed twice to close below its 10 Week EMA:

2. Retracement in the DXY has been relatively shallow, finding support around the 38.2% level - suggesting the uptrend may resume from here:

3. USDCAD, USDCHF trade near weekly/daily support levels while AUDUSD is near a major daily resistance level. GBPUSD and EURUSD also look bearish in the short term. All suggesting we may see further strengthening in the US dollar.

4. Fundamental backdrop: last week's key earning reports disappointed. Alcoa's numbers failed to impress and JP Morgan, while profitable, signaled problems in consumer credit delinquencies that sent the broad market lower. The disappointing earnings coupled with concerns over China's attempts to slow down its booming economy provided a convenient argument for traders to shy away from "risky", higher-yielding currencies in favor of US dollar and Yen's relative safety.

As I mentioned several times in the past, there are two favorable scenarios for the dollar: strong, sustained recovery or, quite the opposite, the return of fear into the markets. Somewhere between the two lies the worst case scenario for the dollar - a long, sluggish, jobless recovery and  a stagnant US economy - the perfect conditions for the Fed to maintain low interest rates and loose monetary policies.

When the DXY climbs, Dollar/Yen ratio will usually serve as a good barometer as too which one of the scenarios above is playing out. Expectation for strong US growth will normally send USDJPY higher, while return of fear into the market will cause the dollar to gain strength against most currencies but the Yen, sending the Dollar/Yen pair lower.

New Economic Data Signal Trouble Ahead for USD

The economic data released today for retail sales and unemployment claims both came in worse than expected. I mentioned before that the dollar is a win/win if we see a strong recovery (suggesting rate hikes) or a double-dip recession (back to safety). However, a prolonged, lackluster recovery can spell real trouble for the dollar as the anticipation for rate hikes move further into the future.
It should be noted that some in the Fed are sounding increasingly hawkish. Thomas Hoenig, president of the Kansas City Fed, suggested earlier this week that emergency measures should be expired as scheduled and that the Fed should be focused on the perils of raising rates too late rather than the weak, jobless recovery. Speaking to Bloomberg's Kathleen Hays, Hoenig said that “Monetary policy is about tomorrow. It is hard to keep that in mind when you have 10 percent unemployment.”
One must also bear in mind that markets "choose" how to interpret rate hikes. A small rate hike earlier than expected could be interpreted as a sign of confidence sending the stock market (and possibly dollar)higher.
As for today's disappointing numbers, as of mid day, they seem to have had a negative effect on the dollar but completely ignored by equities as the S&P climbed a couple of points higher, flirting with its major 1150 resistance level.

As One Year Ends, a New Decade Begins

Well, I guess this is kind of a heavy title but we are starting a new year and a new decade and what better way to usher them in than with the my first post for 2010! I avoided posting anything in the last two weeks of 2009 mainly because of holiday mood but also because volume was so thin across the board, leading to spikes and extreme moves which did not contribute to a clear direction in the markets. 

I figured now would be a great time to take a little survey of the major currencies and take our first baseline for the year. Before we look into individual currencies, it is important to note a major theme that emerged in the final weeks of 2009 and set the stage for 2010. The theme I am talking about is relativity. For the better part of 2009, the major currencies traded in tandem vs. the US dollar with a high degree of correlation. When the Euro appreciated against the dollar, so did the British pound, and the Canadian loonie (Yen was the exception to this rule). Gradually, however, as signs of a global recovery became more evident, some currencies emerged much stronger than others, exhibiting their relative strength against others. The competition in the world of currencies shifted from the "best of the worst" to an arena where clear winners emerged - the "best and the rest" if you will. As the GBP and EUR slid against the dollar in December 2009, the Australian and Canadian dollars kept a much firmer stance, quickly recovering most of their loses against the USD. This could be another sign of normalization. As the recovery takes hold, investors focus more on the fundamentals of the different economies and on interest rate expectations, rather then pure risk on/off trades. With that in mind, let's take a look are where the majors stand. First, the US dollar.

USD - Cautiously Bullish in the Short Term

George Soros said it best in early 2009 when he called the dollar the "fever chart" of the economy. And indeed up until December 09 as the economy got less worse, the dollar ("fever") declined. News and economic reading that came in better than expected actually pushed the dollar lower as risk aversion became less pronounced. That was the trend until December 4th, when a non-Farm Payroll report came in much better than expected, sending the dollar on a four-week rally and revealing a shift of focus from risk of a lingering and deep recession to the inevitability of interest rate increases.  

Both Economist and traders differ in their predictions for when the Fed might start hiking rates but all agree it will not happen before the middle of 2010, at the very earliest. One other certainty is that the Fed will be under significant political pressure to keep rates low due to massive unemployment figures. 

The NFP numbers released today, January 08 2010, and the market reaction that followed their release illuminated both the dollar's sensitivity to interest rates factors and the lingering bullish sentiment for the US dollar.

The NFP numbers came in much worse than expected, exactly the opposite surprise we got one month ago. The reading sent both S&P futures and the dollar down sharply but the losses were brief and mostly erased in a very short time as the market faded the news. Another bullish sign for the dollar is its ability to hang on to most of its December gains even as stock markets hit fresh monthly highs. It seems that the dollar is in a win-win situation: good news supporting the case for a rate hike will send the dollar higher and bad news supporting a double-dip recession will send the dollar higher in a flight to safety. Of course, this assumption also suggests that the dollar will slump in a sluggish recovery where neither rate hikes nor a double-dip recession are on the horizon. 

For the time being, the dollar is still showing signs of strength and a daily chart suggests it may be ready to break out of (or completely fail) a bullish flag:

Euro - the Fallen Star

For most of the first decade of the new millennium, the Euro has been on a meteoric rise against the dollar, climbing more than sixty per cent vs the greenback between 2000-2008. Who can forget the public denunciation and humiliation of the dollar as Her Royal Hotness, Gisele, made it loud and clear she was to be paid in Euros. Alas, even the richest Supermodel on the planet could not have foreseen the looming crash ignited by the sub-prime disaster. The global recession wreaked havoc across the Euro Zone and exposing cracks in Gisele's logic. Fighting its very first battle against a major economic storm, the Euro Zone faces unique challenges that set the stage as we enter 2010. The theme for the Euro Zone as we enter the new decade is fragmentation. While one can argue that the EU and the US share many similarities with respect to the Great Recession, it has become more and more evident that fragmentation and disparities in the Euro Zone's economies are a much bigger problem (or at least perceived this way) than they are in the USA. For example, one can argue that California and Michigan are to the US what Greece and Spain are to the EU. But in the market's eyes, this is not the case. The political diversification and distributed nature of the Euro Zone economy pose a much bigger challenge. 
The Euro is starting 2010 after being severely punished late 2009 for the Greek debt downgrade and lingering concerns about the quality and cohesiveness of the European recovery. Grave concerns regarding East European debt remain in the minds of investors. And the ECB will face tough decisions ahead as a strong German recovery warrants interest rate hikes while much worse conditions elsewhere in the Euro Zone will make rate hikes very tricky. At the close of the first trading week of the year, the Euro is near weekly low levels vs the dollar, monthly lows against the Swiss franc, and is at yearly lows against the Aussie dollar. We should expect to see somewhat of a bounce at this long-term demand levels but fundamentally speaking, the Euro is still out of favor until we hear a more hawkish tone from Mr. JC Trichet.  
Key levels to watch for the Euro are the 200 day MA for the EURUSD and a break below the 1.5500 level on the EURAUD.


Yen - 09's Wild Card -2010's laggard  
In 2009 the Japanese Yen proved to be one of the trickiest currencies to trade, defying both technical levels and fundamentals, due in part to swift and stark political changes. As we enter 2010, the Yen is probably one of the weakest of the Majors. The struggling Japanese economy, plagued by deflation, aging population and heavily reliant on exports is certain to keep its downward pressure on the Yen. The recent, surprising, appointment of a new finance minister, much more dovish than his predecessor, paves the way for further Yen weakness. Nowhere is the Yen's weakness more evident than in its relationship to the Aussie and Canadian dollar as the "carry trade" the last decade carries itself into the new decade. We can expect the Yen to trend lower this year, especially against the commodity currencies.


British Pound
The British economy is just about as miserable as any, recovering from a banking crisis, real-estate bubble, a huge deficit, and in the midst of loose monetary and fiscal policies. However, the implications for the British pound are not so clear at this moment and the GBP has been trending higher vs. the Euro and Yen in a "best of the worst" competition. It remains to be seen how soon will the UK start to remove some of the huge liquidity pumped into its economy during the crisis and move toward rate hikes. At this point, the GBP should be traded mostly on technical levels.


Aussie and Canadian dollars - Kings of the Hill
The run-up in commodities from copper to gold to oil catapulted the "commodity" currencies this year against all other currencies. The undisputed champion is, without a doubt, the Aussie dollar. Boasting some of the highest interest rates among the G20 and a major beneficiary of China's insatiable appetite and various stimuli induced projects around the world, the Australian economy dodged the Great Recession practically unscathed. The high yielding currency proves, once again, irresistibly enticing to would be carry traders and the Yen, once again, is the funding vehicle of choice. The Canadian dollar came in a close second. Boosted by high oil and record gold prices, the Canadian currency finished 2009 on a tear. 
Going back to the theme of relativity it is important to note how the US dollar was unable to keep its gains against the Aussie and the Loonie while pushing the GBP and EUR to weekly lows.


From Best of the Worst to Best Vs the Rest

From what we've covered so far, it stands to reason that:
1. Gisele is still hot but Euro, not that much.

2. The best opportunities this year will probably be shorting the Yen and going long Aussie and Loonie.
3. Special attention must be paid to central banks' exit strategies, timing, and market reaction to both.

 

The Beginning of a Beautiful Friendship? Well, Maybe

For the better part of 2009, the US dollar and the S&P 500 were on pretty bad terms - as one went in one direction, the other took off in the complete opposite direction. In other words, a strong inverse correlation dominated the relationship between the two. In April 2009, George Soros succinctly described the dollar as the "fever chart" of the economy. Indeed, as the US economy recovered from near-death experience, the fever chart (i.e. dollar strength) went steadily down. Recently, though, the US dollar has been seen walking hand in hand with the S&P, signaling a break from the inverse correlation and a possible, new, positive correlation.

Market correlations form, and fall apart, as dictated by shifting market dynamics. For example, most of the time the correlation between the USD and the price of commodities is inverse. However, in some situations one can observe a positive correlation between the them. Such was the case earlier this year when the dollar and gold rallied at the same time. It is important to take note when a well established correlation breaks or reverses, as it may signal changing market dynamics.

The dollar and the S&P are like a celebrity couple and their relationship garners lots of interest and speculations. But like a celebrity couple, they like to keep everyone guessing - will they stay together, or not? When trying to answer this question, we must first note the fact that we are in year-end/holiday trading mode which means thin volume across the board and a general reluctance on the side of big money managers to take on sizable positions. Having said that, we must also note that it is perfectly normal for currencies and equities of the same country to march in tandem - commonly a sign of a strong economy heading toward, or in the process of, interest rate hikes.

It may be a stretch to describe the US economy as "strong" but I think most people agree that things are getting better and interest rates can only go up from their current levels. It is quite possible then for forward-looking markets to anticipate another step toward normalization which may explain the dollar's and equities' newly found friendship. Will the new relationship hold? Only time will tell.

Euro, Trashed

The Euro just can't seem to get a break these days. The beleaguered currency fell out of favor, only two weeks after testing its yearly highs against the USD, following the Greek debt and credit crisis which sent shock waves across the Euro Zone and the currency markets. As storm clouds gathered over Europe, signs of accelerating recovery dominated the US market. And so, in a swift and dramatic change of perception, the USD emerged as the winner. 

A shift of such magnitude and velocity in what is probably the most widely traded currency pair in the world (EURUSD) has a serious affect on all other major currencies. The USD traded considerably higher against all major counterparts. Even this year's superstar "commodity currencies" (e.g. Aussie, Loonie) finally succumbed to the dollar's powerful rise and are now trading at multi-week lows against the dollar. The sharp rise in the dollar became self propelled as it brought an end to weeks and months of USD funded carry trades which had to be covered (which, in turn, contributed to the decline in EUR and Aussie). As for the EUR, it is trading lower against most major currencies, even against the less-than-stellar Pound.

The question on everyone's mind now is how much farther does the EUR have to go? and the answer is not that simple. First, one must take into account the possibility of an exaggerated market reaction due to year-end / holiday mode. After all, fundamentally, not too much has changed in 2-3 weeks. Technically, however, the picture is a little different since major support levels for the EURUSD and major resistance levels for the DXY were easily breached in rapid succession. If we attribute at least some dislocation due to year-end dynamics, then we may expect to see some dollar weakness as early as January, especially against higher yielding currencies such as the Australian dollar. But technical levels alone, leave room for the dollar to continue rising and for the Euro to continue its decline.The next firm support for EURUSD is at 1.4200 although we may start seeing some consolidation around the current level of 1.4300.

For the Euro to get some reprieve, we would first need to see some encouraging signs from Greece and some degree of assurance that other problematic EU members (Spain, Austria) have their issues in order. Any Hawkish statements from Mr. J C Trichet, certainly won't hurt either. Other things that might give the Euro a lift are SNB intervention or the very unlikely event of a credit downgrade for the UK. One thing is for sure: it's hard to imagine anyone in the EU is terribly upset about a declining currency. A weaker Euro is a boon for European exporters and Europe's vast tourism industry.

Trapped in the Rate Race

Recent market action signaled a shift in focus from risk to rate expectations. As previously noted, this was first observed on December 4th when a better than expected non farm payroll report was released sending the USD higher.

A Very Tight Rope

Central banks around the world are walking a very tight rope, balancing a fragile recovery on the one hand and looming inflation on the other. This is an uncomfortable situation with wide political implications: hike rates too soon and you risk a lagging economy and prolonged, high unemployment. Raise rates too late and you will have unleashed a monster inflation. Either scenario is a losing proposition for any administration but the prospect of hyper inflation is by far worse with much broader implications to the economy.

As Mr. Greenspan will probably tell you, maintaining low rates for a long time will eventually result in market distortions in the form of asset bubbles and/or inflation . This is when one nation keeps its rates low - but what happens when the world's leading economies slash rates in an unprecedented, coordinated move? We've yet to find out, but we do know that there's just a lot more money out there, and isn't that the definition of inflation?

Do You Speak Fedish?


Even on a week filled with economic data fanfare, the FOMC is guaranteed to give the best show in town. Higher than expected reading of PPI and CPI in the US and UK respectively sharpened global focus on the possibility of future rate hike. The Fed is highly unlikely to announce rate increases any time soon. However, with the release of the FOMC minutes, scores of commentators all over the media will immediately begin the amusing process of translating the minutes from Fedish to English. Traders, investors and economists alike will scan through the release with a fine-toothed comb in effort to discern even the slightest change in sentiment in order to glean even the faintest hint regarding where rates are headed. 

So what to look for? The Fed is unlikely to raise rates before other emergency measures such as the TARP, TALF, and bond purchasing, are wound down. Therefore it is important to look for any signaling or intention to remove these measures. In addition, it is important to pay attention to any changes in sentiment regarding the recovery and comments regarding the prospects of inflation.

In my free time, I took some Fedish lessons, call it Fedish 101. I was able to discern, with moderate certainty that by repeating the point of a "jobless recovery", Mr. Bernanke is setting the stage for rate hikes prior to any noticeable improvement in employment numbers - a move that, unless gently delivered, can deal a blow to a market struggling with a new breed of consumers who simply spend less.

US Retail Numbers and the USD

This morning's retail numbers came in better than expected. Once again, the USD gained strength on good economic news. Coupled with the USD's reaction to a much better than expected NFP report last Friday, we begin to see the USD trade on rate expectations and not just on pure risk appetite/aversion.
Any so called USD carry trades might be unwound pretty quickly, helping to lift the USD even higher. At this point, it looks like the USD can gain both on good news (i.e. rate hike expectations) and bad news (i.e risk aversion).

On the technical side, the DXY (dollar index), is poised to test resistance at 76.50 which, if broken, may clear the way to further gains. It is also important to note how the USD behaves differently vs. different currencies. Notice the strong move up against JPY, EUR, GBP (the first in overbought territory, the latter two under fundamental pressure) - and the relatively mild gains against the Aussie and CAD.

US Futures signaling a possible up day for the S&P. An up day for the S&P with gains for the USD will further cement the observations above.

USD - Back to Fundamentals?

I know I mentioned the December 4th NFP report in previous posts but I think it is worth pointing out again since it possibly signaled the first sign of some normalization in the forex markets, namely, return to fundamentals.

On December 4th, for the first time in months, the USD rallied on good economic news and the S&P rose at the same time as well. Of course, this was a single event and far from being a trend. However, it is important to note the USD's reaction to today unemployment numbers - the report came in worse than expected and the USD's initial reaction was to decline! this is in stark contrast of what we've been seeing since March.

Another interesting thing to point out is the relative strength of currencies vs. the USD. When the unemployment number came out, the Aussie and CAD gained substantially more against the USD than did the EUR and GBP. This means we may start to further normalization where the USD gains against weaker currencies and lose ground to stronger currencies.

Excuse me, sir, this Yen is a little overdone!

     Can you believe it? it's been almost ten years since we welcomed the new millennium. Ah, the year 2000.... the year that brought us such great excitement of a bright and promising future was also the year that brought us the wrath of the burst of the dot com bubble. It was also the year that brought us what is possibly the greatest carry trade ever - the Yen carry trade. With interest rates effectively at zero, the Yen became the vehicle of choice for funding carry trades against other higher yielding currencies such as the Aussie, Kiwi, and the Euro. It was a smooth sail for carry traders that lasted the good part of a decade - a time of (what then seemed to be) risk free, free money. Investors raked it in hand over fist, collecting interest payments while their higher yielding assets kept appreciating relentlessly. As the world economy recovered from the dot com bust, sending interest rates higher everywhere but Japan, the carry trade became self-propelled. Even a rising Japanese equities market accompanied by moderate rate hikes as of July of 2006 did almost nothing to cool the red-hot carry trade.

Then came Bear Sterns, then Lehman, then....a series of global rate cuts as legions of talking heads on CNBC declared the end of the world was finally here. The unwinding of the carry trade was fast and furious. Within four months(!!!), the Yen has pared a decade's worth of losses as traders rushed to cover their short positions while many others flocked to the Yen, seeking its relative safety in uncertain times. Even as the carry trade seemed completely unwound, the Yen maintained its safe haven status and readily bounced on any sign of weakness in the global recovery which started on March 9th 2009.

A New Government Steps In

Following an August election, a new government, led by the Democratic Party of Japan, took power in September of 2009. With less than one month in office, the newly appointed finance minister, Mr. Fujii, already managed to cause waves in the foreign exchange markets by talking up a strong Yen. We may never know exactly why did Mr. Fujii made such dubious comments in his first days in office. But the result was obvious, and an already upward moving Yen was pushed even higher.

In November of 2009, the global recovery (or bear rally - you decide) showed signs of fatigue and concerns over the sustainability of the recovery started to arise. On November 15th, Japan's preliminary GDP numbers came in  much better then expected. The stronger economic reading for Japan, coupled with a global recovery in question, sent the the Yen on a two week dash that culminated over the Thanksgiving holiday with news of Dubai's impending credit crisis sending tremors throughout the global markets. Even as the dollar advanced against most other currencies, it lost ground to the Yen, reaching low levels not seen in years.

It did not take long for the Japanese government to change its tune as a strong Yen put too much pressure on a very fragile and very export dependent economy. Japanese rhetoric reversed and officials were quick to point out that Yen strength came on the back of a weak dollar without any fundamental basis. Of course, with a struggling economy, aging population, astronomical debt, zero interest rates as far as the eye can see, and loose monetary policy, what fundamental reason is there for the Yen to go higher?

Friday's NFP report shed some light on what could be fueling the Yen's relentless rise - flight to safety. The NFP report, which came in much better than expected sent the Yen on a sharp move down against the USD and other major currencies. The NFP numbers and easing concerns about Dubai (which proved to be short lived) gave the market a glimmer of hope and the Yen's reaction is indicative of its role as a safe haven. Since Friday, dark clouds have gathered once again in the form of credit downgrade in Greece, gloomy outlook in Spain, and lingering concerns regarding Dubai. The result? a stronger Yen.

Waiting for Intervention

Talks about Japanese intervention have surfaced in the media over the last couple of weeks and as of today, it seems a somewhat likely scenario. This is a major shift in paradigm for Mr. Fujii from his remarks back in September. Of course, intervention is an extreme measure and is not guaranteed to work - so whether or not the BoJ will intervene is anyone's guess. What is more likely to happen is for Yen pair to base in the short term, creating an invisible fence to ward of Yen bulls. This line in the sand may provide excellent buying opportunities in some Yen pairs, esp. against strong currencies like the Canadian dollar or the Aussie.