Euro exchange rate needs to match and hold the end-Oct high at 1.3300 to believe that the dollar rally is really over

Foreign Exchange Outlook : The US dollar is starting to make some gains this morning after losing 648 points in the euro exchange rate from last week to yesterday morning (1.2433 last Friday to 1.3081 at 9 am yesterday). This could be a function of the foreign exchange traders buying euros to an overbought level ("too far, too fast"), in which case it’s a correction that reaches support around 1.2860 and a 50% retracement around 1.2760.

That’s if the euro rate upside breakout is the real deal, which is the outcome we get in two of three model systems.

If the euro move up was itself a correction of the bigger and longer-lasting euro downtrend, we may have seen the end of the correction. How you see it depends on the timeframe of the chart you are looking at. In the model system shown in the charts in this report, we do not yet have a true upside euro breakout, although it’s pretty scary. Looking beyond the euro, we see prices crossing over the short-term moving average, linear regression, or previous intermediate high in many cases.

One thing that a lot of analysts agree on-we need to see the euro exchange rate match and hold the end-Oct high at 1.3300 to believe that the dollar rally is really over. The high yesterday was 1.3081, or about 220 points under the benchmark. We would need to see it get hit and held before next Monday, which is going to make the rest of this week and Sunday night a fingernail-chewing, hand-wringing ordeal. The US closes shop early today for the Thanksgiving Day holiday tomorrow and while banks are open on Friday, it’s another short day. So here’s the question: do the Asian and European markets have the guts to set the trend in the absence of the US?

Market News sums up the situation neatly: "Foreign exchange market players do not trust the stock market rally seen last Friday and Monday, and therefore have little faith that the gains seen this week in the euro, sterling, Australian Dollars and Canadian dollars will be sustainable. The rise in stocks was being viewed as a "bear market correction," with renewed equity slippage likely when the rally has ended." According, the dollar exchange rate should come back up when these markets fall back down.

A second factor is emerging - old-fashioned fundamentals. For once we are seeing the Foreign Exchange market react to economic data and institutional responses to the economic crisis and not only knee-jerk reactions to developments in related markets like stocks, the so-called risk aversion theory of exchange rate determination. Pounds Sterling, for example, is well down from its high of 1.5534 yesterday to a low of 1.5290 so far on the 0.5% drop in Q3 GDP and associated gloomy data that reinforces the prospect of some big rate cuts to come.

Risk aversion still has a good grip, though, and as usual, it can be seen best in the Japanese yen. Dollar vs Japanese yen slumped from the Monday high at 97.42 to 95.45 at the US close yesterday and thence to 94.69 overnight, although it’s bouncing upward ahead of the US open. Sterling to Japanese yen is right on its hand-drawn support line on the hourly chart and probably breaking it today. A 50% retracement would take sterling down to 143,10 from the high of 148.61 yesterday. Euro to Japanese yen is also floppy, having run up from 116.39 last week to 126.24 on Monday. So far it has touched the 38% retracement at 122.48 and may do it again today, in which case the expectation would be for a further correction to 121.32 (50%).

This doesn’t make the Japanese yen a runaway or a screaming buy. If Foreign Exchange Traders like what they see as a necessary and sufficient government response to crisis - i.e., if confidence is at least partly restored, the US dollar will be rejected as the safe haven as Forex traders feel comfortable taking on more risk. The yen will get sold as the other half of carry trades into the higher yielders.

But Market News Asia reports this morning that "The failure of Asian stocks to continue their recent rally led to concerns among investors, who then cut positions inyen crosses. UBS said "At present we continue to see firm market demand forsafe-havens and the general flight to liquidity remains intact and there doesnot appear to be any shift in the perception of U.S. paper to serve this purpose. In addition, the overwhelming force of de-leveraging is firmly in place,especially in a weak growth environment."

Confused? You’re not alone.

Seeing the dollar/yen or any other yen cross rates a barometer of risk aversion or risk appetite is not working out too wellthese days.

Bye For NowBarbara Rockefeller
Foreign Exchange Trading
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