Forex - Stress Test Dominates Market Chatter

Forex News and Events: Risk appetite was pared down during the Asian session as investors chose to focus on Fed Chairman Bernanke’s dovish comments. Bernanke's semiannual report to Congress basically reiterated the position reported in the FOMC minutes and policy speeches. However, the markets seemed to have latched on the words “we recognize that the economic outlook remains unusually uncertain. We will continue to carefully assess ongoing financial and economic developments, and we remain prepared to take further policy actions as needed." That statement sent a rush of capital back to recent safe havens in the US dollar, Swiss Franc and Japanese Yen. Just as USD, CHF and JPY all received their boost, US yields & equities dropped like a stone with 10y yields falling 10bp as the chairman spoke. As Europeans sat down at their collective desks this morning, the merits of the stress test are now being hotly debated. The chasm emerging between proponents and opponents is considerable. On one side are EU officials who believe everything will be repaired by this magical report and on the other side is the real market, which remains overall skeptical and unconvinced. For those that have been reading our reports for the last two weeks, we firmly remain in the skeptical camp. One of the CNBC anchors summed up our opinion best when speaking to a Greek finance official declaring that “if Greek banks pass, the stress test fails.” The increased dialog surrounding this issue is obviously due to the proximity of the data release, further amplified by the Wall Street Journal’s report that EU officials are looking to publish the results before tomorrow’s European open rather than at its close. This begs the question, if the regulators haven’t even cemented questions regarding the distribution of their report, how confident can we feel in their thoroughness in analyzing complex balance sheets? The uncertainty and debate still surrounding this report is caustically eroding confidence. We still hold that the stress test will not provide the transparency needed, will not build nor shore up confidence in the EU and will leave us with more questions than answers. In the UK, BoE MPC minutes revealed a 7-1 vote in favor of an unchanged policy rate with Andrew Sentance being the lone dissenter…again. The committee further voted unanimously to hold the QE program unchanged at £200 bn. There was a discussion of increasing QE easing, however no member actually voted for the move. BoE Governor Mervyn King still believes that inflation will continue to ease as growth is expected to deteriorate a bit further. Given these developments, we suspect the sterling will continue to come under selling pressure as the risk is now skewed towards policymakers opting to hold rates steady longer than the market currently expects. Over the past few days, CAD remains the relative outperformer in the FX market. Canadian retail sales and their Monetary Policy Report are due out today and we believe that growth expectations will continue to be adjusted to the upside - giving the CAD even further support.

Today's Key Issues (time in GMT): 08:30 GBP Jun retail sales, +0.5% m/m, +1.0% exp; last +0.6%, +2.2%. 09:00 EUR May ind new orders, unch m/m, +20.2% y/y exp; last +0.9%, +22.1%. 13:30 USD FOMC Chair Bernanke semi-annual House testimony 14:00 EUR Jul consumer confidence index; last -17. 14:00 USD Existing home sales, mn saar 5.20 exp 14:00 USD Leading indicators index, % m/m Jun -0.3 exp 15:00 ZAR South Africa: Interest rate announcement, % Jul 6.50% 14:30 CAD BoC Monetary Policy Report.

The Risk Today: EurUsd As the credibility of the European bank stress tests is put up to increasing scrutiny, the bears continue to pile the pressure on EURUSD; and in the last 24 hours we have seen the 3-week uptrend channel break down, leading to a low of 1.2733. From here the risk-reward profile strongly favours short positions, so we would look to use the back side of that 3-week uptrend as a good entry level for shorts; that trendline resistance is seen at 1.2790 currently, so we’d be happy getting in around there and setting a stop just above 1.2830 (yesterday’s US session high). First destination on the downside will be the 14 Jul low 1.2683, although it’s worth noting that today that level coincides with a very short-term downtrend support so the pair will likely bounce off there on the first attempt. Ultimately we see this bearish trend eventually taking another look at 1.2522 (13 Jul low) and 1.2483 (2 & 6 Jul lows), and very possibly a further extension back towards 1.2000. Should the bears relent enough for the pair to break back within the uptrend channel at 1.2790, expect further selling interest to lie around 1.2840 (support-turned-resistance from earlier this week), the 100-day moving average 1.2887, and 1.2925. GbpUsd After a choppy and indecisive few days trading, we feel GBPUSD is gathering momentum for a move lower –a view based on yesterday’s break below the significant 6-week uptrend and reinforced by a bearish engulfing candlestick on the daily chart over the last 2 days of this week. We now look to sell around 1.5200 levels –the back side of the 6-week downtrend seen at 1.5210 –and await a return to 1.5125 (yesterday’s low). Further downside is highly possible but likely to become laboured below 1.5125 as trendline support is currently seen around 1.5110 and a significant former pivot level remains at 1.5080.Should we managed to conquer those supports, there is a much clearer path towards the next downside targets of 1.4992 (100-day moving average), then the 12 Jul low 1.4949. The risk-reward profile does look a little edgy should we break back above the uptrend at 1.5210, with next resistance not seen until 1.5350 (19 Jul high), 1.5472 (last Thursday’s high), and 1.5525 (15 Apr high). UsdJpy Yesterday we outlined the two possible scenarios in play for USDJPY –the first being a potentially bullish symmetrical triangle pattern with a target at 88.15, and the second one a larger bearish flag pattern which had not yet been activated. That latter pattern now looks to have become activated by the sell-off through trendline support at 87.00-05, and with that we now feel that the smaller symmetrical triangle pattern is as good as dead in the water. The classically defined target on the downside for this new flag pattern is 84.30 with supports ahead of there eyed at 86.27 (16 Jul low) and Nov 2009 lows of 84.83; but as we have mentioned a couple of times recently, down at those levels we would be playing Russian roulette with possible BoJ intervention so anything below 85.50 seems an ambitious enough take profit level for our fear/greed ratio. Any rallies from here are likely to meet fresh sellers around 87.15-20 (back side of the flag) where those who missed the break-out first time around will want to jump in, then further resistance seen at 87.57 (this week’s high from 20 Jul), 88.00 (former pivot), 89.15 (12 Jul high) and 89.50 (28-29 Jun high). UsdChf The 3-week downtrend channel has been violated a number of times in the past 24 hours, but as of yet the bulls have failed to capitalize on the upside break and the pair is continuing to stutter around the trendline resistance. We are still short at 1.0530 from yesterday’s trade recommendation (taking the view that a lack of directional impetus from either the bulls or the bears made it a prime range-trading environment) and are looking at a first target of 1.0450 (Monday’s low), with 1.0400 (double bottom seen last week) as a possible extended target. Some bulls may favour buying on the dips towards, 1.0400, but should they be wrong the landscape below 1.0400 is only dotted with stale support levels at 1.0365, 1.0315 (trendline support), then 1.0230 –could be a nasty plunge with few buyers to slow the descent.

Resistance and Support: EURUSD GBPUSD USDJPY USDCHF 1.2925 1.5525 89.50 1.0680 1.2887 1.5475 88.60 1.0580 1.2840 1.5350 87.15 1.0530 1.2810 1.5214 86.54 1.0439 1.2790 1.5154 86.27 1.0365 1.2710 1.5080 85.30 1.0315 1.2680 1.4992 84.80 1.0230 S: Strong, M: Minor, T: Trendline, K: Keylevel, P: Pivot