The Week Ahead

Brian Dolan & Jacob Oubina
Forex.com

Is the USD rally for real?
The very sudden and very explosive USD rally has many believing that this is finally it for the buck, the move higher we've all been waiting for. That said, the speed at which this happened still has us cautious about a short-term reversal. EURUSD fell out of bed in last 24 hours, plunging to a recent low of 1.5005 after touching a high near 1.5505 moments after Trichet's hawkish inflation comments hit the tapes. The selling that followed was fast and furious as the market took Trichet's subsequent remarks on the weakening Euro-zone economy as confirmation that the central bank will be hard-pressed to raise rates further -- despite the fact that their only mandate is to keep inflation in check. Indeed, the futures market is now pricing in odds of ECB rate CUTS into 1Q 2009. The sharp move leaves EURUSD in "no man's land", below the recent range of 1.5290/1.5930 but above the previous November-March range of 1.4310/1.4980. While the fundamentals of deteriorating European growth and a stabilizing US economy augur for further weakness in EURUSD, we would be cautious about further acceleration in USD gains until we break back below 1.4980/70.

What exactly am I looking at in terms of why we might see a move back into the recent range? Tremendous uncertainty remains on the US outlook, both in financial markets and the broader economy. The financial sector remains in traction after a nasty collision with reality. Home prices are still declining and jobs are still being shed. The main sources of current US growth (exports and manufacturing) are heavily reliant on USD weakness and are increasingly threatened by slowdowns in the global economy. Fears abound about the US economic trajectory after the effect of the stimulus package fades into 4Q, and the list goes on. In recent weekly reports, I have discounted most of these concerns, and I still believe rightly so, but I never denied their existence.

Because the fundamental factors are as fluid and uncertain as they are, I'm going to rely on the technicals to provide the guidance. Statistics frequently lie, and sometimes prices do, but far less often and usually not for very long. Technically, the bottom of the range in EUR/USD was a series of intra-day lows at 1.5280/90 and everyone in the market was keenly watching this level. That made it a much more treacherous level to trade, with potential false breaks taking out reasoned long positions and pulling in break-out sellers who go with the break, only to take it between the eyes on a reversal. Instead, for final confirmation, I will be looking for a few daily closes below the 200-day simple moving average (currently at 1.5224), just far enough below the range lows to lure in unsuspecting break-out traders but then spark a reversal. I will also look for confirmation from gold, with a daily close below $850/oz the key, and oil, with a daily close under the $110/bbl level as the spark.

I am still convinced that we are looking at the best set-up in many months for a break lower in EUR/USD and a further extension of USD gains across the board. A few weeks back I noted the 'persistence' of the USD's advance/EUR's decline and interpreted it as an indication that a larger move was likely also unfolding. That persistence has remained in evidence, with EUR/USD bounces staying extremely shallow and any attempts to rally being sharply rejected (note the many long tails/wicks on the upside of daily candlesticks). Such persistent price movements might also be symptomatic of summertime inertia -- less market interest taking the other side -- but indications from the institutional side suggest asset managers have been mainly exiting EUR/USD longs and have only begun to get short below 1.5500. This suggests a rather badly positioned market (short at relatively low levels) and provides a basis for a correction higher. Rather than getting caught in the cross-fire around range lows, I prefer to take partial profits on USD longs/EUR shorts and look to re-sell on any subsequent corrections.