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The single currency has continued its decline today after falling through some key technical levels at the end of last week including the daily Ichimoku cloud chart and its 200-day sma. The pair has traded in a tight range today between 1.2765 and 1.2830 (the 200-day sma). We see this range persisting as we lead up to some major event risks this week. The first is the US Presidential election tomorrow, then the crucial Greek Parliamentary vote on Wednesday and the Chinese power handover, BOE meeting and ECB meeting on Thursday.
Weaker US ISM non-manufacturing data (the first miss in three months) didn’t do much to hurt the dollar’s march higher. There has been some interesting price action today in the dollar index (the dollar against its largest trading partners). It is testing its 200-day sma at 80.67; however after a sharp move higher today’s price action has been more muted. The candlestick chart is forming a daily doji, which suggests there may be some reluctance by the bulls and they may be booking profits rather than trying to push this cross over the line in the short term. This stickiness is typical at important levels such as a 200-day sma, it may also be down to some concern about the US election. Both candidates are neck and neck according to the latest Ipsos/ Reuters poll, but Obama seems to have an edge in swing states at this late stage. However, with the disruption caused by Sandy, which may prevent some people in the Democratic heartlands in the North East from voting, this is a particularly close call and you could see some investor nervousness building in the next couple of days as investors choose to wait on the side-lines until US citizens have chosen their next President.
So what could the potential outcomes mean for financial markets?
Obama victory – Republican Congress: A split government may be the worst outcome for risk assets as it may focus minds on the upcoming fiscal cliff. In 2011 the stand-off between Democrats and Republicans over the debt ceiling brought the US close to bankruptcy, it lost S&P’s coveted triple A credit rating and financial assets lurched lower – the S&P 500 dipped to 1,100 in the aftermath of the debacle. This may be good news for the dollar and other safe havens.
Romney victory and Republican House: This may be the most risk-friendly outcome in the short term as 1, stocks tend to react well to the news of a Republican victory as it is deemed the most business friendly of the two parties and 2, a united Congress and President could push through a deal to avert the fiscal cliff before the early January deadline. However, to temper the rally in risk assets, the Republicans are anti-QE, so a risk rally could be curtailed if the markets believe that Romney’s position in the White House could cut short the life span of QE3.
Obama Victory – Democrat-held Congress: This is an unlikely outcome according to the latest polls as not all seats are up for re-election. However, risk sentiment may drain if the market thinks that a Democratic government will be anti-business. It has threatened to change the tax code (i.e., allow some tax breaks for the rich to expire) which may fuel risk aversion. Markets don’t like uncertainty so more uncertainty regarding the fiscal cliff could be met with risk averse financial markets.
This is a very crude breakdown of what certain outcomes could mean for financial markets. It is worth remembering that the US will be fighting for airplay with the Greek budget vote on Wednesday. The Greek government has a very narrow majority in parliament and some MP’s have threatened to vote against the budget. Expect chaos in the financial markets if the vote doesn’t pass. This would make it very unlikely that Greece would get its next tranche of bailout funds and would most likely leave it spiralling towards bankruptcy before the end of the year. A panic of this scale has always been averted since the sovereign crisis first came to light, but the Eurozone authorities and the Germans seem more concerned about larger Eurozone countries like Spain, who have made adjustments to their public finances and if Greece doesn’t play ball it could fall to the wayside.
Don’t dismiss the power of Greece
The knee jerk reaction from a failed Budget vote could be a mass sell-off of the euro, European banking stocks and peripheral bonds including Spain’s as people worry that Madrid may be left to fend for itself down the line if it deviates from the fiscal path of austerity. Thus, we expect some scrambling by the Greek PM Samaras to get the vote passed and maintain the (fragile) status quo until the next tranche of funds are due.
A short-term recovery could be on the cards
Overall, risk assets remain range-bound with a bearish bias. Supports lie at 1.2610 (the base of the daily cloud) in EURUSD and 1,400 is a major support level in the S&P 500. Commodities have actually staged a recovery this afternoon, which may suggest that selling pressure could abate in other markets in the coming days like stocks and FX. Gold has managed to find support ahead of a key level between $1,660-70 per ounce. Since commodities led the sell off (and they tend to move before other asset classes like stocks) the recovery today bodes well for other asset classes in the near term and tomorrow’s major theme could be a mini-recovery in risk and respite from the dollar bulls.
Thus, I would not look to sell EURUSD right now, and instead would wait to establish shorts on bounces back towards 1.2830-50, targeting 1.2610 – the cloud base of the daily cloud in the medium-term.
EURUSD: daily Ichimoku cloud chart
One to watch: AUDUSD
The RBA makes its policy decision tomorrow at 0330 GMT. The market expects rates to be cut to 3% from 3.25%. However, expectations of a cut have shrunk to 55% right before the decision from 80% + a few months ago. Thus, if the RBA does not hike rates tomorrow morning then there may be limited scope for more upside. The Aussie bucked the overall FX trend today and out-performed the US dollar after some strong economic data and expectation that the RBA may remain on hold. We could see a pop back above 1.0400 to 1.0420 initially if the RBA does stay on hold. However, this pair will also move with overall risk sentiment, so if the market recovers tomorrow we may see a push back above 1.0450 towards 1.0500 in the near-term.
AUDUSD: daily chart
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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