Fiscal health of underlying economies weighs more heavily as EU, US grapple with debt burdens
The past week showed an unusual divergence: fading overall risk appetite as per the barometer of major global equities, yet strength in the leading risk currencies, the AUD and NZD. Note that when we speak about “risk” currencies in forex, we refer to those that best correlate with other risk assets like equities, that is, that move up and down along other risk assets. The terms “risk currency” or “safe haven currency” are not talking about the actual safety of the currency as a store of value. At least, not until recently.
To reflect this phenomenon of how we’re seeing the NZD and AUD serving as safe haven currencies (amazingly without yet having relinquished their risk appeal too) without the direct influence of the troubled EUR or USD, we look at the AUD and NZD vs. the JPY
We believe the reason for this is that given the sovereign debt issues in both the EU and now US, a new focus on the fiscal health of the economies underlying currencies has recently become a more important factor in choosing a flight to safety currency.
Let’s look at the charts.Equities: Using The S&P 500 As Risk Barometer
Stocks had their biggest weekly drop in 2011 this week, understandable given the further confirmation that the slowing growth and deficit/ solvency issues in the EU and US must eventually weigh down the major global indices, given how close they remain to multi year highs of this past April fueled by QE 2 cash.
Looking at the weekly chart for the bellwether S&P 500, here’s how those fundamentals are being reflected.
S&P 500 WEEKLY CHART COURTESY ANYOPTION.COM 05JUL 30 2330
- Persistent downtrend since late April (blue descending line), which would be steeper were it not for the big bullish green engulfing candle of 26 June 2011 that was fueled by what has since proven to be premature optimism about a solution to the Greek crisis
- Potential bearish Head & Shoulders Pattern formed by weekly candles of February 20, 2010, May 1 2011, and July 10, 2011
- On the S&P’s daily chart, a few more bearish hints.
S&P 500 DAILY CHART COURTESY OF ANYOPTION.COM 07jul 30 2347
- Another decisive weekly close below the 50 day EMA (red). The last time that happened, in early June, the index tested down to the 1250 range and even briefly below its 200 day EMA (purple).
- The price is now firmly within the lower bands (orange & dark green) of the Double Bollinger Band Sell Zone, indicating more downside ahead. See 4 RULES FOR USING THE MOST USEFUL TECHNICAL INDICATOR, DOUBLE BOLLINGER BANDS for details.
Bullish Signs: Only Resilience
The biggest bullish factor here is that despite the bearish fundamentals noted above this index and many other global indexes are still down less than 10% from their highs, and that’s a resilience that should be respected until we get a break below the 1250 level on the S&P 500.Common Denominator Of Strongest Currencies: Fiscal Health
Meanwhile, the currencies that have been strongest in recent weeks, the NZD, AUD, and CHF, while representing different ends of the traditional risk spectrum, share a common theme. All have healthier underlying economies with lower debt than the top ranked safe havens of the past years, the USD and JPY. Again, we compare these 3 recent top currencies to the JPY, to eliminate most of the EUR or USD volatility and thus better demonstrate how the AUD, NZD, and CHF have all prospered against the backdrop of deteriorating EU and US debt conditions.
WEEKLY CHARTS AUDJPY, NZDJPY, CHFJPY, COURTESY ANYOPTION.COM 02aug 01 1006
The key takeaway point: The only thing these share in common is strong fiscal health and relatively low debt. We suspect the reason is that events of recent weeks have caused traders to seek safety as defined by economic health and low sovereign debt levels rather than by traditional considerations like interest rate differentials.So What About The CAD?
If currency traders are seeking currencies with the lowest sovereign debt levels, why hasn’t the CAD participated in the recent rally? Canada has very low debt/GDP, a healthy banking system that did not participate in real estate bubbles or require bailouts. Yet, only at the start of this week has the CAD started to move up vs. the JPY.
Why? In addition to relatively weaker data vs. the AUD, NZD, and CHF, we suspect the reason is that the CAD is so tied to the fate of the US economy, destination of about 75% of Canadian exports. The nascent reversal at the start of this week coincides with new hope that the US debt ceiling will finally be raised in time to avoid default.
WEEKLY CHART CADJPY COURTESY ANYOPTION.COM 04aug 01 1019
Admittedly, the CHF should be similarly influenced by the EU, which is the destination for most Swiss exports. No clear explanation handy. During the spring/summer of 2010 it indeed sank with the EUR, but that hasn’t been the case in 2011.Additional Considerations For The Coming Week
A few thoughts to add.
EURUSD Direction In The Coming Weeks
Looking at the below EURUSD weekly chart, we note the following
EURUSD WEEKLY CHART COURTESY ANYPTIONS.COM 04jul302315
The pair remains in a multi- week downtrend. Only a decisive break above that downtrend line (blue) would change our opinion
The 1.4000 area remains strong recent support since late April given the price action since then, so only a break below this level will open the way to another leg lower to the next major support zone around 1.3800, which features 3 different mutually reinforcing support elements:
- The 1.3800 price level itself, a nice big fat round number that has been working will over the past months
- The 50 week EMA (red)
- The 38.2% Fibonacci retracement
Given the recent breakthrough in the US debt impasse, the EURUSD is likely to maintain its current trend lower.Ramifications: Bullish on Precious Metals, USD, Bearish on EURUSDUSD RALLY IN THE CARDS?
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING DECISIONS LIES SOLELY WITH THE READER. IF WE REALLY KNEW WHAT WOULD HAPPEN, WE WOULDN’T BE TELLING YOU FOR FREE, NOW WOULD WE?