Forex Market Update

USD and JPY flailing for support as markets line up at the risk punch bowl for another round. Are consumers as confident as the market?

Big week for US treasury auctions with $115 billion on the block this week. Is weak USD trade getting crowded?

MAJOR HEADLINES – PREVIOUS SESSION

* UK Jul. Hometrack Housing Survey out at -7.7% YoY vs. -8.7% in Jun.
* Japan Jun. Corporate Service Prices out at -3.2% YoY vs. -3.3% expected
* Germany Jun. Import Prices rose 0.4% MoM vs. 0.7% expected
* Germany Aug. Consumer Confidence rose 3.5 vs. 2.9 expected
* Sweden Jun. Trade Balance out at 17.3B vs. 9.0B expected
* Hungary Central Bank lowered rates 100 bps to 8.50% vs. 9.00% expected

THEMES TO WATCH – UPCOMING SESSION

(All times GMT)

* US Jun. New Home Sales (1400)
* US Jul. Dallas Fed Manufacturing Activity (1430)
* US Fed's Bernanke at recorded town hall meeting (2200)
* New Zealand Jun. Trade Balance (2245)
* Australia Q2 NAB Business Confidence (0130)
* Australia RBA's Stevens to Speak (0300)

Market Comments:

The signs of a bullish reversal that materialized late last week failed to find confirmation and here we are again seeing the USD challenge the low of the multi-month range again as equities have bulled up to highs once again in the one-way express higher (the hottest two-week streak since 2003!). EURUSD was within 40 pips of its high for the year today, and USDCAD dipped its feet in the waters below 1.0800 again, testing the lowest levels since October of last year. AUD is also testing its highest level vs. the greenback since the Lehman catastrophe. A contrarian would note that the CFTC was out reporting that net USD shorts are at near record levels. EUR longs are at the highest level since July 2008 (that was the month of the 1.6000 top just before EURUSD tanked). There can hardly be much fuel left in the EUR rally from these levels.

The US and China begin a series of talks today. The usual items are on the agenda, and the US will expend considerable effort trying to assuage China's fears about the values of its US debt holdings. Meanwhile, the most important factor in global currency markets will likely be virtually ignored: China's overvalued currency and how its unwillingness to allow the Yuan to appreciate is turning other currencies into safety valves. The pressure in the system is enormous, but China's ability to keep the global imbalances on track with its myopic weak-Yuan policy seems to be even larger now. Should the pathetic European economy feature an ever-strengthening currency now? China's reserve diversification is a key driver in this market. The recent massive increase in their reserves coincided with a move weaker in the USD - much of this was likely due to diversification pressures on capital flows rather than trade flows, which show a rapidly unwinding of trade imbalances. A return to risk aversion combined

Bloomberg leads with an article this morning indicating that equity analysts are bullish on a net basis and expect earnings growth to hit 25% next year - which if it came to pass would be the biggest earnings increase since 1995. This challenges our view that end demand will remain extremely weak as the final deleveraging that must take place as we move forward is in the private balance sheet. This process has only just begun. Many have pointed out that the better than expected results for some companies in Q2 is coming from efficiency gains and cost cutting rather than from more healthy sales growth. The paradox of saving will quickly eliminate any earnings growth from austerity.

This week's data schedule is not particularly heavy. Tomorrow's US Consumer Confidence number will again be very interesting to contrast with the optimism (if that's what it is) in the markets. US Q2 GDP is out on Friday. Besides the numbers, we will of course have our eyes glued to the wires for the results of the US treasury auctions this week, as the Treasury tries to unload a record amount of debt for a week. The auctions may go well considering that the debt is for two-, five- and seven-year notes, a bit more comfortable for the bidder who is concerned about inflation materializing down the road with their relatively short duration... Another item to keep an eye on that we discussed last week is the high-frequency-trading (HFT) issue, which has started getting a lot of press recently. Senator Charles Schumer of New York is getting involved and has proposed prohibiting an order type that makes the shops able to manipulate. Any policy effort that shows the potential to disrupt these HFT operations could change the market system in one fell swoop. While the HFT players are nasty parasites in the market, they are a very important part of the ecosystem nonetheless and a disrupt could cause massive volatility. This is an important issue for all asset classes.

Chart: EURUSD
EURUSD - the persistent fake-outs continue, as EURUSD touches to a new local high today, only to dive back down into the range. Technical trading has been frustrated at almost every turn lately as we await a bigger expansion in volatility and move out of the range before trying to draw a bead on the technicals. Important tactical downside confirmation level for a possible bigger move lower comes in around 1.4200/1.4180. Otherwise, the 1.4338 looms as the obvious upside barrier for now.