View: Break of DXY support significant, EM crosses look the most constructive option now
The break up in the dollar we saw during September looked a positive development for the greenback, but the pronounced failure of the key support area at 75.75/76.00 on Thursday was significant from a technical perspective and rules out any test higher in the immediate future. Indeed, the natural instinct of the market now should be to take the index to test down towards the 73.50 area which proved such solid support throughout June, July and August.
With bulls gaining confidence more widely, lured by hopes of a Santa rally, the obvious whipping boy is the USD. The Fed as ever remains firmly attached to dovish rhetoric, even if the widely anticipated ‘twist’ has only limited real impact, which will keep interest rate differentials blowing in a hostile direction – at least until the ECB cuts rates. It is also probably too early to become attached to the cyclical story with the downside risks to US growth substantial enough to offset what remains a dire picture for Europe (we’d stress the recent breakthrough on the debt crisis had nothing at all to do with fostering growth, if anything austerity focused policies in club Med and elsewhere have become even more closely linked to the support mechanism of the EFSF). This backdrop will probably be viewed as a success by the Fed, a weak dollar perceived to be one of the indicators that are supportive of recovery, alongside higher equity valuations. Bernanke has said as much.
In a world of ‘the least bad currency is king’ we’re left looking for more viable substitutes to be long. Despite the debt crisis solution in Europe we still find it difficult to come up with a constructive reason to buy the EUR and our gut still tells us to use rallies as an opportunity to sell, although we’d prefer to wait for a confirming technical sell from our indicators. GBP is being dragged along on the euro’s coat tails for the time being but we think this rally is poised to turn and would look to the first instalment of Q3 GDP due on November 1st as a potential trigger. There were plenty of disruptions in Q2 but any rebound is likely to be tepid. Median estimates see q/q growth at 0.3% and only one respondent in the Bloomberg survey is calling for a negative print. On a y/y basis the trend will slow further. Consumer confidence remains depressed thanks to a weak labour market and rising inflation, fiscal policy is also biting so the outlook for the fourth quarter is hardly inspiring too.
As we noted in our report yesterday though (http://wp.me/p1G1Fr-hk) the best opportunities in the FX arena appear to lie elsewhere, we like short USD/MXN for the time being while EUR/PLN and USD/ZAR also offer opportunities to bet on improved risk appetite lasting. The big macro bet of Asia currency appreciation took a big knock during the recent panic phase but the fundamental arguments for this remain solid too and the regional JPY crosses might also be a nice way of positioning for any BoJ intervention for an added kicker.
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