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The euro has staged a minor rally this week versus the USDEUR (FXE, UDN). The market is trapped, momentarily, within the 1.28/30 area. There was a period of euro strength when the prepared text of Bernanke's speech said the current level of QE would continue until there was solid evidence of recovery. During the press conference, he seemed to indicate that tapering off had been discussed and this caused a market reversal.

The weekly trade has been confined to a narrow range within the main body of last week's trade. These seem to be few pending fundamental reports that can break the stalemate.

There are more stories about the amount of European non-performing bank loans. Stories persist about the vast sums that will be needed to keep the banks solvent, especially in Spain and Italy. These non-performing loans are called "extend and pretend" loans. The banks roll them over and pretend they will get repaid.

To keep the banks afloat, the ECB loans the banks funds, but the ECB wants collateral. Acceptable collateral, however, is getting harder to find, as the European recession damages ratings of existing paper.

To the puzzle we must add the activities of the Fed. They keep adding to their balance sheet, buying outstanding loans, further contracting the amount of good collateral available. Perhaps the ECB is not the lender of last resort but rather, it is the Fed. Zero Hedge notes the Fed has loaned $1.03 trillion to foreign banks that have U.S. branches.

This sounds like a crisis in the wings, which will surface when we have time for a new crisis. Should this happen, it is difficult to anticipate how the market will respond, but I guess specs will move in to the safe currency/investment du jour.

We talked about the yen extensively here, and have little to add today. The market today is continuing the retracement and is now around 1.01. Should we close at this level, this gives us a weekly reversal from the USD high of 1.0372. The action is very similar of that in the week ending April 21. Then the yen was unable to conquer the 100 handle and retreated to 97.

We should note the volume of futures trade at the CME was 398K yesterday. This trading volume exceeded the trading volume in the euro, 326K and was more than the total OI in the yen, 227K. The OI yesterday was down 3.1K and my guess is there is more liquidation today. For the yen bears, this is another caution flag.

My forex calendar shows BOJ Governor Kuroda has a busy week with speeches Sunday and Wednesday, interspersed with the BOJ Minutes published Monday. We should have ample trading opportunities.

The Australian dollar has remained under pressure this week. As we expected, the COT report showed the large specs had moved to the short side as we sold off in the previous week. Australia is still paying the price for the commodity boom, which has given them the "Dutch disease."

An elevated currency and high labor costs have made it impossible for manufacturing in Australia to compete. This week, Ford (NYSE:F) announced it would discontinue production in Australia. Holden, a joint operation with GM (NYSE:GM) and a subsidized Australian venture, is also losing money. The lower yen has given Japan a competitive advantage, and Hondas (NYSE:HMC) and Toyotas (NYSE:TM) are selling.

Some of the large brokerage houses have lowered their target on the aussie to 90 by year-end. Looking at the weekly chart, there has been support at the .96/9650 level four times in the last three years. After touching that level, the pair rallied to parity every time.

Perhaps this time, it will be different. The RBA did reduce the bank rate to 2.75, which proved to be the catalyst for the break. On Tuesday June 4th, we get the results of another CB meeting. We need to follow this pair closely in the next fortnight. What are the chances we get everybody short and then have a run back to 100?

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Source: Weekly Forex Review - What Next?