FOREX TRADING

Yesterday’s modest bounce in EURUSD off the lows saw almost no follow-through today and the Euro was generally weak from late Europe and throughout the US session today on the latest signs of nervousness about counterparty risk in the European banking system – particularly the last couple of days of stories and rumors about the largest Spanish banks’ difficulties. These difficulties are wrapped up in the entire sovereign debt issue as banks abroad are reluctant to lend to entities in a country that is experiencing sovereign debt stress. And while Greek spreads have been stabilized for now at very wide levels by the recent bailout package, we are seeing a significant further stretching in sovereign Italy- and Spain-Germany spreads, a worry due to the size of these countries relative to Greece/Portugal and because they have very large, internationally significant banks.

Today’s weak Euro and the signs of European bank stress finally began dragging on broader risk sentiment as the US trading session wore on today and the bulls’ comeback attempt crumpled severely into the close, with the psychologically important 10,000 level in the Dow Jones Industrials suddenly under threat again in the final half hour of trading. This morning we discussed the importance of the old 1090 level (previous significant low) in the June S&P500 future, and indeed, this proved the pivot point of the day, as 1089.50 was the high level traded before range trading set in and then the drop in sentiment in late trading. Commodity currencies largely followed the swings in risk appetite, collapsing later in the day as they proved once again that when the “risk-off” button is pressed, they overtake the Euro to the downside. The underperformance of the Aussie takes place despite a story from the FT today that China is reconsidering it position on its central bank’s Euro holdings. Only the USD is able to absorb the kind of flows we can infer from such reconsideration. EURUSD is likely to remain under pressure here as the “crowded trade” rally in EURUSD we saw last week seems to have been a three-day wonder.Sterling remains rather stable in this environment, its moves largely echoing the moves in the greenback, as the UK is often given props for its ability to determine its own fate, and as support for government debt seems to translate into less fear that the country is in danger of default. Still, the dimension of bank stress makes it tough to buy the pound. Let’s see how EURGBP behaves as it nears the lows since late 2008 at around 0.8425. Our suspicion is that as long as the pressure remains on risk, the pound will outperform the single currency. Could we see 0.8000 in EURGBP and rather soon?

A story circulated today suggesting that the Rudd government is reconsidering the severity of its plan to tax mining companies. This gave the Aussie quite a bump intraday, but the power of the subsequent sell-off was redoubled by the end of the US session on the sudden onset of risk aversion, showing us that this is really just a side issue for the currency relative to the other powerful themes in play.

Chart: EURUSD

EURUSD is closing close to recent range lows, putting the pressure firmly to the downside again. If the range isn’t able to hold, we could look for a go at the next psychologically significant level at 1.200 and then even the 2005 low below 1.1650.

Chart: Italy and Spain now the focus for EUR?

The shift may be moving from the Portuguese and Greek spreads now to those for Italy and Spain, which are moving more independently of their former PIGS cohorts than previously. Here we chart the 10-year debt spreads for Italy and Spain vs. Germany as compared to a trade-weighted Euro index. Data source: Bloomberg.

Looking ahead

The pressure is back on the downside in risk on a close like we are seeing today. A report out right at the close here tells us that the US Treasury has sold 1.5 billion shares of Citi stock acquired during the bailout phase of the financial crisis. The exit strategy of the public continues – an exit from the very programs that created the mirage of the recovery and triggered the inevitable “connect and project the dots” by the dismalists. It is hard to see what is going to stop this move until it becomes so severe that the authorities intervene once again. Does that happen around the time AUDJPY hits 70 or 50? Those are the kind of potential ranges we are playing with here, so we should all adjust our leverage accordingly.

Stay ever so careful out there.