The U.S. Dollar finished the week sharply higher after posting gains against all the major currencies. The catalyst behind this week’s strength was the action by the Fed to stabilize its balance sheet by shifting assets from mortgages to long-term debt. This sent a signal to already worried investors that the Fed was making room for the possibility of a prolonged downturn in the U.S. economy. Investors sought safety in the Greenback on concerns that the slowdown in the U.S. economy may soon trigger a halt in the global economic recovery.
As pessimism soared regarding the outlook for the strength in the global economy, investors moved funds into the Japanese Yen in the typical flight-to-quality fashion, but a few comments from the Japanese government, much stronger than the usual “verbal intervention” rhetoric, caused investors to scramble out of the Yen as the threat of an actual intervention began to be taken more seriously. After reaching a 15-year low earlier in the week, the Dollar/Yen rallied as the fear of an intervention trumped the desire for safety.
The USD JPY finished higher and in the process posted a weekly closing price reversal bottom. This formation, once confirmed by a follow-through rally next week, often leads to the start of a 2 to 3 week retracement to a major 50% level, currently identified as 89.55.
Friday’s rally in the Dollar/Yen helped form a new main bottom on the daily chart at 84.73. Based on the short-term range of 88.11 to 84.73, traders should watch for minor resistance at a retracement zone at 86.42 to 86.82. Once this area is overcome on the short-term charts, the market is likely to accelerate to the upside. If momentum dies out on Monday, it is likely to be in this zone, so this is a key area to overcome in order to sustain the developing rally.
The current two-day rally in the USD JPY has most likely been a reaction to the “verbal intervention” by the Japanese government earlier this week. Some traders feel the government will intervene at this time, but doubts still linger about its effectiveness.
According to the Bank of Japan minutes published overnight from the July 14-15 meeting, the BoJ is closely monitoring the effect on the economy of a strong Yen and falling stock prices. If one interprets this to mean that the BoJ is seriously considering an intervention at this time, then this news will act as the catalyst to drive the Dollar/Yen sharply higher.
Throughout the entire financial crisis the Dollar and the Yen have both benefitted from investors’ unwillingness to hold on to risky assets. Most of the rally in the Yen has been traders seeking shelter in safe-haven assets. The possibility of a rally in the Dollar/Yen exists at this time because speculators feel the Japanese government will intervene in order to protect the interest of its exporters. One key to this rally taking place will be whether a stock market break will trigger a flight-to-safety rally, thereby limiting gains in the Yen following an intervention. In other words, if equities break hard, will the news of an intervention be enough to counter-act the demand for the lower risk Japanese Yen? If not, then the Yen seems destined to move higher.
The EUR USD closed sharply lower for the week. This currency pair accelerated to the downside following a change in trend earlier in the week when the market crossed a swing bottom at 1.3119. Downside momentum is building which could drive the Euro into a major retracement zone at 1.2605 to 1.2433.
Although recent economic data has suggested a developing recovery in the Euro Zone economy, some traders feel that this is backward thinking since the reports are based on stale data. Going forward, investors remain skeptical about future growth especially if a slowdown in the U.S. economy spreads globally.
The British Pound finished the week lower after finding resistance at a .618 retracement level at 1.5967. Once the rally stalled and buyers became scarce, the trend easily turned down on the daily chart when a swing bottom was crossed at 1.5819.
The downside move accelerated earlier in the week after the Bank of England lowered its outlook for growth. This added to the concerns that the implementation of new austerity measures and higher taxes will tie up the economy and possibly trigger a double-dip recession. Further adding to the weakness was a report that U.K. home prices fell for the first time since July 2009, indicating that there is more supply than demand. Tight credit and employment worries have kept many potential British homebuyers on the sidelines.
The strong rally in the Dollar was the story this week, but next week, the focus will shift Pto the Japanese Yen. Shorts are nervous about whether the Japanese government will intervene and may begin to panic as the government debates what to do about the high priced Yen. The longer the government takes to make a decision, the higher the Dollar/Yen may rally, before moving sharply depending on what the decision turns out to be. Either way one looks at it, the Yen is set up for a volatile week.
Even if the Japanese government intervenes, many investors feel that hedge funds and institutions will treat this as a buying opportunity following a sell-off. Some traders feel that no matter what the government tries to do, a weakening global economy will eventually overcome the benefits of an intervention. This is the primary reason why Japanese officials are taking their time before taking action. It doesn’t make sense to flood the market with Yen if it is only going to be used to set up more selling opportunities.
The huge rally in the Dollar Index, following a test of a Fibonacci retracement level at 80.45, could continue next week if the Greenback is treated as a safe-haven currency. The charts indicate that this market could rally to 84.69 before finding any solid selling pressure.
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