Weekly Review and Outlook Euro Broadly Pressured after a Volatile Week, USD/JPY Heading Back to 80

It's been an extremely volatile week with lots of headlines flying around but three developments should be paid more attention to. Firstly, Euro was broadly weak in spite of ECB's rate hike and the signal of maintaining tightening bias. Even though the Greece situation was temporarily resolved, worries on contagion has indeed intensified. Secondly, the sharp reversal in US treasury yields took yen crosses broadly lower on and could be setting the stage for more upside in the Japanese yen ahead. Thirdly, even though the job data from US was deeply disappointing, selloff in risk was relatively brief and shallow. There is no confirmation of reversal in risk sentiments and dollar remains vulnerable to more selling ahead.

ECB raised the main refinancing rate by +25 bps to 1.5%, the highest level since March 2008. The interest rate corridor stayed unchanged at +/-75bps. While there were few changes in the language in the accompanying statement, the central bank noted the momentum of economic recovery has moderated. The ECB continued to describe the monetary stance as 'accommodative'. Concerning inflation, the ECB stated inflation rates will likely stay above +2% in coming months and it pledged to prevent faster inflation to give rise to 'second-round effects'. The central bank did not signal when the next rate hike will be. Yet, the comment that 'it is essential recent price developments do not give rise to broad based inflation pressures over the medium term' indicates further rate hike later this year cannot be ruled out. 

In spite of rate expectation, Euro's upside was limited by intensifying concern on debt crisis contagion. Moody downgraded the credit rating of Portugal to Ba2, or junk, citing there is 'growing risk that Portugal will require a second round of official financing before it can return to the private market'. The downgrade was also affected by the rollover plan for Greek debts. Moody worried that involvement of private investors in a new bailout plan for Greece will later be set as a pre-condition in Portugal's rescue plan. That is 'very significant because not only does it affect current investors, but it is likely to discourage new private sector lending going forward, and therefore reduce the likelihood that a country like Portugal will be able to regain access to the capital markets at a sustainable cost'. The downgrade triggered worries about a 'downgrade contagion' to Ireland. CDS on Portuguese, Irish and Greek sovereign debts rose to record highs last week. Indeed , CDS on Portugal is suggesting more than 50% chance of default in five years.

Technically, EUR/USD is still staying inside a triangle pattern in converging range, suggesting indecisiveness in the market. However, The sharp fall in EUR/CHF last week is opening up the case for another record low below 1.18 in near term. The steep decline in EUR/GBP also suggests that the cross is vulnerable to more selloff back to 0.86 level. EUR/JPY reversed ahead of 117.88 resistance and the technical development indicates that fall from 123.31 is likely resuming in near term to below 113. EUR/AUD's break of 1.3228 support also suggests that recent down trend is resuming for 1.2926 record low. We'd believe that 1.4 in EUR/USD and 1100 in XAU/EUR are important levels for Euro to defend. While Euro is bearish against swissy, yen and aussie, and to a lesser extent sterling, the selloff might not accelerate as long as these two levels holds. However, break will trigger much steeper and broad based selloff in the common currency. 

The benchmark 10 years US yield dropped sharply last week after disappointing US non-farm payroll report and just managed to hold 3.00%. Expectation on the non-farm payroll report was high the impressively strong ADP report. But, investors were hit back to reality after NFP showed merely 18k job growth in June and that's way off market expectation of 89k, not to mention that 150-200k adjusted expectation following the 157k ADP job growth. May's data was also revised down to 25k. April's figure was revised down slightly to 217k. May and June together were the worst two months total since last August and September. Unemployment rate also unexpectedly ticked higher to 9.2%. The poor job data reignited talks on the prospect of QE3. A former BoE policy maker, now a professor at Dartmouth college commented on the US situation and said "QE3 looks increasingly on the table. What are they going to do, let unemployment start rising again?"

Yen crosses were generally lower following US treasury yield on Friday. In particular, USD/JPY seemed to have finished the recovery pattern that started back in June and is possibly heading to below 80 again. Further weakness in USD/JPY, if accompanied by 10 year yield sustaining below 3%, will likely take other yen crosses lower ahead. 

DOW looked like going to have a take on 12876 high after the ADP number on Thursday but the brake was pressured hard after the poor NFP number. Nevertheless, at this moment, we're not seeing a reversal in stock year and that is possibly just a brief retreat. Stocks are indeed supported by the QE3 speculations. And as long as 12539 in DOW and 1330 in S&P 500 hold, we're still expecting more upside in stocks in near term. Similarly, commodities are still near term bullish as long as the CRB index stays above 340 level. And such developments will continue to support Canadian, Aussie and Kiwi. Indeed, AUD/USD and USD/CAD were just staying in tight range in spite of the post NFP pull back. Kiwi even managed to close at new record high against the greenback. Strength in equities, commodities and weakness in treasury yield will limit dollar's rebound attempt.  

 Dollar index continued to stay in triangle pattern from 72.69 last week. More sideway trading would likely be seen in near term. But after all, we'll stay bearish as long as 76.36 resistance holds and expect an eventual downside breakout to extend the down trend from 88.70 to 70.70 historical low. 

Bernanke's testimony at House Financial Services Committee on monetary policy and economy and FOMC minutes will be a main focus of the week. The minutes will likely provided details of the discussion on monetary policy normalization strategy. Bernanke will likely further provide details in the testimony. A main focus is on whether Bernanke would loosen up his guard on further quantitative easing in consideration of the poor job data in Q2. Another focus will remain on the development in Greece's second bailout package. It's reported that no progress was made on the details of private sector involvement in the second bailout after two weeks of negotiation among EU, ECB and IIF. EU finance ministers will also discuss the results of stress tests on 91 European banks that are due to be released on July 15 by the European Banking Authority.

• Monday: Japan household confidence; Canada housing starts
• Tuesday: BoJ rate decision; UK RICS house price balance, CPI, trade balance; US trade balance, FOMC minutes; Canada trade balance
• Wednesday: China GDP; Swiss PPI; UK jobless claims; Eurozone industrial production; US import prices, Bernanke testimony
• Thursday: New Zealand GDP; Eurozone CPI; US retail sales, PPI, jobless claims
• Friday: BoJ Minutes; Eurozone trade balance; US CPI, Empire state manufacturing, industrial production, U of Michigan confidence;

USD/JPY Weekly Outlook

USD/JPY edged higher to 81.46 last week but subsequent reversal and break of 80.76 minor support suggests that choppy recovery from 79.69 has completed already. Initial bias remains on the downside this week and break of 80.25 minor support will affirm the case that fall from 82.21 is resuming. Further break of 79.56/69 support zone will also confirm resumption of whole fall from 85.51 and should target 61.8% projection of 85.51 to 79.56 from 82.22 at 78.54 next. On the upside, break of 81.46 is needed to invalidate hits view or we'll stay cautiously bearish.

In the bigger picture, note that USD/JPY's rebound from 76.41 low was held by medium term long term falling trend line as well as the 55 weeks EMA. Thus, down trend from 124.13 could still be in progress. Current fall from 85.51 might now extend through 75.98 for a new record low. In any case, break of 85.51 is needed to revive the case that USD/JPY's down trend has finished. Otherwise, we'll stay cautiously bearish in the pair.

In the long term picture, the minimum target of trend resumption, that is, a break of 79.75 low (1995 low) was met. While the rebound to 85.51 was strong, there is no indication of reversal of the multi-decade down trend yet. We'd look at the structure of the rise, as well as whether USD/JPY could take out 100 psychological level before giving favor to the trend reversal case. Otherwise, we'll treat current price actions as part of a long term consolidation pattern at best.