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 pound sterling made another move higher on Tuesday as it reached as high as 1.4838 before settling a bit lower. It touched the highest since mid-May and continues a retracement phase in cable. There is now no major resistance on the hourly chart until the double-top at 1.5048.

From a fundamental perspective, we have claimant count data and retail sales data on Wednesday and Thursday but the market is entirely focused on the June 22 budget. In order to get the pound moving higher Chancellor of the Exchequer George Osborne will need to strike a balance between a credible plan to lower the deficit and something that doesn’t stifle the economy. It’s a tall task.

Technically, the daily chart clearly shows that we’re in a retracement phase but we have to point out that the RSI is beginning to look very overbought. We think the market will press into the 50.0%-61.8 % Fibonacci “box” but we are worried about the timing. If the market moves higher over the next few days it will leave the market in a severely overbought position ahead of the budget and that could lead to a big move lower if Osborne disappoints. If the news is relatively positive, there is still a great deal of resistance clustered around 1.50 and that should stall the market.

We are looking for any push above 1.49 in the days leading up to June 22 as an opportunity to establish short positions. Short-term traders, however, should look to enter into longs but cover them before the 22nd, when we’re expecting a big move.

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.

First, we would like to update yesterday’s post. We noted that USD/JPY was gearing up for a big move and that is exactly what happened. We were cautious on the early move (especially since we had a slight bias to the downside) but once the news that Japan’s Prime Minister quitting hit, we knew which way this pair was heading. His replacement will likely be Fiannce Minister Naoto Kan, who has been quoted as saying he prefers a weaker yen. It seems as though the technicals and fundamentals are aligning for this trade. A strong U.S. non-farm payrolls report on Friday will likely lead to another leg higher.

The U.S. dollar has been strong today but it has been badly outpaced by it’s northern neighbour as Canada’s loonie has led the forex market. If we get a daily close below 1.0414 we see it as a bearish signal.

The Bank of Canada hiked interest rates on Tuesday but didn’t commit to further rate hikes and we saw a disappointment trade combined with a risk averse environment that left a negative technical picture. We were thinking about entering longs but today’s impressive rally in CAD has taken us aback.

We are now back below the key 200-day moving average. The pair is about to hit some significant technical support at the 100dma (1.0330) followed by trendline support and the old range bottom of 1.0205.

Still, we find it very hard to be long USD/CAD after today’s price action. We caution against agressive shorts because today’s move seems so out of the ordinary. A close above 1.0414 and we might wade into a long position with a very tight stop. If we close below that level we start looking for ways to short the pair.

Yesterday we pointed out the weakness in the Australian dollar and noted the bearish patterns. AUD/USD went on to fall badly. Today, we are looking at EUR/AUD and an interesting weekly chart.

The downtrend in this pair has been clearly and cleanly in place for 10 months. On Wednesday we went from the bottom of the range to nearly the top in a one-day 600-pip move. This is a positive for the euro on this cross but it doesn’t yet signal a reversal. Instead, it looks more like a short squeeze. Watch for a test of the top of the range in the day ahead but look for heavy selling around 1.50. Gold is very important to this pair. With the $30 fall in gold on Wednesday, we are cautious of a further pullback, which would be bearish for AUD.

The currency market seems to have disconnected from stocks, bonds and the broader correlations are stretched. The AUD and NZD were beaten down badly today while the EUR and GBP rallied, throwing a wrench into the risk-aversion/risk-appetite trade. We have to note that when correlations start to break down, as we’re seeing, it’s a sign of very high uncertainty in markets. It often leads to high volatility and quick moves. We see no end in sight to the incredible trading opportunities that are presenting themselves every day.

The Australian dollar fell to an 8-month low today against the Canadian dollar, breaching technical support and breaking out of a 3-cent range. This commodity currency cross is one of the least volatile trades in the forex market because eliminates much of the ‘risk’ trade and allows market participants to focus on the relative strengths of Australia and Canada. Last week, Canada posted the largest one-month gain in jobs in history and that has increased speculation that the Bank of Canada will hike interest rates in June. On May 12, Australia will reveal its April jobs report. The market is expecting  22.5K new jobs. The strength of the report will be a big factor in whether the Reserve Bank of Australia raises interest rates. The market, however, is showing that it expects the Bank of Canada to hike rates more than the RBA in the coming 18 months.

As we can see, the pair carved out a rough range between 0.9178 and 0.9475 (297 pips) since the start of the year. Today, the range broke to the downside after higher-than-expected Chinese CPI cooled optimism for the Asia-Pacific region. Technically, the measured target of the range and breakout is 0.8881, which corresponds very well with the 38.2% Fibonacci retracement of the huge March 2009 to Nov. 2009 rally at 0.8867. Other support includes the July 2009 major low of 0.8796 and the Aug. 2009 low of 0.8983.

Short-term momentum indicators show the pair as oversold. The RSI has fallen to 28.70 and we are beyond the lower reaches of the Bollinger bands. That indicates that the market is potentially oversold in extremely short-term durations. It should be noted, however, that momentum indicators usually flash overbought/oversold signals after a range break.

Beward of tonight’s Austrlian employment report.

We worried about the euro in our post yesterday and it appears our worries were well founded. The European session led to a huge short squeeze in the euro, pushing it briefly above our resistance level at 1.3016. The gains were short-lived, however, and the euro has plunged back below 1.28.

We can see the huge reversal on the daily chart. The implications going foward are bearish. The Eurozone rescue efforts won’t be seen as a failure unless we fall below the 1.2521 low from May 5 but at this rate it won’t take long.

Analysts around the world were quick to dismiss the rescue efforts. Some noted how the 750 billion euros will be enough to cover funding needs for Greece, Portugal, Spain and even a portion of Italy’s deficit over the next three years but others noted that the required deficit-cutting and growing public unrest in Germany and Greece are threats.

We won’t argue with the market’s reaction. The European sovereign debt crisis will be over when it’s over. Some stability above 1.2521 will be a good sign but until we see a close above 1.3016, we will remain in the bearish camp.

USD/CAD was unable to retake the 1.02 handle in two attempts earlier in the week and has once again turned lower. The conditions are now right for further USD/CAD declines and likely a new low.

The move higher in the USD touched off the upper Bollinger Band but was unable to close at that level. With risk appetite looking strong and the potential for a huge bailout for Greece, we think Canada’s currency stands to gain.

The RSI shows absolutely no oversold conditions in the U.S. dollar. Our first target is the cycle low at 0.9936. That will likely be tested in Friday’s session or on Monday. We will be trading this with a very tight stop at 1.01. A rally above there will most likely lead to a third test at 1.02.

We have to give ourselves a big pat on the back for yesterday’s call on CAD/JPY. It was the best trade in the forex market over the past day as it rallied 237 pips.

Here is the updated chart:

There is nothing not to like about this chart. The sell off on Friday is followed by a perfect morning star formation with a close above Friday’s open. Moreover, the move higher stalled just at the former support line. We said yesterday that our initial target was 93.50 and the market topped out at 93.60 before pulling back.

The catalyst for the move higher in CAD was a hawkish Bank of Canada statement. We foreshadowed this in yesterday’s note. Here is what the BOC said about its conditional committment to keep rates low until the end of Q2: “The need for such extraordinary policy is now passing, and it is appropriate to begin to lessen the degree of monetary stimulus.” 

For the yen, the catalyst for the slump was the positive tone in equity markets. Stocks worldwide have rallied about 1%.

Now that we’ve taken up plenty of space lauding our efforts (we wish they all went this perfectly) the question is, where do we go from here?

We continue to like long CAD positions. The absolute best time to buy a currency is when a central bank embarks on a tightening cycle. Here we are at the very precipice of what could be a long-term move higher in interest rates.

In the short-term, however, the situation might be stretched. We will definitely be holding long positions but looking to add on any weakness for a move to our target of 100. The market is struggling at the aforementioned trend resistance and we may see some consolidation down to 92.80. That would be our initial buy point. We would cover on a move down to 92.50 because that would target 92.05. If we do see a move to the low 92s, we will be adding agressively.

For so long, the Australian dollar and New Zealand dollar have traded in near tandem. Now, there has been a huge divergence.

Today, the New Zealand dollar was among the worst-performing currencies while the Australian dollar and Canadian dollar were among the top gainers.

The story is also one of divergence. The Reserve Bank of Australia continues to raise interest rates while the Reserve Bank of New Zealand has held rates unchanged for more than six months.

It’s also clear that New Zealand’s central bank doesn’t want the NZD to appreciate and has made pains to emphasize that its economy isn’t as strong as Australia’s.

Technically, a divergence like the one were are seeing is often a reason to set up trades that benefit from mean reversion. We don’t think that’s the case here. We are emerging from the worst economic crisis in a generation. The recovery has been like a tide that lifts all boats. Now, the market is in a stage where it has grown more discriminating.

So far, the CAD and AUD look like winners. NZD may prove to be a winner as well but so far, it’s lagging and expect the performance of the NZD to continue to reflect that.