• China not going to be a white knight for Europe
  • French banks downgraded by Moody's
  • Aussie knocked hard on broad risk liquidation
  • Yen strong for now but we project major weakness ahead

As we anticipated in Tuesday's analysis, markets are once again back under pressure with all of the flows running into the US Dollar and Yen. While we question the relative outperformance in the Yen on its safe-haven status (see below), the currency for now remains a viable beneficiary of risk liquidation flows. The primary driver of this latest wave of selling has come from China, where officials have dismissed any expectation for a white night rescue of the European markets. Instead, the recommendation from China has been that European countries should press ahead with reforms and initiate responsible fiscal and monetary policies. To add insult to injury, Moody's has come out and downgraded some French banks ahead of the European open to open the door for an acceleration in the risk sell-off.

The Australian Dollar has been the hardest hit of the major currencies, to even underperform against the Euro as market participants look to quickly exit from higher yielding assets. We have been arguing for some time that the safe haven appeal of the Australian Dollar in recent months has made little sense, and with the local economy already showing signs of deterioration, we see this as an added incentive to be looking to exit the antipodean. Perhaps some downward revisions to inflation forecasts from Australia's ABS could also be weighing on the currency, with the more contained inflation forecasts to potentially take a lot of pressure off of the RBA and help push the central bank into a more aggressive accommodation.

On the strategy front, with the Swissie short trade now well on its way, we look to the next potential major mover, and this leaves us staring squarely at the Yen. We are now waiting for the currency to undergo a similar bout of selling ahead and have a hard time seeing how things won't play out this way. A few months back very few would have been able to anticipate that the more active central bank would have been the SNB. Given the super aggressive measures taken by the Swiss central bank to depreciate their local currency, we can only expect to see similar measures taken by a Bank of Japan whose economy might arguably be even more at risk to currency appreciation than Switzerland.

The Bank of Japan name is synonymous with currency intervention and the central bank has plenty of ammunition to throw at the problem when they feel it is necessary. Given that the Yen is also trading just off record highs against the buck and some other major currencies, we do not suspect that the central bank will welcome the additional spillover flows into the Yen resulting from the Swiss depreciation. While it is true that the current deteriorative state of the global economy should funnel more money into the Yen on the liquidation of risk correlated assets, the Japanese Yen is by no means a safe haven currency given the equally uncertain Japanese economic outlook and natural benefit to the economy in having a weaker currency.

As such, we predict that any additional appreciation in the Yen will open the door for a major central bank reaction that equals or exceeds the one we have just seen from the SNB. The Euro/Yen cross is trading by multi-year lows and has dropped back below levels even seen at the onset of the crisis in 2008. We think that any additional upside pressures on the Yen will soon escalate pressures for the newly appointed Japanese officials to speak out on the unwanted currency strength and set the stage for a strong central bank campaign of aggressive currency intervention. We may not see this play out over the coming sessions, but keep a close watch for our outlook to materialize over the coming days and weeks.

ECONOMIC CALENDAR

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TECHNICAL OUTLOOK

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EUR/USD: The latest downside pressures have intensified with the market easily accelerating below critical support at 1.3835 to mark a significant shift in the structure. A closer look at the monthly chart dating back to the record highs from 2008 shows a progressive decline with the market in the process of carving a series of lower tops and lower lows. The clear break below 1.3835 does a good job of reinforcing the potential for the carving of the next major lower top below 1.5000 and opens the door for a more meaningful decline towards 1.2000 over the coming weeks. In the interim, look for any rallies to be well capped below the previous support now turned resistance in the 1.3835-1.4000 area, while back under 1.3500 accelerates.

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USD/JPY:This is a market that looks like it trying very hard to establish some form of a base after recently setting fresh record lows just under 76.00. Although the downtrend remains intact and has been fairly intense, longer-term studies welcome the prospects of the formation of a material base and shift in the overall structure. Price action over the past several days has been confirming, with the market very well supported in the 76.00's and unable to extend the downtrend to fresh record lows. Instead, the break back above 77.00 is looking more and more constructive, with the weekly chart also showing bullish tendencies after quietly putting in three consecutive positive closes. From here, we look for the establishment back above the 50-Day SMA at 77.90 to reaffirm our recovery outlook and accelerate gains towards next key resistance by 80.25 further up. Ultimately, only a daily close back below 76.50 would give reason for concern.

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GBP/USD: Overall price action seems to suggest that this market could once again be looking to roll over in favor of some fresh medium-term declines. Any gains in recent months have proven to be very well capped above 1.6500, and this latest break back below 1.6000 opens the door for a pick-up in bearish momentum. Next key support by 1.5780 has just been broken and a daily close below the level will confirm bias and accelerate declines for a retest of 1.5345 further down. Any interday rallies are expected to be well capped below 1.6100, while ultimately, only back above 1.6500 would give reason for concern.

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USD/CHF: A recent acceleration of gains beyond critical resistance and a previous lower top at 0.8550 confirms bullish bias and from here, we see room for fresh upside above 0.9000 and towards 0.9500 over the coming days. Look for any setbacks to be well supported above previous resistance now tuned support at 0.8550 on a daily close basis, while ultimately, only back under 0.8200 would delay. A break and close back above the 200-Day SMA for the first time in several months will provide more ammunition for our highly constructive outlook.