Forex Investment and Currency Trading

Risk appetite remained favorable during Monday’s Asia session, with modestly higher Chinese equities, following last Friday’s upside surprise on US existing home sales. Thus, the USD was weaker against European and commodity currencies, and the JPY was weaker broadly. USD-JPY continued to gain, also on favorable US-Japan yield differential shifts, testing the 200-day moving average at 98.89. The fact that a medium-sized Japanese broker’s newly established global financial stock investment trust fund (toshin) on Friday gained popularity with inflows of Y10.6bn appears symbolic of improving risk appetite for Japanese retail investors. At his lecture on 22 August in the Fed annual Jackson Hole conference, BoJ Governor Shirakawa stated that the authorities should prevent acceleration of bubble on unfounded expectations of low interest rates for an extended period of time. Opposition DPJ Representative Hatoyama, the most likely candidate for the next Prime Minister, stated that the party does not intend to increase JGB issuance in FY2010 and review spending items. Some analysts believe that some market participants’ expectations of a stronger JPY on a loose fiscal discipline and higher domestic yields are overdone.

The Federal Reserve’s annual Jackson Hole Conference came to end without having much effect on financial markets. Federal Reserve Chairman Bernanke and ECB President Trichet both delivered speeches marked by a tone of cautious optimism but did not reveal much new information about the respective monetary policy outlooks. The real determinant of price action since Friday has been the unexpected surge in July US existing home sales. On the back of the data, the S&P closed up +1.86% on the day to post new highs for the year and made a clear break above resistance created by the 38.2% retracement of the plunge from the October 2007 high to the March 2009 low. From a technical point of view, the way has been opened for a rally to 1120, about 9% above current levels. The equity market strength carried over to Asia with the Nikkei 225 up +3.35% on the day and the Shanghai Composite Index posting a more tepid gain of +1.10%.

With the S&P posting new highs for the year, the broad environment is dollar negative. Indeed, the improvement in risk appetite provided EUR-USD with a substantial boost on Friday to test significant trend-line resistance (1.4372) from the all-time high of July 2008. A break above this level would open the way for additional gains of about three big figures with the next major level of resistance seen at 1.4621, the 61.8% retracement of the dive from the July 2008 high to the October 2008 low. With the two-year Eurozone-US swap spread largely flat over the last few sessions, interest rate differentials are neither supporting the move nor working against it. In any case, in recent months, the correlation between EUR-USD and the S&P 500 has been much stronger than the correlation between EUR-USD and rate differentials. In other words, the bias remains to the upside for EUR-USD.

The “risk rally” leaves USD-CAD with a near-term bias to the downside. Thus far, the pair has held below resistance (1.0859) created by the short-term trend line from the August 19 high. Significant trend-line support from the September 25, 2008 low comes in at 1.0655, and a break below this level would suggest a move towards the aforementioned lows of 1.0300. However, the short-term direction of USD-CAD should also be influenced by today’s release of June Canadian retail sales. The market looks for a weak headline number of -0.3% mom, but a constructive ex-autos number of +0.2% mom.