USD Rally

The ECB announced today that two European banks used up $430M in FX swap lines, underscoring the very real shortage of USD at banks and the consequent forthcoming demand for dollars. Meanwhile, Eurostat is forcing Germany to consider its holdings of Hypo RE & WestLB debt as sovereign. The implications, as per Maastricht Treaty constraints, could be enormous for Euro nations if this is a precedent.

Meanwhile, the BEA announced that the United States BoT for June plunged to -$49.9B vs =$42.1B consensus. This, in combination with the revision in inventories, should bring Q2 GDP to around 1% or below. With the ECRI LEI still under -10, the double-dip thesis should find its last needed confirmation in the August ISM until becoming officially representative of the present US economy.

In the markets, today was a total rout. The S&P plunged 2.82% today, while 10yr yields dropped another 96bps. A variety of significant levels and moving averages in FX crosses were broken, as well as in other risk assets, signaling rough times ahead for markets in the near future.

The USD was the biggest beneficiary of today, with the Dollar Index surging to 82.62, as we predicted in yesterday’s post. There are large USD short positions, both structural & speculative, and these put the USD at risk for a huge move higher and assets at risk for plunges. The Morgan Stanley FX flow data confirms the short positioning:

USD shorts

DX

After breaking back below the 38.2% Fibo retracement from 2009 highs yesterday, the EURUSD continued its selloff by plunging 330 pips on the news of the USD swap lines use. It doesn’t look like EURUSD will make it to the 1.35 level we have been mentioning as a potential topping point and the reversal seems to be here in this cross. The break below the 1.31 Fibo level was confirmation that we’re headed downward. We expect USD Libor to continue higher from here, and as the USD-EUR Libor spread tightens, the EURUSD should continue selling off.

EUR/USD

Cable seems to have topped out at the 1.60 level we mentioned just days ago and today broke below the important 1.58 level, confirming our suspicions from previous posts. Next stop is the 200d and below if the USD continues strengthening. The recent UK housing data was very weak as well, and if Jeremy Grantham’s conception of the UK housing market as a bubble is correct, then crashing home prices could be on their way, and with it crashing GBP rates.

GBP/USD

AUDUSD broke back below its 200d today, after following through from its rising wedge breakdown we highlighted right around the top a couple days ago. It has some S/R around the 8850-8900 level, but if/when that is taken out, we could see some serious selling develop. If that support level holds in the short term, it sets up the potential for a head & shoulders reversal. Lots of FX crosses are showing a completed left shoulder and close-to-completed head, with necklines around late July lows. This could result in big moves down in risk FX.

AUD/USD

USDJPY was choppy today, as it found some buying near November 2009 lows. It is quite extended here and has been following 10yr yields very closely of late. The 10yr was bid heavily yesterday on the FOMC news of MBS proceed reinvestment into Tsys, and continued its rally today on the risk-off event. However, the 30yr responded to risk yesterday and yields actually went up, further widening the record 10s30s right now. We expect the 30yr to find more buying as risk continues being sold, and while the 10yr may have more upside room, we believe it is extended for the moment, and expect the 10s30s to find tightening in the near-term. Even if 10yr yields continue downward, the tightening of long-end spreads should prove bullish for USDJPY (again, in the near-term only), and catalyze a short-term bounce. We still expect the important 85 level to eventually be broken, even as early as this fall, but a bounce up to about 87.50 or its 200d may be in the cards for USDJPY and going long this cross presents an attractive risk/reward at these levels. Obviously today’s lows being taken invalidates that.

USD/JPY

In equity, the S&P broke below its 200d today on strong volume and is now hovering right above its 50d. Just like risk FX crosses, there is a potential for some support around late July lows (also near the 50d), and a bounce from there could lead to a lower high, which would confirm a head & shoulders development. A break below the 50d would signal big declines to follow. We expect a bounce off the 50 in coming days and any retest of the 200d to be sold on. Summer choppiness is ending and the new trend appears to be down. This fall could get ugly.

SPY

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