There is an old saying amongst traders that “the trend is your friend”, meaning you should always trade in the direction of the larger market trend. This article attempts to identify which major currencies are trending and to access the strength of those moves, and the possible fundamental and technical factors which could influence their progression.
Of the major currencies, the yen and the euro are in the strongest trends, despite recent pull-backs over the last week. The pound is of interest because it has been forming a multi-year triangle which could be on the verge of breaking out and beginning a strong trend, but this will be covered in another article. The Australian dollar is consolidating and the U.S dollar is mixed. Below we will concentrate on the yen and the euro since they are the currencies in the strongest trends.
The yen has weakened versus all major currencies in 2012 and 2013. This is reflected in the 12% rise in USD/JPY since the 2012 January lows. EUR/JPY and GBP/JPY have shown similarly strong trends.
Initially this was due to poor balance of trade figures because of the impact of the global financial crisis and the country having to import all its energy after the Fukushima Daiichi disaster led to the government closing all its nuclear power stations.
The downtrend gained momentum after the victory of the ADP party in December’s election. The then leader Shinzo Abe coined the now famous phrase: “unlimited yen printing” to emphasise his commitment to fighting deflation, and it shaped expectations of an aggressive monetary easing agenda.
New sources of weakness have also emerged: for example, the recent economic recoveries in the U.S and Europe have encouraged the return of the ‘carry trade’, in which the lower yielding yen is sold in exchange for higher yielding currency.
In addition there are reports of Japan’s life insurers unwinding large hedges set up to protect balance sheets from the yen excessively increasing in value. This has also increased the sell-off, and could sustain it further.
However, sceptics say they expect problems to re-emerge in the euro-zone during 2013 which will lead to resurgence in safe-haven demand for the yen which will push it up again.
The U.S fiscal cliff could also lead to the adoption of more aggressive monetary policy measures by the Federal Reserve which would probably be bigger than the measures used by the traditionally more modest BOJ, leading to further yen appreciation – at least against the dollar.
From a technical perspective, USD/JPY has surpassed the key 92.11 target from the multi-month inverted H&S at the lows, indicating it could already be nearing exhaustion.
Oscillators are also overbought further increasing the possibility of a pull-back developing. However, the H&S target is only a minimum price objective and momentum often remains overbought for long periods in strong trends, so the uptrend will probably eventually resume.
There are no obvious reversal signals and it is probable that after a pause the uptrend will begin again, with the next significant level from both a technical and fundamental perspective at 100.00.
The euro has risen over 10% since bottoming in July 2012. The strong uptrend has taken it from lows of 1.2042 in July to a high of 1.3478 in the week ending the 1st Feb 2013. Is the trend likely to endure?
There has been no major event which could signal a turnaround in the outlook for the euro-zone economy which continues to struggle. The improvement, rather, has been as a host of small victories which have added up together to create more stability. The actions of the central bank seem to be supporting the currency too after it has launched a variety of schemes to inject liquidity and credit into the system.
The peripheral economies at the centre of the euro-zone crisis have broadly divided into two camps: those which have shown improvement and those which have not. The former included Ireland and Portugal and to some extent Italy. These three countries have implemented austerity measures successfully and Ireland even showed some signs of growth in its economy last year, Italy seems to have responded well to its technocracy and Portugal has stabilized. These improvements have eased the outlook for the euro-zone as a whole.
Greece and Spain, however, have become the new bête noires of the crisis. Greece has lurched from one bailout to another, failing to stay within the conditions of each agreement and falling behind in its ability to meet its debt obligations. To this end in December 2102 it requested another substantial debt haircut, which brought its debt-GDP ratio back in line with targets, however, most estimates are that on current levels of activity it will not fall back down to meet the EU/IMF targets of 120% by 2020.
The problem is not so much the large debt but the fact that the economy is in a deep recession, shrinking by around -7.0% a year. If Greece could simply stop its economy from shrinking then it might have a chance of getting back on the road to recovery. What are the chances of it doing that?
Greece’s main industries are Shipping, Tourism and Agriculture. Shipping is significant and accounts for 16.9% of the world total. It is currently enjoying a renaissance and has stayed broadly immune from the crisis – its prospects for growth are good.
Greek tourism has fallen partly because its business comes from other crisis-hit countries where potential visitors have had to tighten belts. It could be the political instability and portrayal of political riots and violence on the media has put other potential tourists off. Greece has attempted to open up new markets to Russia, which has helped a little. Given its dependence on European business, however, tourism may offer less winnable prospects for growth.
Agricultural exports are also mostly to the rest of Europe and may also have been hit by the crisis. However, they are less sensitive to economic travails compared to tourism so will probably remain robust if not offering particularly brilliant prospects for expansion either.
Overall, therefore, the prospects for the economy to grow are quite small and the economy may be a source of uncertainty for some time as it rebalances following the economic crisis.
The other country at the centre of the euro-zone crisis is Spain. The country, however, appears to be recovering and importantly it managed to make it through 2012 without asking for a bailout, or for the ECB to use its OMT bond-buying mechanism. A combination of factors, including the implementation of austerity measures, strong large banks, employment reform and powerful multi-national corporations all helped keep Spain afloat.
This was quite an achievement given the country’s economic problems, including an incredible 26% unemployment rate. There were even signs of green-shoots in 2012, including a rise in exports and tourism, which seem to indicate Spain may have a good chance of weathering the financial storm.
Overall, it seems the euro-zone is recovering. The crisis in the periphery has eased, although problems remain. It remains to be seen whether the green-shoots noted in 2012 will take hold.
Greece could be a major factor in deciding whether the rally in the euro remains intact. If it can stop shrinking at such a fast rate and settle down economically and politically then this will give the current rally in the euro a massive boost, alternatively if the situation worsens it could drag the euro down again.
From a technical perspective the mid-term bullish rally in EUR/USD is still intact and will probably extend to a natural end at the major down-sloping trend-line connecting the 2008 and 2011 highs at about 1.4100.
The inverted multi-month head and shoulders at the lows supports this forecast, giving a price objective of 1.4280, which is actually above the major trend-line linking the ’08 and ’11 highs.
However, last week’s bearish engulfing is a warning of short-term weakness, with a move back down to the 1.3240s or even major support at 1.2950 possible before a probable resumption higher.