After a multi-month rally in the equity markets increased trader demand for risk and simultaneously brought down the value of the Dollar, sentiment appears to be shifting back toward the Dollar as investors realize the road to a global economic recovery is going to be long and hard.
The Euro and the British Pound in particular were hit hard this week as bearish economic reports led traders to believe that the Euro Zone and U.K. economies would not be able to turn around without additional central bank help.
Besides the bearish fundamental news, almost all of the Forex markets posted weekly closing price reversals down. This pattern usually indicates the start of a 2 to 3 week break so brace yourself for more bearishness in the Forex markets and more upside action in the U.S. Dollar next week.
Negative European economic news spooked EUR USD traders on Friday, sending the market sharply lower and solidifying a loss for the week.
Bears were in control most of the day as a report from the Euro Zone showed that the economy had contracted at a faster pace than estimated by economists. Talk is circulating that the European Central Bank may have to cut interest rates below 1% and get aggressive with its application of quantitative easing.
Better-than-expected U.S. economic reports on Friday could not turn the Euro higher which is a sign of just how far the negative sentiment had shifted. The break in equity markets also demonstrated a decrease in demand for higher yielding assets.
Technically, the Euro posted a daily reversal top earlier in the week at 1.3722. This top was slightly below the March high at 1.3737. The current chart pattern suggests a break to 1.3089 is likely.
Look for the weakness to continue into next week.
The GBP USD closed lower for the week after posting a new move high at 1.5351. Technically, this weekly closing price reversal top is a sign of a possible major top.
The news this week was not all that positive for the U.K. economy either, as the Bank of England reported that the anticipated economic recovery would be slow and drawn out.
Included in the announcement was a bearish projection of below target inflation for the next three years. This news was basically a signal that the Bank of England would have to continue or even step up its government asset buyback program.
The BoE quantitative easing program is another way saying €œwe will flood the economy with cash€. This activity is very powerful and if done incorrectly could trigger inflation and debase the currency. As long as investors feel the BoE will have to act aggressively, long-term gains in the Pound should be limited.
The USD CAD posted a weekly closing price reversal bottom. This is a potentially bullish signal which indicates the possible start of a 2 to 3 week rally. Based on the developing chart pattern, look for a minimum rally to .1.2268.
Most of the strength this week in the U.S. Dollar was attributed to the decline in the equity markets. Traders are becoming more averse to risk as they await more positive news that the Canadian economy is beginning an upswing.
One concern that traders should be aware of is the possibility of some action from the Bank of Canada. If the BoC feels that the Canadian Dollar is getting too expensive, they may decide to take some action to devalue the currency. This could include a bout of quantitative easing. It€™s nice that the Canadian Dollar has been appreciating, but if it leads to less demand for Canadian exports then the BoC is going to do all it can to push the value down.
The trend turned down on the USD JPY weekly chart. Based on this bearish chart pattern, the next downside targets are 94.28 to 92.58.
This current break was triggered earlier in the week when the Japanese Yen rallied as weak economic news in the U.S. triggered a profit-taking break in the equity markets. This action led to a reversal in the carry trade, a strategy in which traders borrow the lower yielding currency to invest in higher yielding assets.
As the stock market break grew legs throughout the week, Japanese investors were encouraged to repatriate to take protection. The current technical pattern suggests that this carry trade reversal strategy is likely to continue.
Risk adverse Swiss Franc investors helped drive the USD CHF higher as the Dollar regained its status as a safe haven asset. Traders have become less optimistic about a quick recovery in the U.S. economy. Furthermore, weakness in the Euro versus the Swiss Franc is leading to speculation once again that the Swiss National Bank stands poised to intervene if necessary. This would be bullish for the USD CHF.
Technically, the USD CHF posted a weekly closing price reversal bottom. As trader appetite for more risky assets declines, look for a possible rally to 1.14708 over the next 2 to 3 weeks.
In summary, the Dollar should be buoyed next week by a combination of fundamental and technical factors. Fundamentally, weak economic reports should continue to come out of the U.K. and Euro Zone. Remember that these two regions were affected by the recession after the U.S. so any recovery is going to start with the U.S. first. In addition, the European Central Bank€™s slow response to the crisis should also have them behind the eight ball when it comes to a recovery. Technically, the string of weekly closing price reversals is pretty strong indications that the short-term trend is ready to turn.
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