Perhaps it is the California air, where I am on a business trip, but it seems that the euro bears have run their course for the time being and a corrective phase may be unfolding. The late buyers of dollars against most of the major and emerging market currencies look vulnerable.
Just like I brought to your attention the importance of the gaps in the euro and Swiss franc created by the sharply lower opening on May 7, I warn that the price action following the news about the ECB cutting of credit to a few Greek banks was important and revealing.
When the news first broke, the euro was of course sold off, but it could not make a new low and then rebounded quickly. The same is true for the Swiss franc, or the inverse for the dollar. I see it as a further confirmation of the extent that the market is short euros and long dollars (against a range of currencies). It warns the market is stretched and vulnerable.
The price action, coupled with the high probability some are assessing a Greek exit, reveals market psychology. Participants are seem to0 confident in knowing the outcome of what is still a life time away in terms of short-term momentum players time horizon.
We have seen this before. The market acts is if the apocalypse is are the corner. Yet, there seems to be almost a self-correcting mechanism at work. Policy makers take some steps to demonstrate their resolve and take a step away from the edge of the abyss.
The pressure on the euro, and the risk-off general theme requires a steady stream of poor news to continue to feed the Bear. Suggestive comments from policy makers, more emphasis on the growth/investment pact. The G8 Summit and the EU Summit (heads of state) are both forums for such talk. The rhetoric that most often emerges is one of cooperation and resolve to act. Market positioning is so stretched that anticipation of this is all it may take.
Let's be clear. My understanding of the macro fundamentals have not changed. They favor the dollar. I am warning here that the technical condition may be changing. Specifically, here is the kind of move that I think is increasingly likely:
The euro initially has potential toward $1.2785-$1.2850. A move through the top end of the range could see $1.30. The key gap resistance is essentially $1.3065-$1.3080. Sterling can initially test on $1.60 and if that is easily broken there is potential toward $1.61. The Australian dollar can test $1.0000-20. The US dollar can slip back into the CAD1.0050-70 area. On the crosses, Norway has outperformed Sweden and Australia has outperformed New Zealand. Neither cross shows signs of topping, but if the correction unfolds they should also correct.
The yen seems particularly difficult. On one hand, corrective pressures should weigh on the yen against the dollar and euro (and other currencies). On the other hand, the dollar has been gaining on the yen for more than a week. I suspect this means that the yen may weaken more on the crosses than against the dollar.
Emerging market currencies can also rebound. In that space, I like the Mexican peso and the South African rand.