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Wednesday September 8, 2010 - 13:57:35 GMT
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U.S. Dollar Under Pressure but Investors Still Jittery over European Banks

The U.S. Dollar is giving back some of Tuesday’s gains overnight but investors remain jittery over European bank concerns.


There are no major U.S. economic reports this morning which may mean increased volatility early. Later in the day, the Federal Reserve releases its Beige Book. This report will offer assessments on different regions of the economy by the central bank’s member banks and is used by the Fed to determine interest rate policy at its regular meetings.


While not expected to have a major influence on the Dollar’s direction today, it is likely to clarify the Fed’s recent decision to leave interest rates at historically low levels and the reasoning behind the Federal Open Market Committee’s decision to use the proceeds from its mortgage investments into Treasury Bonds.


The Japanese Yen hit a 15-year high versus the U.S. Dollar on Tuesday as investors shed risky assets. Safe haven flows partially triggered by a report in the Wall Street Journal sent cautious traders scrambling this morning for protection, driving down the USD JPY.


The WSJ report brought up an issue that had been buried since July 23 when Europe released its bank stress test results. If you recall, analysts were expressing concerns about the methodology of the tests. Traders ignored these concerns at the time and continued to drive the Euro higher for another two weeks before finally topping at 1.3334. Tuesday’s Journal article said that stress tests conducted on European banks earlier this summer understated some lenders’ holdings of potentially risky government debt.


Technically, this morning’s sell-off in the USD JPY took out the August 24 bottom at 83.59, before finally stopping at 83.51. In my opinion the lack of follow-through to the downside following the break through the bottom is a sign that investors still feel the Japanese government or the Bank of Japan is poised to take action to prevent the high priced Yen from hurting the export market and damaging the economy.


This doesn’t mean the USD JPY will turn its trend around, but it probably indicates that the bears will take a cautious approach when pressuring this market rather than applying heavy selling pressure. This type of trading is likely to prevent whip-saw type action that occurs when a market gets oversold too fast.


Concerns over the health of the Euro banking system may have caught U.S. traders by surprise on Tuesday. Coming back from a three-day week-end, many traders had expected the EUR USD to continue last week’s rally partially fueled by Friday’s better than expected U.S. Non-Farm Payrolls report.


What yesterday’s WSJ article did was plant a seed of worry in the minds of investors who believe that the poor performance of the U.S. economy is the only problem to be concerned about now. While yesterday’s trading action doesn’t mean its time to bail on the Euro and buy the Dollar, it does indicate that perhaps long Euro positions have to be pared as a pre-caution against another possible round of sovereign debt selling pressure.


Technically, the EUR USD looks pretty busy. Despite Tuesday’s sell-off, the main trend on the daily chart remains up with a pair of swing bottoms at 1.2625 and 1.2587 still intact. Once these bottoms are violated, the main trend will turn to down.


A break through 1.2587 will also mean that a key 50% level at 1.2605 will have been violated. This action will set up the market for a further decline and a possible test of the .618 Fibonacci level at 1.2433.


To some traders looking at the retracement levels, it appears the market will accelerate to the downside once 1.2605 is violated. This may not be the case, however, because a major uptrending Gann angle at 1.2536 may impede the break and perhaps trigger a counter-trend technical bounce.


On the upside, Monday the EUR USD found resistance on a downtrending Gann angle from the 1.3334 top at 1.2882 on Wednesday. The closing price reversal top formed at 1.2919 following a test of this angle was confirmed on Tuesday. The first objective of this pattern at 1.2773 was reached this morning. In fact it was exceeded, indicating that further weakness is likely.


Unless some high ranking official refutes the Wall Street Journal article questioning the risky government debt held by European banks, a wall of worry is likely to be built along with short positions by hedge funds. This could lead to the start of a prolonged move down in the Euro.


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