Looking back at the week, one would have to say that the action on Thursday, August 7 was the set up day for the breakout in the Dollar. Throughout the week the U.S. Dollar had been trending higher, but the U.S. economic news for the week was giving no indication that the Dollar deserved to breakout to the upside.
During the past week the U.S. Dollar was able to withstand heat from mounting losses at Freddie Mac and AIG, poor same store sales from Wal-Mart, and a six-year high in Initial Claims. Lower crude oil helped, but there was always the fear that a geo-political situation would flare up causing it to rally. All of this came to a head on August 7 as the U.S. Dollar was able to shrug off the economic negativity and stand tall while all around was falling apart including the U.S. stock market.
The timeline tells the story for the U.S. Dollar this year starting with the first top in the EUR USD on April 22. That first top was shortly after the G-7 meeting and close to the day Luxembourg Finance Minister Jean-Claude Juncker stated that the Euro's recent advance against the Dollar is not "desirable." Additional comments from G-7 members followed, and the EUR USD started its first major break for the year. Some could say that this was a "verbal intervention" by the G-7. The subsequent break set the range for the next three months. The bottom on May 8 at 1.5283 identified the area traders were going to defend as the market continued to withstand attempts to break this level into June.
During the April to July time period one thing became clear: the Commitment of Traders Report for futures contracts started to show net long positions in the Dollar for the first time since 2005. Looking back at the chart formation it now becomes clearer that the top taking place was a distribution of the EUR USD. It seems that that the big money had committed to a long Dollar, and was waiting for the economic slowdown to spread to the Euro Zone. Once the Euro Zone began to experience a slowdown, it just became a matter of time before the short positions that had been built for several months would pay off.
Some can argue that the "top" came to the EUR USD when the Fed stopped cutting interest rates on March 17. This may also be true as the last leg up from 1.3359 started with a surprise interest rate cut on August 16, 2007. There is no question that interest rates will play a part in the strength of the U.S. Dollar as this break develops. Looking at the current chart formation, the first downside objective of this break is 1.4699. After the Fed begins to bring interest rates back to an acceptable level, the EUR USD is likely to retrace the entire rally this past year back to 1.3359.
The USD JPY is expected to remain strong as major technical resistance levels are being penetrated. The strong stock market is also encouraging cash flows from Japan as investors seek higher yielding assets. Finally, the Japanese economy may be on the brink of a recession as the government stated that the economy is "deteriorating."
The GBP USD dropped sharply this week even taking out at main bottom from March 2007 at 1.9181. All indications are that the U.K. economy is headed toward a recession. Low employment, falling consumer confidence and weakness in construction and housing should continue to pull this economy down. Although the Bank of England left interest rates unchanged at 5%, some are calling for the BoE to start aggressively cutting to help stimulate growth. The BoE has chosen to let the situation correct itself out of fear of igniting inflation with a rate cut. Only time will tell if its decision is correct. In the meantime, the GBP USD should suffer more downside action.
The USD CHF rallied sharply higher on the strength in the U.S. stock market and the weakening Swiss economy. Traders used borrowed Swiss Francs this week to finance some of their purchases in the U.S. stock market to take advantage of the higher returns offered by riskier assets. Continue to look at more upside potential as traders gain confidence in the possibility of U.S. economic recovery.
The USD CAD is expected to continue to post gains on the weakness in the commodity markets. Losses in crude oil, gold, wheat and lumber are expected to hurt the Canadian economy in the form of lower exports. The U.S. economy is also expected to start showing signs of strength as the credit crisis seems to have settled down. The strength in the U.S. stock market is also drawing funds out of Canada, putting more downside pressure on the Canadian Dollar. The overall weakness in the Canadian Dollar means that the Bank of Canada is less likely to raise rates until sometime in 2009.
The AUD USD had another down week as the mounting daily losses have added up to the largest break since 1980. Breaking commodity prices, particularly gold and wheat, are helping to slow down this country's economic growth. The Reserve Bank of Australia is leaving the door open to a rate cut later in the year. The acceleration to the downside is a sign that more bearish economic news is expected. Although this market will be subject to periodic short-covering rallies, the long-term trend has been set so be patient and wait for short-covering rallies to initiate new shorts.
The New Zealand Dollar should continue its long-term break as a bad housing market, high unemployment and low consumer confidence are leading traders to believe the Reserve Bank of New Zealand is likely lower rates again in 2008. Reserve Governor Bollard is indicating that he sees room to cut further. There may be technically based short-covering rallies as traders are beginning to believe that this market has dropped too much too soon.
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