Currencies Reverse Course on Confluence of Risk Negative Developments

• Risk aversion themes dominate in early Tuesday trade
• RBA leaves rates on hold at 4.75% as expected but accompanying statement much more downbeat
• Moody's concerned with China banking system outlook
• Rumors of yet another China rate hike over the coming days
• German courts hearing lawsuits against contributions to rescue plans

The thin holiday trade is now behind us with the markets transitioning back into normal trading conditions. So far, the initial reaction in early Tuesday trade has been a risk off reaction, with currencies coming back under pressure and giving up a good deal of gains seen since Friday. The Euro has already taken out Monday's low to break a sequence of consecutive daily higher lows and fundamental developments over the past few hours could continue to weigh.

The primary source of the risk off trade comes out of China with Moody's saying that it has found another $540B of Chinese government debt that local auditors failed to disclose in a recent report. Moody's has therefore issued a warning that the outlook on the Chinese banking system may turn negative. At the same time, there have been a number of rumors circulating that there will be yet another China rate hike over the coming days. China rate hikes are always viewed as risk negative with the impact from such monetary policy measures interpreted as having a cooling influence on global growth prospects.

Meanwhile, the ongoing saga relating to the Eurozone debt crisis is still very much alive and weighing on sentiment, with Germany's top court hearing lawsuits against Germany's contribution to current rescue plans. Additionally, a doom and gloom article in the UK Telegraph reports that the IMF is making the same mistakes in Greece as it did in Argentina a while back.

On the economic calendar front, some better than expected Aussie trade data has failed to have any positive influence on the currency, with broader negative sentiment and risk liquidation factoring more heavily into price action. The RBA has also come out leaving rates on hold at 4.75% as expected, but has issued a more downbeat than expected accompanying central bank statement. Comments that the high Aussie Dollar is having a “noticeable dampening impact” and that “2011 growth is unlikely to be as strong as forecast” are weighing heavily on the antipodean in Tuesday trade and coupled with the broader risk off environment, have left the Australian Dollar as the clear underperformer on the day thus far.

We established a short position in Aud/Usd on Monday after the market was looking well overextended (and following some weaker than expected Monday Aussie data), and the trade has already shown some good downside follow through from our entry by 1.0750. Kiwi is another risk correlated currency that has come under a good deal of pressure, with the currency sharply reversing course intraday and retreating from early Tuesday fresh post-float record highs by 0.8335.

Looking ahead, Eurozone and UK services PMIs along with Eurozone retail sales are the key releases in European trade, while the US eases back into things with the only notable release coming in the way of factory orders due at 14:00GMT. US equity futures are surprisingly flat into the European open, while commodities are mildly offered.

ECONOMIC CALENDAR

TECHNICAL OUTLOOK

EUR/USD: Overall, medium-term price action remains quite choppy and we continue to like the idea of selling into rallies in anticipation of a more sizeable pullback below 1.4000. From here, look for the formation of a fresh lower top somewhere below 1.4700, with Monday's topside failure by 1.4580 potentially representing this next lower high. Tuesday's early break back below Monday's low confirms the bearish outlook with the market also breaking a sequence of consecutive daily higher lows. Ultimately, only a close back above 1.4700 would negate outlook and give reason for rethink.

USD/JPY: After undergoing a fairly intense drop off from the 85.50 area several days back, the market looks to have finally found some support in the 80.00 area and could be in the process of carving out some form of a base. Look for setbacks to continue to be well supported around 80.00 with only a close back below 79.50 to give reason for concern. From here we see the risks for a fresh upside extension back towards the recent range highs at 85.50 over the coming weeks and the latest break and close back above 81.00 helps to confirm. Look for a test of next key short-term resistance by 82.20 over the coming sessions.

GBP/USD: Although the short-term structure remains bearish, setbacks seem to be well supported in the 1.5900's for now. However, we classify the latest price action as some bearish consolidation ahead of the next major downside extension with the market now looking to establish back below the 200-Day SMA and extend declines below next key support at 1.5750 further down. In the interim, look for any rallies to be well capped ahead below 1.6250 on a daily close basis. Rallies towards 1.6200 should therefore be used as a selling opportunity.

USD/CHF: Despite the intense downtrend resulting in recently established fresh record lows below 0.8300, short/medium/longer-term technical studies are looking quite stretched to us, and we continue to like the idea of taking shots at buying in anticipation of a major base. The latest break back above the 20-Day SMA is encouraging while a push beyond 0.8550 will ultimately be required to officially relieve immediate downside pressures and accelerate gains. In the interim, look for intraday setbacks to be well supported ahead of 0.8400.

Written by Joel Kruger, Technical Currency Strategist

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