Euro against the ropes? Far from it thanks to Trichet and the G-7

Last week we stated that our focus was on the mood shifts of EURUSD more than on specific economic indicators. We stated that 1.4500 would be tested but were not sure if it would happen early or later in the week. It was tested throughout the week, with the low of 1.4480 happening momentarily after the release of a worse-than-expected US Non-Farm Payrolls. Was this the signal that the remaining dollar bulls needed to short EURUSD? Not really.

A lot of a potential USD was relying on a united resolve from the G7 to “talk up” the USD. On part this was due to G7 desire to raise the prominence of G20 ministers – there is a G20 finance minister meeting in a month. But the lack of such a statement at a time when the market expected one opens the door for the US dollar to test new lows against the euro, yen, swissie, and Canadian loonie.

Japan Finance Minister Fuji’s warning of “action” against excessive moves in a direction should be understood as a verbal intervention. But this new stance conflicts with his previous statements and creates confusion in the market. After all, the new ruling Democratic Party of Japan has signaled a resolve to refocus the economy away from exports. The best way for currency markets to bring clarity to USDJPY will be to test the resolve of Japanese leaders in defending a particular level, starting with 88.00.

The ultimate homage to USD strength came last Monday from none other than ECB President Jean Claude Trichet. Talk about the kiss of death. Trichet’s desperate attempt to talk up the need of a strong USD for Europe had the opposite effect. Last week we pointed out that the Swiss SNB and Bank of England were signaling satisfaction with anybody selling the swissie and cable, respectively. Trichet’s words effectively telegraphed: “sell euro, buy USD”.

There is something about doing the opposite of what G3 leaders say about currencies anytime the market senses disunity or lack of resolve!

Last week, we saw yet a new SNB intervention (the 3rd this year) as EURCHF hit 1.5075 on Wednesday. Yet EURCHF closed at 1.5090 two days later. It was as if the market was saying to the SNB, is that the best you’ve got? Part of this fundamental shifting of “medium-term equilibrium currency rates” is what G7 leaders are trying to contain.

In our view, currency markets appear to have priced in the bottom of global economic weakness. Almost by definition, a falling global economy drives up risk-averse behavior toward the safest assets, creating a distorted condition of high Treasury and high USD demand. As currency markets go back to a sense of normalcy, they have to try to look objectively at US asset risk in a context of high US deficits for the foreseeable future. If the sky is not falling, it is reasonable to think that a medium term equilibrium rate could be above EURUSD 1.50 , below USDJPY 0.88 and below EURCHF 1.50. But this sort of fundamental re-pricing causes friction with policy-makers that are well aware that markets will tend to overshoot in whatever direction they are going.

What specific levels are we watching? On the downside we are looking for EURUSD support near 1.4400 within a channel dating back to March and April 2009. The ForexDatasource proprietary FMV (fundamental market value) indicator for EURUSD for Monday Oct 5 gives us a support price of 1.4528 – virtually unchanged from last week. The FMV line has been EURUSD supportive for most of the past 2.5 months. The FMV line is an indicator that uses fundamental inputs (like CPI, GDP, interest rate differentials) to determine overbought/oversold situations for specific currency pairs.

The 200 moving average line for the 4H chart has risen to 1.4504 from 1.4480 last week, still providing adequate support for EURUSD. The ideal opportunity would be to BUY EURUSD as it approaches/break 1.4500 with a stop loss set at 1.4400, with an initial target of 1.4700 as early as next week.

If EURUSD were to be temporarily breached, we see a potential target at 1.4400 but have a real hard time seeing it go beyond that point. Most likely, EURUSD holds 1.45 and that becomes a good point to buy the euro with a 1.4700 target.

For GBPUSD, cable is near the bottom of the 1.58-1.67 channel of the past 4 months. After a successful test of 1.58, there might be some momentum building for cable. Although nothing is really new from the UK economy or policy makers, sterling may benefit from widespread USD weakness out of this weekend’s G7 meeting. Cable strength appears to be poised to flex some muscle in EURGBP in a gradual move towards 0.9000.

In other pairs, we maintain our bias on a EURCHF below 1.50 and USDJPY breaking 0.88.


Javier Paz reports are also published at the forexdatasource.com blog, where additional resources are available for registered visitors.