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It’s been another positive day for risk assets as stocks and the euro both extend yesterday’s gains.  Q3 earnings for Johnson & Johnson, Coca Cola and Goldman Sachs all beat estimates. Interestingly, Coke sales advanced by nearly 4% in Europe over the last quarter, shrugging off the sovereign debt crisis and helping revenues to advance to $12.3bn. Coke may not be a perfect barometer of the economic temperature in Europe, but when big blue chip companies perform well it can be good news for the overall market. US stock futures are poised to open higher today.

Is the EURUSD rally fragile?

It’s hard to know what is driving the euro higher right now. From a fundamental perspective the decline in inflation in September to 2.6% from 2.7% is currency neutral, while the improvement in German investor sentiment is a good sign, the overall level of the headline ZEW index is still back at 2010 levels. There may be some expectation that Spain will apply for a bailout/ precautionary credit line later this week, especially after lawmakers in Berlin said that Germany was open to a “precautionary credit line” for Madrid, which would be enough for the ECB to activate the OMT. This helped EURUSD to pop above 1.3050 (a key resistance zone) during lunchtime in London, but by itself it is not likely to continue to sustain EURUSD gains. The next key resistance level is 1.3175 - the double top from last month. In the short term, EURUSD is starting to look overbought and we may see a pullback for the rest of the afternoon.

I am slightly wary about this move higher in EURUSD and believe that strength will be sold in to. While I don’t advocate selling here, if we extend gains above 1.31 I would be getting ready to make my move. My justification is that 1; markets tend to rally into EU summits before selling off after a disappointing outcome. If Spain does not apply for a bailout or credit line, which Madrid seems loathe doing, then the markets may consider the ECB’s OMT programme nothing more than a lame duck, unable to stall the onslaught of the sovereign debt crisis. 2, The markets may be willing to ignore the strength of US economic data for now, but how long can this continue? The good retail sales print on the back of a fairly strong employment report earlier this month could shorten the life span of QE3. Added to this, another victory for Romney in the second Presidential debate in the US this evening could put the odds in the Republican’s favour to win next month’s election. Romney has pledged to do away with QE and even Bernanke if he became President, which may boost the dollar as QE is considered negative for the Greenback.

The US bucks the global inflation trend

This afternoon’s trading session may be dominated by the rise in the US’s CPI rate last month. Headline prices rose to 2% from 1.7% in August, while core prices also edged up to 2% from 1.9% last month.  This data is fairly policy neutral for the US as the Fed is concentrating on the unemployment rate and also seems willing to tolerate higher inflation to help boost growth. The newswires are dominated by the resignation of the CEO of Citigroup, but the board is behind the new guy so we think the changing of the guard at one of the US’s biggest banks should be fairly smooth.

The inflation trade: gold

Elsewhere, gold has been fairly volatile today after recovering from a low of $1,730 earlier in the session. We mentioned yesterday that the gold price is becoming sensitive to global inflation data. The US has bucked the global trend of weaker prices for September, which has helped to boost the gold price, which is aback above $1,740. We think the yellow metal is poised to range trade over the medium-term as we try to determine the effectiveness and scale of global monetary policy and wait to see if downward pressure on prices in the UK, Eurozone and China persist. $1,765 – the 21-say sma and a key resistance zone – may cap gains in the short term, while $1,700 looks like fairly solid support.

One to watch:

Who doesn’t love a break-out trade? When the market gives us clear signals traders breathe a sigh of relief, which is why I am flagging up USDJPY. It is testing the top of the daily Ichimoku cloud chart at 78.80 today. This level is significant for a couple of reasons: 1, anything above the Ichimoku cloud is considered a technical uptrend. 2, USDJPY has not been above the cloud since April of this year. A daily close above 79.00 may open the way to extend gains to 80.00 and potentially even 82.00. Support lies at 78.20 then at 77.70. Watch this space…

USDJPY Daily chart:

Source: Forex.com

Best Regards,

Kathleen Brooks| Research Director UK EMEA | FOREX.com

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