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A Correction Arrives (Finally)

|Includes:CUD, ERE, iPath EUR/USD Exchange Rate ETN (ERO), FXA, FXB, FXC, FXE, FXF, FXY, GBB, JYN, SPY, SZE, UDN, UUP

The S&P 500 has fallen approximately 46 pts from its highs, keeping risk traders at bay and pairs such as GBP/USD, EUR/USD and AUD/USD remain consolidated, with downside support levels under constant pressure.

Throughout this recession we have seen the staunch correlation of these pairs to the world equity markets, where risk trading reigns supreme, and few things have caused them to separate this relationship along the path. The occasional interest rate news and other local events are common among driving what seem to be nonsensical spikes and heavy movements in price, though from a macro perspective, we seem to religiously revert back to this relationship.

The dollar is slightly weaker tonight, after a correction the stock market helped push the pairs higher late in the US trading session. We now sit in the middle of a range that began approximately 2 weeks ago, with lower highs being made across the board.

After 2 weeks of consolidation and indecision among buyers and sellers, the S&P 500 has officially broken through its supportive trendline, and bears are now targeting lower retracement levels. Likewise, the Nikkei, FTSE and FESX are in the same boat, finally falling over from an overheated rally that began in early March.

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Because of this, we look to badly needed US dollar strength in the weeks to come on the back of risk leaving world equity markets for the time being, bringing EUR, GBP AUD, etc to lower levels.

A “V” shaped recovery is great for political talk, but reality is another issue. Despite a string of better-than forecast numbers over the course of the past several months, world economic data is still very generally poor and sectors are still in rough shape. What wealth has entered these sectors over the course of the past few months has provided little in terms of sustenance, as more debts need to get paid off from beatings taken over the course of the past year. We had little reason to believe this rally would continue for long; the only question was: “how high before another collapse?”.

But as we all know, markets move up, down and sideways, and this equity market support break could temporarily be the beginning of a head and shoulders pattern or some other mutant of this. When we translate this over to currencies it means we could indeed go higher on GBP, EUR and AUD; it’s still not out of the question, though bias is certainly down.

Particularly for GBP, the currency seems to be resilient to sellers this past week, but downside levels continue to get tested. EUR is weaker; thus, it’s been my weapon of choice to sell when markets are moving lower. Two weeks ago we had strong sentiment leaning to the upside on all of these pairs, and is now vanishing little bit by little bit.

Using GBP/USD as an example, here are our alternatives as I see them now:

For buys:

The downward-sloping diagonal trendline is the first major area of resistance, followed by highs at 1.6618 and 1.6661. A potential move into this area could see a short term retracement, or bounce from the diagonal trendline or highs, followed by a breakout. Ideally, a long position would be taken on confirmation of this momentum , anywhere between the diagonal trendline high and 1.6618. A target on this trade would potentially be as high as the 1.7100 area, if it can clear the 1.6780 area. We would lock ourselves in at breakeven ahead of the local resistance (1.6661) to protect from any failures.

For sells:

Downward pressure on the 1.6239 and 1.6212 area continues. If a failure is truly to occur and in any time soon, we would like to see a day of heavy selling pressure going into this level, ideally selling ahead of this zone to protect ourselves from any false breakouts. The major area of support below this zone comes in at 1.6130 and 1.6114 (retracement confluence) and 1.6089, as well as a slew of rather ambiguous support levels from bumps made on the hourly charts in the most recent uptrend. Because we have a ‘triangular’ pattern taking shape, the likelihood of a big pullback from an area like this (1.6130-1.6089) is possible, though we would prefer to lock our trades in at breakeven and see if we can ‘ride it out’ for lower lows.

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Short SPX