The Scale is Tipping Towards The Euro

The EUR/USD may get very bullish if we take into consideration that the balance of pros and cons favor the Euro. While the US concerns about sub-prime lending and the housing market continue, positive economic reports are coming out of Europe. The German IFO report shows a healthy manufacturing sector and strong business confidence. This was despite worries that the raise in German taxes would hamper the results.

Meanwhile new home sales in the US were reported lower as well as consumer confidence although the latter may be very well tied in with the first. Consumer confidence may very well be a result of increased volatility in the markets and increased negative press coverage. By human nature consumer confidence can be swayed by such factors. The just released Durable goods orders was also a poor reading, although it represented a rebound from the previous report. More importantly than the indications of a slowing economy is the increased variation between actual results and expectations. What really drives the market is anything that strives away from market expectations. Also, we can not take lightly the fact that the revisions to previous results were made to the downside. These add more impact to the already negative results.

Looking at interest rates, it is becoming clearer that the US can not afford to raise rates again. For one part, it will definitely not help the sub-prime lending market. Most likely the FED will not lower rates either as inflationary pressures remain. On the Euro-side, the International Monetary Fund supports further monetary policy tightening for the euro. This supports the hawkish BCE view and we can expect to see them raise interest rates to 4% in April.

With US rates remaining at 5.25% we will continue witnessing a decreasing interest rate differential. Although the EUR/USD is breaking upwards, it is surprising that the USD is not taker a harder hit. Rarely do the scales tip so far to one side. Some resistance may be due to the EUR/USD closing in on all-time highs but more likely analysts are waiting for what FED president Ben Bernanke has to say as he can cause some volatility.

JPY Is Rallying Across the Board Once Again

I was strongly advocating getting in new short positions and claiming that the USD/JPY was going to test 115.35 again. This was when the pair was around the 117.10 level. The problem, and a common one, was that prudent investors most likely placed their stop orders too close. Trading this as a medium to long term strategy like I claimed would lead one not to place very close stops, however, my position got stopped out as well being that the USD/JPY passed the 61.8 Fibonacci line in the retracement of the previous rally.

However, after I saw that the JPY was rallying again, I placed fresh shorts in USD/JPY and NZD/JPY (has the biggest interest rate differential for carry trades) and is now making tremendous gains as we speak! The USD/JPY is already at 116.03 as we speak, look at where my screen shot left off minutes ago!

In regards to fundamentals (long-term view), Japan's economy is fueling up. In regards to short term technicals we see that a head and shoulders formation played out.

Influential Speakers

•BOJ- Traders note a Bloomberg report this afternoon quoting Vice Fin Min Tanaka who states that further BOJ policy changes may take some time.

•ECB President Trichet toned down his degree of hawkishness to signal a pause in April and potentially in May as well.

News Highlights

•China Trade Surplus Widens, Yuan Gains On Speculation

•…shares of New Century Financial were suspended for trading this morning, raising concerns that the company may have no choice but to file for bankruptcy

•In addition to subprime mortgage lenders, who make loans to people with poor credit, the market was worried about retailers, which the Commerce Department said eked out a meager 0.1 percent rise in sales last month

USD/JPY will likely retest 115.30 levels

Continuing on the question whether the Yen will continue to rally as people liquidate their carry trades, there were interesting articles on dailyfx.com pointing out that the Yen will likely continue to appreciate. The volatile stock markets will likely cause higher risk aversion and investors will turn not use their low-interest rate debt to fund the riskier investments. This mean less short positions on the Yen but if this is not enough the Bank of Japan will likely continue their plans of raising interest rates. There has long been arguments of the Yen being undervalued as the BOJ occassional would buy USD in order to keep their currency low to help out exporters.

Most importantly is that interest rate differentials are decreasing as opposed to increasing. The US was raising interest rates at a solid pace while the Japan rate was down to zero percent. Now the tides have turned and BOJ is raising rates while the FED starts considering lowering the USD rate. I would use the recent USD/JPY rebound (115,19-116,75) to put in a fresh short position as I think it will test the 115.30 levels again.

Medium Term Opportunity Perhaps?

The Japanese Yen had a big rally having gained 160 pips vs the USD heading into Monday morning. We see a very close relation between the stock market decline and the JPY rise. Mainly, a strong JPY will hurt exporters, a country which relies strongly on selling abroad. Many of us might wish we got into this rally earlier for some quick gains, however, it may not be too late yet. The long awaited rise of interest rates in Japan have some large implications for its currency. Although the USD/JPY is since bouncing back, carry trade strategies tend to be longer term in nature. Thus, it might not a bad time to go long the yen for the medium term as more people decide to liquidate their Yen-based debt. In addition to this, more Japanese will begin to repatriate their yen.

Global Selloff - Here We Go Again

Being the first ones to wake up, the Asian markets will be the culprit once again for starting a chain reaction in other stock markets. Many of us towards the west woke up to find out that Japan's NIKKEI lost 3%. China's stock market plummeting was last Tuesday so this marks the fifth trading day of continued selling pressure. Of course analysts said almost at once that there was no need to worry, that it was just a temporary correction. However, you wouldn't expect them to announce panic from one day to the next. Although agreed that there is no need for panic, the market can very well be indicating a coming recession in the business cycle. Remembering that the market tends to anticipate the business cycle, we should take into consideration the factors related to a recession such as changes in monetary policies. Interest rates will have to be modified not just to control inflationary prices but to either spur or at least not deter economic output.