After the extreme volatility of last week now is a good time to take stock and consider any technical ramifications of the wild moves in the markets. We will look at the Dow Jones and the AUDUSD in particular.
What is striking is that although the Dow fell by nearly 15% since the end of July, it held above the lows reached last summer then the markets also took a battering. After making a double bottom around 10,750- it has bounced back strongly. This suggests that the moves over the last two weeks were not capitulation - when even the most die-hard bulls throw in the towel. Instead we have seen bargain hunters come back into the market in recent days, so there are still some people who can see value in the market.
But we don't believe we are out of the woods yet. Growth is definitely slowing down across the globe, the Eurozone debt crisis is reaching a critical stage and there is no solution in sight as yet and it looks like global central banks won't be able to step in and pump economies with liquidity to ward off another recession. Due to this we would urge caution.
So where do things stand now?
There are two possible outcomes that will depend on how economics and politics play out in the coming weeks. The first is that although the markets may not have capitulated, if we see either a rapid deterioration in the growth outlook or a further escalation in the sovereign debt crisis engulfing the core economies of Italy, Spain and France then there may be a deeper sell-off than the one we witnessed earlier this month. Alternatively if we get a neat solution to the Eurozone debt crisis (we think this is unlikely) and a rebound in global growth later this year then the markets are in a good position to continue to recover.
But until then we could be in for a bit of a range-bound autumn. 12,800 is a double-top in the Dow Jones, which should provide stiff resistance, while 10,800 - 11,000 should provide good support for now.
Dow Jones Industrial Average daily chart
The markets are getting closer:
Correlations between asset classes have improved markedly since the start of this month.
The below table looks at AUDUSD, Dow Jones and EURUSD since the start of this month (table 1) and since the start of the year (table 2).
As you can see, risky assets have become dramatically more correlated in the past few weeks as risk appetite has deteriorated relative to the start of this year. Crucially, the Aussie is more correlated to stocks than the euro is, which puts its claim to being a safe haven firmly to rest.
Overall, it looks like we are in risk-on/ off mode for some time yet.
Dow Jones (white line) and AUDUSD (orange line)
NB: Watch out for today's Franco-German summit. It looks like a final solution to this crisis won't materialise until Germany agrees to the issuance of Eurobonds. We think this is unlikely, but we will be watching this summit closely to try and determine how committed Germany is to saving the Eurozone.
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Please note these are Bloomberg charts and do not represent the prices offered by forex.com
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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