Euro trying to bounce – has lots of room to do so

The Euro is bouncing on China’s possibly interest in propping up the Italian bond market, but how high does the dead cat bounce take us? Merkel is also out making a show of supporting Greece.

We’ve got the news out of the bag that China will buy Italian bonds, but we’ve seen this story before, the last time around as Spain was in the sovereign debt crosshairs. This could certainly make a difference at the margin on the scale of a few days at a time, especially when the Euro selling has gotten particularly brutal and the market seems to have gotten too one-sided. But a Chinese bid is not a game changer as far as European risks are concerned.

German Chancellor Merkel was out today trying to defuse the situation, expressing the need to avoid a “disorderly process” regarding Greece’s situation. She also pointed out this morning that the troika’s return to Greece suggests that Athens is moving in the right direction in dealing with its budget.

In EURUSD, we’ve got an enormous range to deal with here – if the market decides to take it easy on the single currency for a while, we could certainly see a retracement to the 1.3900 area without inflicting any technical damage on the bearish trend (1.3905 is the approximate 0.382 Fibo of the massive sell-off wave we’ve completed to the sub 1.3500 lows). Meanwhile, there’s not much in the way of support below recent lows until the 1.30 area.

Elsewhere, AUDUSD bounced with risk appetite yesterday, and the best barometer for the latter, the US S&P500, continues to shy away from recent lows. The first support line comes in around 1130 and the big one comes in around 1100. This zone is key for the direction of those currency pairs that are most sensitive to the risk on/risk off trade, like many Aussie pairs, etc.

Chart: AUDUSD
AUDUSD bounced from the lows yesterday on the news of China possibly buying Italian bonds. The 200-day moving average around 1.0385 is an obvious tactical resistance point as the pair has basically begun to confirm the change of trend to the downside over the last few days. The next downside confirmation area for the pair comes with a daily close below the previous low daily close at around 1.0180. Further confirmation might be found in other markets, for example, if copper closes below the 3.90 area in the days/weeks ahead. Overnight, PM Gillard complained that forming a “new economy” would be difficult given the currency’s strength. The market may just offer the PM a helping hand in the months to come as the Aussie star may have peaked for the cycle.



Krona tumbles
Yesterday was a watershed day for the Swedish krona, which fell to pieces against the broader market. There was no obvious data catalyst, but last week’s Riksbank has set interest rates in a tailspin and the yield differential versus, for example, the rest of Europe has tightened significantly since then and was applying a good deal of pressure. We discussed recently whether the market might be trying to use SEK as a safe haven currency from the Euro, and whether that was a plausible idea given the history of the currency’s pro-cyclical behavior (strong export market and tendency to rise and fall with equity markets).  Yesterday seemed to give us our answer as SEK came unglued and zipped all the way back above the 9.00 level. The 2-year government yield rate is all the way down to 1.00% now versus trading well above 2.00% as recently as July. Over the same time frame, the US 2-year rate has shifted a mere 15 bps or so lower, so one can easily intuit what that means for the US-Sweden yield spread and the “carry trade” of USDSEK.

Chart: EURSEK
EURSEK rallied very sharply yesterday, a rally that got underway well before the news of China buying Italian bonds. The significance of the 9.00 level is clearly enhanced by the 200-day moving average.



Looking ahead
Let’s see whether European official attempts to trumpet their solidarity can stabilize the Euro for a time and whether risk appetite stays within the range. These determine the short term momentum. On the economic calendar, watch for the UK CPI/RPI data later, as well as the monthly reminder of the scary UK terms of trade in the form of the Visible Trade Balance for July. The US calendar is quiet today save for third-tier data. Watch Australia’s Consumer Confidence level for further signs that Australia confidence continues to crumble after the NAB Business Confidence survey overnight notched its lowest reading since early 2009. One wonders if we switch from white hot momentum to rangy behavior as the market ponders next week’s FOMC meeting outcome.