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Sunday September 25, 2005 - 11:32:42 GMT
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Forex: Trendways Weekly Analysis

Sunday 13:50 GMT

With only one week left to month end, there is now a high probability for my mid summer scenario, namely that the market would most probably stay in consolidation at least until the end of the third quarter, to materialise. I have the feeling that October may be an interesting month ahead and this will be discussed today and during the coming week as there are quite a few things pointing to a possibly very exciting fourth quarter. In this opening paragraph let's only say that the USD finished the week with pretty strong gains across the board (with USD/CAD being the exception as usual). On a weekly closing basis the Dollar gained 200 pips v EUR, 230 v CHF, 120 v JPY, 330 v GBP and 95 v AUD, while it lost 85 v CAD. The price action has been perfectly in line with the model direction and on Wednesday/Thursday the very technical retracement also offered good opportunities to re-enter long Dollar positions for good profits which didn't take long to come up as all major pairs reached good technical levels. Thus EUR/$ and cable met their second and third T&S support levels (they had been set at 1.2040 and 1.7750 for Friday), also $/JPY and $/CHF more or less reached their second and third resistance levels (set at 112.55 and 1.2950 respectively). What was interesting was that $/CHF and GBP/$ finished well beyond their DHDL, but during the day (and also on Thursday) they both gave the opportunity to take small fast profits on contra trades. Sterling's sharp decline, particularly v USD but also seen on the crosses, must have not surprised Trendways readers for it had been well anticipated and discussed as a strong probability both on this page last week and also on the daily IMC updates (several technical reasons had been discussed pointing to that direction).

In the opening paragraph I mentioned that October (and Q3 in general) might prove to be a very interesting period. May I remind that also last year the market remained in long lasting consolidation for almost six months and then set off to a strong trend by mid October, when the model breaks generated the Q4 very strong moves (I recall EUR/$ breaking the model upwards at 1.2480 and rallying several hundred pips thereafter). Such seasonal strong action in October to year end are seen more often than not as the market gets out of summer doldrums and a last strong effort is made by big market players for a final improvement of their yearly P/L. Last year such a major move ended the correction and consolidation and led to a continuation of the magatrend, resulting to new USD lows in December. Whether we might see a more or less similar major move now will be discussed below however, if it comes, don't take ot for granted that is will be a copy of what happened in 2004, neither in direction nor in size.

Last week I gave on this page a brief probable market outlook for the next three and six months and wrote that over the shorter end period I rather expect a stronger Dollar, then some weakness by the end of Q! next year, giving a few reasons for such a scenario. Let me combine those thoughts with what we have seen a week later:

1. -- On political considerations, during last year's final quarter we had ahead the uncertainty of the coming US elections which certainly was a negative factor for the US currency. This year such a factor is not present while at the same time we have deteriorating conditions in the EU. The confusing results of the recent German elections which may lead to unstable coalitions, the French and Dutch referendum 'no' votes and EU failure to reach a seven year budget agreement, all these factors are negative for the EUR.

2. --On fundamentals, the steady rate hikes by the Fed, a course which is expected to go on further and bring the Fed rate to 4% by year end and very likely higher in early 2006, looks a good enough reason for the market to keep the USD on bid mode or at least not rush to sell it aggressively any time soon. The sluggish EZ growth and stubbornly high unemployment rate have kept the ECB off any serious thoughts pm following the Fed's path and, as EUR interest rates haven't gone up with these monstrously high oil prices in an attempt to combat inflation, one can hardly expect the ECB to raise rates in the next three months when oil prices may see a stabilisation and eve some modest correction.

3. --On technical ground, as I have repeatedly explained in the past, megatrends which take 4-5 years to complete don't get a complete correction within a matter of only a few months but they usually need 12-18 months for such a full cycle (or for a megatrend major reversal). I find it hard to believe that such a major USD downtrend has completed its correction and should resume soon. The EUR/$ major top 1.3665 was marked late last December and the correction low we have seen thus far (1.1865) was marked in July. The time elapsed between 1.3665 and 1.1865 has been too long to characterise only a medium term correction and too short to define a complete long term correction of the megatrend. These factors very likely suggest that, if anything, the Dollar long term downtrend should not resume any time soon (shorter term interim USD downticks every now and then should ot be precluded, though). Therefore, whether July's EUR/$ low has marked the long term correction low or not (I think it hasn't), we can reasonably expect the EUR (and the other majors) to spend more time near the lower end of this year's range (if not lower).

Such longer term thoughts as discussed above may be challenging to think about but, obviously, they can be of use only for planning and hedging over a longer horizon and they certainly don't help much in the direction of shorter term trading activity. We thus better leave them aside and look now at what we have in hand. The current technical environment looks quite interesting albeit with some conflicting indications on the short term horizon and let me mention below some of them:

The TC's of the major pairs have completed their adjustment by reaching almost zero values and only that of GBP/$ is a kind of exception as it has duly been falling but with still more ground to move lower (a full adjustment completed at 30 would be very strange). The EUR/$ TC, in particular, not only bottomed last week at zero but is also rising now on USD strength but, of course, such low levels (around 4 this Monday) are not yet very reliable in telling us that an oncoming strong and lasting TC rise is already on the table and we might see this indicator stall or even change direction again (a good example of the unreliability of low TC values has been seen in the last few days in the case of AUD/$). In any case, the TC behaviour of the major pairs is clearly telling us that a cycle has been completed and a new one may begin soon (if not already began on Friday). As usual, we can never say with certainty in advance in which direction such a new cycle will be, but we can at least expect some action. The underlying direction will be indicated only by he model and, for the time being, the model direction supports the positive USD case until we get a new directional model change.

I mentioned earlier some conflicting factors. Among those I would like to refer mainly to two such factors, the short term DI and the medium term MTI and WI:

The DI's are now clearly indicating that the majors have entered or are approaching short term oversold territory. We already saw $/CHF and cable closing well beyond their DHDL on Friday with EUR/$ and $/JPY getting fairly close to their respective DHDL. Although this might persist during the coming week (and even a move towards the DMDL may still be seen), the fact is that these levels can kick back and we have already had the case of $/CHF which, after reaching its DHDL last Tuesday and early Wednesday when it rose for the first time above 1.28, it backfired on Wednesday evening and fell fast and sharply to 1.2660 before resuming its upmove. Both pairs ($/CHF and cable) can remain overstretched a while longer if the market decides to test the late July EUR/$ second low around 1.1960 as Friday's close is not too far off. Such a move would see this pair also meet its current DHDL and, should this prove to be the case, one would hardly expect he CHF and the GBP to survive the pressure as well. A similar case to that of EUR/$ can also be made for $/JPY where the market could be tempted to test July's high around 113.70. To be on the safer side, let's just keep in mind that such overextended levels and with the DHDL's coming into play, it wouldn't be prudent to try to chase the Dollar on further gains, at least not without any retracements similar to that seen last Thursday. Whether one is willing to trade contras or just stand aside during such overshooting periods is a matter of personal value judgment and taste.

On the other hand, the medium term indicators (MTI and WI) are now showing very neutral levels or the currencies v USD in the medium run and certainly not at all an overstretched condition like that of the short run discussed above. This mainly due to the fact that the major pairs closed around their WBL on Friday and this obviously makes the WI neutral, but the non model based MTI is giving the same picture, too. The weekly charts (links as usual at the bottom of the page) illustrate the picture as they show the WBL plotted together with the weekly range bars. A relative exception to the general picture is once again the loonie (not at all surprisingly for this unit), which is showing a very neutral short term picture (DI almost zero) and a relatively oversold medium term picture with its MTI at -3.02 and WI at -1.51, but USD/CAD is normal as in its case the model is still hostile to the USD.

A pair which should be watched closely is AUD/USD. Despite its brief violation of its model point on Friday, the Aussie escaped a model break since the marginal price extension on the downside stayed with the 15 pip error margin and it close just above its model point. Monday could be a critical day given the proximity of the key model level now. With regard to the crosses we again saw quite a few "delicate" cases last week. EUR/JPY held its established range with the WBL again containing the downside. GBP/JPY finally obliged to obey its new model direction with a good decline off levels which actually offered good opportunities for a short position. The 198's are tough anyway but this pair is not at all oversold. EUR/GBP again touched its model point but failed to confirm an upside model break. As the TC still needs a downside adjustment, I think that the probability of the model holding much longer is a rather low one. EUR/CHF kept closing well above both its DBL and WBL. I can't preclude a further rise and eve a test of the mid 1.56's, however, given that $/CHF is much more O/B than EUR/$ is O/S, some consolidation in the 1.55 handle looks the more likely case for the time being.

Let's finish this weekend's analysis with a few words on linear analysis. EUR/$ ha a short term steep resistance line coming in around 1.2220 with a lower parallel now found at 1.1980. A similar short term resistance line on cable is found around 1.8075. $/CHF and $/JPY have short term steeply rising support lines coming in around 1.2725 and 111.20 respectively. There are no clear patterns at present except perhaps in the case of $/CHF, where the inverted SHS formation I mentioned a couple of weeks ago may still be valid and, in any case, it has already yielded a god upmove since first discussed here. Fibos are not playing any role now except, maybe, for GBP/$ where the 61.8% retracement level (around 1.7740) of the upleg 1.7270-1.8500 was still holding until Friday closing time but now is only a handful of pips away and therefore extremely vulnerable.

Weekly charts:



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