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.

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.

Risk aversion and the Fed’s announcement of further quantitative easing have pushed USD/JPY down through support to the lowest level in 15 years. Japanese officials expressed concerns in the Asia-Pacific session about the rising yen but that has done nothing to slow the rally. Japanese Finance Minister Noda told reporters in Tokyo that recent moves in the yen have been “a little bit one-sided.” Meanwhile, Japanese Trade Minister Masayuki Naoshima said that deciding on FX interventions is difficult in an interview with Jiji Press. USD/JPY fell as low as 84.73 but was most recently down 47 pips to 84.97. The pair fell as low as 84.83 in November 2009 during the height of the credit crisis but USD/JPY hasn’t traded below since 1995. If the pair can close below 84.83, it will be an extremely bearish signal.

A reason for the weakness in USD/JPY is that U.S. growth in the second quarter may have been far worse than the 2.4% pace that was initially estimated by the Bureau of Economic Analysis. Two surveys private economists show they are expecting more than a full point of revisions. Bloomberg has just released a survey suggesting growth will be revised to 1.2% but it’s based on just four responses. Similarly, Dow Jones has a listed consensus at +1.3% (it’s unclear how many were surveyed). After four quarters of contraction, the U.S. economy grew at a pace of 1.6% in Q4 2009 followed by quarterly readings of 5.0%, 3.7% and the most-recent 2.4% rate. It appears that growth is stalling as government stimulus fades. With momentum clearly slowing, more questions will arise about the possibility of negative growth and recession. Slower-than-expected inventory builds are a large part of the downgrade. Today’s unexpectedly large U.S. trade deficit for June will also hurt. One notable market watcher is saying today that growth could be revised to as low as +0.5%.

We expect a bounce in USD/JPY in the immediate term but will be looking to sell. We will also sell on a close below 84.83 with an eventual taget of the all-time low at 79.90.

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.

We’re not huge fans out old-fashioned trendlines but when a line has been tested and it has held several times, it’s important. That’s the case with the long-term uptrend in gold. The support level proved to be worth watching but it broke today and the outlook for gold is looking increasingly negative for the short-term.

The trendline is from the credit crisis low of $682.41 on Oct. 24 2010 through the November low of that year and a low in January 2010 and March of this year. Gold bounced off this trendline last week but the bounce was shallow and now the market appears to breaking definitively lower.

Today, gold is down $19.50 to $1164.05 per ounce. The next significant level of support is the 200-day moving average at 1148.07. The 200dma hasn’t been breached since January 2009. Further support rests at $1043.

We hate to be short in an uptrend but will look to a $10-20 rally as an opportunity to establish a short position.

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.

One week ago, we talked about the potential for USD/CAD to rally and that is exactly what has happened. The initial catalyst was a soft report on Canadian retail sales but the broader move has been driven by international worries about a double-dip recession.

We noted that Canadian fundamentals remained strong but when we looked at the chart, it was clear the U.S. dollar wanted to go higher against CAD. What happened? We have rallied from 1.0393 to 1.0639.

The 200-day moving average has given way, downtrend resistance was only a hiccup and we are nearing our initial target of 1.0678. We would take profits on longs initiated below 1.0450 because we think there will be some consolidation here. We see a push to 1.0650 in the coming day but expect that to be the top for the next 2-5 sessions. Initiate shorts at 1.0650 or look for a pullback toward 1.0550 as an opportunity to establish fresh longs for a push toward our eventual target of 1.0850.

Looking over our charts over the past week we noticed the impressive performance of NZD/JPY.

The New Zealand dollar was the best performer in the forex market last week as it gained 3.4% against the yen. The NZD found a bid after stronger-than-expected first quarter inflation and building hawkish expectations for the upcoming RBNZ meeting on April 29.

Economists expect no change in the benchmark lending rate but they may signal growing worries about inflation and higher rates to come.

Meanwhile, the JPY broke down against the CAD last week and is now in danger of breaking through strong resistance in USD/JPY. The longer-term technical picture against the NZD isn’t as bullish, however, so a pullback is possible. We will be keeping a close eye on 68.60, which we see as a pivot.

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.