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By Dean Popplewell

The market downtrend continues to develop. It is difficult to get individually enthusiastic when it's a tight range despite the volatility within that range. It’s even more suffocating to try to express certain trading strategies within that defined range. This has been the only theme that investors have witnessed over the past two trading sessions. However, thank Spanish bad debt data for having opened up this morning's range. Bad debts held by Spanish banks hit a record high in July (+$222b or +10% of credit) and deposit outflows (-7.8%, y/y) are gaining pace as the Spanish banking system sufferers a deeper economic and financial crisis.

Overnight, regional equities have drifted lower as the boost from the Fed’s bond buying program announced last week dissipates. To date, investors have wanted to know how long the exuberance of QE3 was going to last. Not long it seems, would be the most accurate of answers, now that risk is somewhat beginning to be priced out. Most asset classes seem to have been overbought due to market euphoria. Investors are now looking for that equilibrium and not a price vacuum.

Expect the market's attention to drift towards China’s September preliminary manufacturing data out this Thursday. The Fed cannot continue to do the PBoC job. This summer’s biggest mystery is why the PBoC has not done more to support internal growth. Analysts will tell you that Chinese industrial output and exports growth happens to be at its lowest level since the beginning of the financial crisis. Yet the CBanks monetary policy remains relatively tight. U.S. QE will push capital flows to emerging markets. Some of these flows will end up supporting China’s questionable real estate and equity prices, and naturally “pump up liquidity in the banking system, pushing bank lending and investment higher.”

If the Fed happens to get U.S. growth off the canvas, then China will have a stronger economy to export to, certainly one that should have more of a renewed appetite for Chinese goods. China remains the world's unknown growth factor. It’s either a soft or hard landing.

Last night's RBA minutes were a touch more dovish, and again provided little forward guidance. Policymakers “discussed the possibility that the high level of the exchange rate was weighing more heavily on the economy than might be expected.” Overall, while the international outlook was more subdued than a few months ago, with domestic growth close to trend and inflation expected to be consistent with target, the stance of monetary policy remained appropriate. There is scope to adjust policy in response to any deterioration in the growth outlook. With some major CBanks using QE to “inadvertently” weaken their domestic currency, others will be worrying about the strength of their own currency. A sustained Aussie raises the chance of a rate cut from the RBA in response to tightening monetary conditions. An economy's growth and exports cannot continue to bankroll the manipulated value of currencies.

Other data making headwind this morning is the U.K.’s annual rate of inflation slowing in August (+2.5% vs. +2.6%). The slowdown reflected a smaller increase in prices for clothing, footwear and some household goods. It seems that these costs have successfully offset the rising price of fuel costs. The slowdown in the annual rate of inflation may reinforce expectations that the BoE will print more money to buy more bonds to aid in the British economic recovery. Futures and FI dealers expect the BoE to act in November now that the core inflation also slowed on the year (+2.1% vs. +2.3%).

EUR pullbacks are inevitable, certainly given the summer's surge in risk appetite and uncertainty surrounding timing of a Spanish bailout. It’s not if, it’s when. The impact of the Fed policy should keep the dollar subdued and favor a market buying the single currency on dips. Even the German ZEW index is not aiding a currency that is beginning to open up. The index came in at -18.2 compared to expectations for-19. However, the current conditions index is lower than expected at 12.6 compared to a market forecast of 17.7. ZEW says that the ECB may have helped improved sentiment but the economy is seen as rather moderate.

Sept 18

For the EUR, daily charts are heavily overbought with its four-month high (1.3173) its short term cap. Corrective easing action is on the cards ahead of another run north. According to the techies, the underlying trend remains with the bulls. It seems that market strategists prefer to buy dips back to 1.3010 as fresh buying opportunities, ahead of last Friday’s low of 1.2980.

Forex heatmap

Source: EUR Pullbacks Are Inevitable And Needed