The U.S. dollar has made four big moves higher in the past four days. In the process, USD/CAD has risen above downtrend resistance and the mid-July highs. At the moment, the USD is overbought so we would advise waiting for a down day to establish long positions.

The RSI, at 68.42 is nearing the same levels as the spike high in May and if recent history proves correct, we will likely see a move lower (possibly back to as low as 1.04) before we see a renewed push higher.

Fundamentally, there is a similar story about to play out. The Bank of Canada meets September 6 and the market is pricing in a 45% chance of an interest rate hike. We expect that economic worries and market jitters will force the Bank of Canada to reconsider raising rates. At the moment, 100% of economists survey expect the BoC to raise rates. With recent Canadian economic data trending lower and no inflation worries, the BoC is likely to change course. Alternatively, they make hike rates by 25 basis points but make it clear that there will be no further rate hikes. In either case, the Canadian dollar will weaken (and USD/CAD will rally).

We expect to see 1.13 at some point before the end of the year.

North American markets got a big boost from news that BHP Biliton had proposed a $37 billion takeover of Potash Corp. The takeover suggests corporations are willing to invest and spend, something that has been up for debate. Companies have been hoarding cash, unwilling to hire or invest due to the uncertain economic environment. If the move by BHP is the start of a trend, it will signal growing corporate confidence in the worldwide economy – something that will boost AUD and CAD.

There is a downside bias as USD/CAD consolidates in a wedge formation. A drop below minor support at 1.0305 would point to further losses for the U.S. dollar against its Canadian counterpart.

For the Australian dollar, the candlestick patterns are bullish in the short-term but a buy signal won’t be confirmed until 0.9081 is breached. With Asian markets risk averse at the moment, there may be good value in establishing longs if AUD/USD drifts toward 0.9000.

Despite its status as a growth currency, the Canadian dollar is holding up relatively well early in this week’s trading. To us, this looks more like a reflection of a slumbering, mid-summer market than any reflection about Canada’s economic strength.

Usually, the Canadian dollar moves in tandem with the Australian and New Zealand dollars but we’re not seeing that today. Instead, USD/CAD is chopping close to unchanged. Typically, when European and North American traders get to their desks, the pair will play catch-up. This is especially the case at this time of year when many traders are on vacation. That makes it a great time for independent traders to front-run the market.

On a daily charting basis, CAD  is carving out a wedge formation. Friday’s bullish hammer reversal candlestick points to further gains but they may be capped at psychological and downtrend resistance at 1.0494 – 1.0500. We feel like this chart is gearing up for a huge move but it may take some time to develop.

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.

The market is expecting the FOMC to downgrade the assessment of the U.S. economy. It’s probable they will indicated that employment growth is lackluster, consumer spending has disappointed and housing indicators continue to point to another leg lower. The wording will be less explicit but the market will be spooked by any worrisome signals, however slight. The initial reaction will be a slump in the stock market and that will translate into JPY strength.

 
One possibility is that we will see Bernanke’s “unusually uncertain” phrase included in the FOMC statement. The reaction to “unusually uncertain” would be mostly muted with perhaps some JPY and USD strength.

 
Market chatter also centers around what the Fed will do with money invested in mortgage-backed securities that are expiring. Until recently, it was believed the Fed would destroy the money it used to buy the securities but now there is talk they will recycle the dollars and buy Treasuries or further mortgage-backed securities. With inflation unlikely and deflationary fears rising, we fell this step will eventually be taken. We don’t think a program will be announced today but we expect them to emphasize that there is more they are prepared to do if the economy worsens further. We think such an outcome is USD-neutral. If the Fed, however, talks more explicitly about new programs or introduces them, we will see a broad USD selloff. Currencies like AUD, CAD and EUR would be expected to outperform in such a scenario barring a major downgrade in the economic outlook.

One final thing to watch is Kansas City Fed President Thomas Hoenig. He has dissented at the previous four FOMC meetings and is in favour of raising interest rates. We believe he will continue to dissent. The risk is that he will fall in line with other FOMC members on the “extended period” language. This would be a slight USD-negative. Overall, however, we feel the market (and the FOMC) has marginalized Hoenig.

USD/CAD attempted to break down below support yesterday but was harshly rejected. The fresh uptrend has continued in today’s session and the technical outlook is looking increasingly bullish.

We can see a rough outline of a hammer reversal pattern yesterday and a more clearly defined hammer today. Support comes in at the 100-day moving average (purple) along with the Jule low of 1.0277 and uptrend support from the low in April.

Initial resistance resides at the 200-day moving average (red) but we don’t think that will pose a serious hazard to bulls. Instead, look for an inital rise to downtrend resistance at around 1.0570. Place stops below the 100-day moving average as another test below will likely see follow through.

The strongest trend in the forex market at the moment is a falling USD and rising JPY. USD/JPY has been declining for nearly 11 weeks. This will be a big week in terms of U.S. data and there is talk that Japanese officials may intervene in the market is USD/JPY falls to 85.00. Watch for U.S. data on consumer confidence, durable goods, the beige book, GDP and the Chicago PMI. If the outlook continues to darken for the U.S. economy, look for this pair to continue sliding.

U.S. Federal Reserve Chairman Ben Bernanke roiled markets last week when he uttered that “the economic outlook remains unusually uncertain.” Markets take their cues from the Fed. Remember it was Bernanke’s comment in April 2009 about “green shoots” that helped prompt a huge turnaround in financial sentiment. Many traders stand by the old adage “don’t fight the Fed.” What Bernanke’s comment meant was that they are in data-watch mode, unsure of which direction the U.S. economy is headed. “We will continue to carefully assess ongoing financial and economic developments,” he said. His comments have focused the market’s attention on incoming U.S. economic data. As a result, the U.S. dollar is moving more than usual after economic data releases. We are seeing solid rallies against the yen on stronger economic data and deep slumps on soft figures. An “unusually uncertain” market is prone to big moves whenever there is a hint of clarity. Keep an eye out for signs that make the outlook more certain, for better or for worse.

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.

AUD/USD had made a bullish breakout of the double-top at 0.8869 and appears poised for a test of the 200-day moving average.

Positive news out of China continues to boost the Australian dollar. Officials in China today upgraded output growth forecasts to 13% from 11% and said they will act to stimulate consumers in the second half of the year. In all the excitement about the German PMIs and U.S. corporate earnings today, these headlines have been overlooked except in the forex market. This is very good news for Australia as it ships much of its raw material exports to China.

Technically, this chart is now looking outright bullish.

In the short-term we will likely see a retracement close to 0.8869 in a classic ‘buyer’s remorse’ move. Afterwards, however, we expect a quick rally to the 200-day moving average at 0.8967 and eventually to the mid-May high of 0.9077. We can’t rule out a re-test of the cycle high at 0.9420.

The sell-off in USD/CAD following the Bank of Canada decision didn’t make any sense to us and now the technicals are setting up for a move higher.

We have seen an intraday reversal on daily chart that could finish the session as a bullish hammer reversal pattern. The caveat is the 50-day moving average (purple) that comes in at 1.0444 today.

If that breaks, expect a move to 1.0680, at least. The bottom today puts in a higher low and is well above the most recent 1.0277 low.