Forex - After the Stress Test

Forex News and Events: The substance and meaning of Friday’s Stress test results are still be hotly debated. Financial pundits are putting enormous emphasis on the European open as the barometer of the market’s sudden confidence in the results. We are still unconvinced about the stress tests and doubt that a single market open/trading day will create the directional rush some participants are looking for. FX markets initially took on risk in Asia but the gains were quickly eroded. Seven of the EU banks, out of a total of 91, failed the stress test. The test did not find any troubled institutions in countries such as Italy and Portugal and just one in Greece. Of the banks that did fail, they only needed to 3 million Euros to meet their Tier-1 capital ratio of 6%, quite a low figure for major banks. The EU’s widespread denial of the possibility of a sovereign default is vexing to analysts, but it’s understandable from a political and market stability standpoint. Overall, if the purpose of this test was to gauge the probability of a sudden bank collapse in the EU, than it misses the mark. We maintain the view that Europe’s problems are largely structural and thus no test will address these problems. The macroeconomic assumptions used in the adverse scenarios were not very difficult nor believable. Ireland’s GDP growing 1% is not an emergency scenario.  Markets will continue to watch LIBOR and credit-default swap spreads carefully as well as the equity markets’ reactions – especially to see which banks come under heavy selling pressure. The Euro’s strength is limited as domestic growth prospects will diminish as the austerity measures kick in. Global growth is still decelerating and the credibility of the single currency has been damaged in recent years. In addition, we have our eye on the Swiss Franc to outperform across the board. The Swiss version of the stress test, released Friday prior to the EU test, was more rigorous and comprehensive. With the added scrutiny, market participants can be confident in Switzerland’s banking sector. We suspect capital will continue to flow from Europe, into Switzerland, as investors seek out a safe haven for their assets. We are still very impressed with the UK growth figures released last Friday. Q2 GDP figures came in well ahead of expectations at 1.1% q/q and 1.6% y/y, ahead of the 0.6% q/q & 1.1% y/y expectations. While PMC member Posen has raised the question of further QE to prevent the UK’s economy from taking another dip, we are leaning more to the views of Sentence that inflationary pressure needs to be tackled now. We will be watching for the opportunity to go Long sterling, especially in the EURGBP. Today’s final thought is on the Yen. There has been a noticeable lack of rhetoric surrounding its recent strength. The current government coalition believes that markets themselves should set prices, even though there has been no noticeable erosion in exports (June exports increased a whopping 27.7% y/y). This week’s June CPI will be in negative territory and we believe it’s only a matter of time until Japanese rhetoric begins and we see the Yen lose ground.

Today's Key Issues (time in GMT): 07:30 SEK Jun trade balance; last SEK2.7 bln surplus. 07:30 GBP Details of UK financial supervision reform. 14:00 USD Jun new home sales, 335k AR eyed; last 300k. 00:00 PLN Interest rate announcement, % 3.50 exp/prior

The Risk Today: EurUsd Well, the European stress tests were just as underwhelming as expected, so for now EURUSD’s short-term uptrend remains intact and the markets look pretty directionless this Monday morning. Our gut instinct is that the medium-term direction for this pair will be lower, but in the short-term we would be willing to play this one either way depending on the outcome of a potential symmetrical triangle pattern now visible on the hourly chart. The lower edge of the triangle coincides with the short-term uptrend line, so a break below that support (currently 1.2825) would be the signal to go short with a target below around 1.2480. Given that target is some distance away, supports on the downside are a potential hazard at 1.2793 (Friday’s low),1.2733 (21 Jul low), 1.2683 (14 Jul low) and 1.2522 (13 Jul low). Should the bullish triangle scenario play out instead then we need a break above 1.2950 to trigger long entry, and eye a target above at 1.3300. Next resistance is expected at the 100-day moving average 1.2874, 1.3028 (20 Jul high) and 1.3093 (10 May high). GbpUsd After the false break of the 6-week uptrend last week GBPUSD has bounced emphatically higher, and impressive UK GDP figures on Friday has catalysed the rally further to highs of 1.5501. In doing so, the pair has now surpassed the 15 Jul highs at 1.5472 and is now expected to make a move on the more significant 1.5525 (15 Apr high). Above there lies yet more technical resistance (namely the 200-day moving average 1.5558 and 23 Feb high 1.5575) which should stall the rally on the first visit, but beyond there the skies are clear for a run on 1.6000. Nearest support is back down around 1.5350 pivot level, with the lower edge of the 6-week uptrend now coming in below at 1.5280. Should the trend break lower once more then first stop on the downside will be 1.5125 (last Wednesday’s low), followed by 1.5080. UsdJpy The bearish flag pattern we had been tracking last week has now decisively been dead and buried by the move back above 87.50, and if anything we look to be carving out a range between 86.25 –87.75. At current levels towards the upper end of the range, the most attractive strategy is to sell some and await a return to 86.50ish levels, but ensuring we keep a tight stop on the topside to keep the risk/reward ratio manageable. There is a possibility that from here, a break above that range ceiling (87.75) could indicate a double bottom chart pattern has been activated, and if so, we should be getting long there and aiming for a target above of 88.85.Sellers are expected to step in around 88.00 (former pivot), 89.15 (12 Jul high) and 89.50 (28-29 Jun high). UsdChf Finally, someone told the bulls about the break of the 3-week downtrend channel and we managed to get a bullish engulfing candlestick pattern on the daily chart to finish the week; it only took about 3 days... The decisive burst higher on Friday afternoon hit a peak of 1.0564 but progress has been halted by resistance coinciding with the 19 Jul highs, so for now the pair is now consolidating above 1.0500. We see a potential bullish flag pattern on the hourly chart that suggests a break above 1.0560 should be taken as the signal to go long, with a target on the topside around 1.0715; however we think buying on a dip to 1.0500 (the lower edge of the flag) also represents decent value with 1.0450 likely to offer some protection below. Only resistance levels above to be wary of are the 14 Jul highs at 1.0618 and the 200-day moving average at 1.0640.

Resistance and Support: EURUSD GBPUSD USDJPY USDCHF 1.3030 1.5525 89.50 1.0680 1.2874 1.5558 88.00 1.0640 1.2950 1.5525 87.75 1.0618 1.2928 1.5471 87.14 1.0527 1.2793 1.5350 86.27 1.0365 1.2730 1.5280 85.30 1.0315 1.2680 1.5125 84.80 1.0230 S: Strong, M: Minor, T: Trendline, K: Keylevel, P: Pivot