The euro is not oversold from a daily perspective but it is approaching some solid support levels that could provide quality buying opportunities.

On Wednesday, the euro’s nearly 300 pip fall against the U.S. dollar was the largest one-day fall since September of 2008. That’s worse than any single day during the European debt crisis. Without doubt, we see the euro moving lower from here in the medium term. In the short-term, however, we are nearing uptrend support and support from the June low of 1.2737.

We could see a further slide close to support on Friday, especially if U.S. retail sales disappoint. But looking to next week, there is very little on the data docket to spook the broad market. To us, that skews the risks toward a mild recovery trade. With that in mind, we would look for opportunities to buy the euro at below 1.28 with the expectations that we will see a re-test of 1.30 in the week ahead. If the euro does return to 1.30 we will be quick to take profits and initiate short positions for an eventual fall to new lows.

Our initial reaction to the stress tests is disappointment but we think the trade is to buy EUR/USD with a stop at the session lows. We would have liked to see a better stress test that included all the sovereign debt on banks books (rather than just the trading book). But what’s priced into the market? There is a €700 billion backstop on sovereign debt in Europe so there will not be a default. With economic data improving the market is pricing in a diminished chance of a double-dip recession so that is unlikely as well. The euro is down 60 pips to 1.2832 on the slightly damaged credibility of the ECB but we thought the U.S. stress tests were a sham as well (they forecast 9% unemployment in the adverse scenario). The market will turn its focus back to European and U.S. fundamentals and we believe that will reflect positively on EUR/USD in the short-term. Stop at the session lows but look for an eventual rally to 1.32. Remember that in a sentiment-driven market anything is possible so stay nimble.

The U.S. dollar has become the dog of the foreign exchange market and we expect the EUR/USD to continue rallying after a short pullback. The USD eked out only small gains against only the CAD and AUD on Thursday and experienced substantial declines against EUR, GBP and JPY. The market is beginning to grab hold of a theme that the U.S. economy will underperform expectations. Although we have seen a slight rebound from the dollar early on Friday, the overarching theme remains.

The trigger for the sudden surge in USD selling was Wednesday’s minutes of the June 22-23 meeting. In them, the Fed lowered growth forecasts and said the U.S. economy may not fully recover for 5-6 years from the Great Recession of 2007-09. Richmond Fed President Jeffrey Lacker, who is usually optimistic, even allowed that the U.S. will recover “perhaps at a pace that is less robust than has been typical of past recoveries.” Financial regulation reform, which passed on Thursday, is also making the U.S. a less competitive hub of global finance.

At the same time, the focus is shifting away from Europe. A recent sovereign downgrade of Portugal by Moody’s elicited hardly a blip in the forex market. On Thursday a successful Spanish bond sale further reinforced that a euro breakup and sovereign defaults are no longer a pressing concern.

The huge rally in EUR/USD yesterday pushed the euro above the 100-day and 100-month moving averages and points to a continued recovery in the euro. Expect the consolidation that has begun in Asia to continue as the week comes to a close. The RSI isn’t overbought and there is plenty of technical fuel for a rally but the odds favour intraday shorts on Friday.

The euro rallied to the highest since May 12 during the North American session before pulling back somewhat in Asia-Pacific trading. The catalysts were a successful Greek 26-week T-bill sale and broad risk appetite.

The rally in EUR/USD was a major technical victory. It pushes the pair definitively above downtrend resistance and above 1.2719, which is the resistance from last week’s high. The move also formed a bullish outside reversal candlestick patter. A small pullback will be a good buying opportunity but watch for resistance at 1.2766, which is the 100-month moving average.

We may be seeing a paradigm shift in the forex market. Bad news in the U.S. is no longer translating into a broad risk trade.

In the past, bad news in the U.S. would lead to a ‘risk off’ trade where the JPY was the main beneficiary but the USD also rallied against EUR and the commodity bloc. Over the past three days we have seen risk aversion coming from China and bad news in the U.S. Instead of seeing EUR/USD strength, we are seeing weakness.

Remeber that currencies are relative. Over the past 8 months, the euro has slumped based on euro-centric worries. The thinking was that European economic growth would lag U.S. growth by a large margin.

The outlook hasn’t improved for Europe but it is now darkening for the U.S. and elsewhere. Relatively, that’s a good thing for the euro.

If this is a paradigm shift, it’s major. It’s would be reminiscent of the USD during the financial crisis. Initially, the USD was falling to record lows as it appeared the crisis was limited to just the U.S. housing market. Later, when it became clear that the U.S. housing crisis was going to send the worldwide economy into recession, the USD rallied. This wasn’t good news for the USD, rather, it was relatively good news.

We are not yet saying there has been a paradigm shift but we are on the lookout. The caveat is that we are at the start of a new month and new quarter. Trading patterns often get skewed by flows. We won’t get a real idea of what is happening until July 6, when the U.S. returns from holiday.

Today’s price action was the signal we were looking for to mark the top in EUR/USD. We had a blowout to the upside that has aggressively reversed.

The main news of the day is that China will allow the yuan to appreciate against the USD. Analysts are scrambling to interpret the news and the market has been equally undecided. The U.S. dollar has been a main beneficiary on sentiment that U.S. manufacturing will be more competitive. Initially, the stock market liked the news but a stronger yuan probably means slower worldwide economic growth so that sentiment appears to have taken over.

The idea that China is curbing growth and inflation is weighing on the EUR. There is also a feeling that the entire up-move in EUR/USD was fuelled by short covering. CFTC data released late Friday shows a massive contraction in EUR net shorts so there is evidence that the slump has been little more than position squaring.

The daily chart now shows a downside reversal. We also see an inverted hammer pattern. Confirming the downside is the resistance at the top Bollinger Band, the RSI and the 50-day moving average.

We are seeing some signs of vulnerability in EUR after a streak of six rallies in seven sessions. We touched a fresh weekly high in the North American session on Wednesday but we later closed lower and EUR is down through early Asia-Pacific trading.

Technically, the RSI and Stochastics are flashing highly overbought signals. We are also well above the mid-Bolliger Band. We think any move close to 1.2453 is a wonderful opportunity to establish shorts.

Perhaps the top story in the day ahead will be the results of Spain’s efforts to raise as much as €3.5 billion through the sale of 10 and 30-year bonds. On May 20, Spain paid 4.045% in a 10-year auction but the notes are currently trading near 4.939%. The market will want a yield close to 5.00%; if it’s above 5.25%, the euro will weaken. A failed auction (where it’s cancelled due to lack of interest) would knock the euro down about 200 pips, possibly more. Another metric to watch is the bid-to-cover ratio, which shows how many times the number of bids per dollar sold. A ratio below 1.5 would be worrisome while something over 2.0 would be a positive for the euro. For the 30-year bond auction, a yield over 6.10% would be euro-negative while under 5.70% would be positive.

Spain has about €16.2 billion in debt that needs to be paid in July and Madrid will need to raise funds in order to make the payments. If, however, Spain can find access to funds at reasonable borrowing rates, it won’t have any major debt obligations to repay until April 2011. Success at today’s auctions would clear the way for 10 months and give the euro room to breathe and retrace recent losses.

The euro has started out the week by rising the highest since June 4 as it builds on a rally for the past week.

Over the past six months it has been rare for the euro to string together several up-days. We remain extremely bearish on EUR and will be using this bounce as another opportunity to sell. The question is: when is the right time to sell EUR/USD?

We noted the IMM data released on Friday. It showed EUR net shorts near record just shy of a record high. Remember that IMM data is from the prior Wednesday (in this case June 11). On that day the euro traded at 1.19 compared to 1.2178 currently.  That points to a short squeeze over the past few days. But with the market positioned so agressively short, the squeeze could still have some way to go.
We see three simple targets. 1.2334, 1.2467 and 1.2691. We don’t see the highest target as realistic. Market participants are so bearish on EUR that it will be sold long before it hits 1.26.

Looking at the Ichimoku Cloud on our 4-hour chart we think a somewhat agressive move higher to 1.2567 is possible if we get a close above the top of the cloud (on a 4hr chart).

We will have our sell orders ready, however, once it gets above 1.2334.

Note that the European Union is hosting a summit beginning Thursday. The market will be looking for signals about fiscal austerity and plans for further market intervention.

We have seen some life out of the euro this week so let’s take some time to evaluate the long-term prospects of the European single currency.

We all know that the euro-dollar has been in a long-term downtrend. Since trading at a high of 1.5138 in December the euro plunged to a four-year low of 1.1877 just this past week. That’s a more than 3200 pip decline over six months – truly an amazing decline.

Almost all the money made trading the euro over that time has been on the short side. Rebounds have been shallow and short-lived. Many analysts have been preoccupied by calling the bottom and once again that’s where we are today.

Let’s have a look at the chart. We can see the long-term downtrend but just in the past week we have rallied about 200 pips. Can the rebound continue? Or is this another bounce to sell?

Technically, we can see that the downtrend is well-intact but there has been solid pop. There is no significant support until 1.1637 so much of the market is focused on that target.

Looking at the Bollinger Bands, they show that the euro has traced along the bottom for some time now but there have been periodic rebounds to the upper band. We see some scope for a rebound to the mid-point, at roughly 1.23 or even the upper band, which should trend down toward 1.2450.

On the other hand, it would be no surprise to see the euro continue falling. Many of the corrections have been very shallow and today’s price action suggests we could be heading lower again.

The head and shoulders patter we warned about last week was finally completed in EUR/USD as the pair broke down in spectacular fashion today. The catalyst were comments from a spokesman for Hungary’s Prime Minister who said the nation is in a “grave situation” because the previous government “manipulated” data and “lied” about the state of the economy. Turkey isn’t a part of the euro but is on the periphery of the zone. Worries about Spain also ignited and credit default swaps around the region soared.

Technically, EUR/USD continues to be in bad shape. We have frequently advised selling this pair and always advise following the trend. As everyone knows by now, the trend in EUR/USD is lower. We watched over the past week as a host of economists, strategists and commentators advised buying euros. Obviously, they were wrong.

The only question is: how far will the euro fall? The market has squared its focus on the late-2005 low of 1.1639. As we previously mention, this corresponds with the measured target of the head and shoulders pattern.

We think that any entry point is a good one for the coming week but, as the RSI shows, we are oversold on the two hour chart.  It would be no surprise to see a rebound to 1.21 late on Friday or early next week. This would represent a great entry point provided you could withstand a potential short-squeeze to 1.23, which would be our stop. The whole trade represents a potential profit of 450 pips and a loss of 200.