Weekly Review and Outlook: Markets Getting Tired of QE II Talks? Dollar Rebounding?

News flow was generally negative for dollar last week. FOMC minutes showed some members thought it’s appropriate to have further easing “before long”. Bernanke latter echoed and said there is a “case for further action”. Initial jobless claims refused to drop and has indeed rose back to 465k, showing sluggishness in the employment market. Headline CPI remains low at 1.1% yoy while core CPI moderated further to 0.8% yoy in September, showing increased risk of deflation. On the other hand, ECB members were hawkish, confirming ECB’s stimulus exit stance. Singapore widened the trading band of Singaporean dollar to allow faster appreciation while there are speculations that other Asian central banks will follow.

Dollar was under much pressure for most of the week and naturally, we should see acceleration in dollar’s decline. However, that’s not what we saw. Instead, Bernanke’s dovish speech seemed to have squeezed the last downside move out of the greenback as the dollar recovered impressively on Friday to pare much of last week’s loss. It’s possible that dollar is finally finding a bottom as markets are getting tired of QE II talks. It’s seems that QE II is fully priced in for November meeting and market will start to feel indifferent to any further speculations.

One important development to note was that sharp rebound in long term treasury yields. $TYX, yield on 30 year bonds, staged a strong rebound through September’s high and breached 4% briefly before closing at 3.999%. It was the strongest rally for 14 months. Indeed, while short term yields, including $TNX, yield on 10 year note, dived recently on QE II expectations, $TYX refused to follow and has started to trend higher since August. Yield on 30 year bond compares to 10 year note also reached a record high of 1.46% last week. The development suggests that investors are quietly pricing in chances that Fed’s easing effort will reignite inflation in the long run.

Another sign of of dollar bottoming is seen in the sharp selloff in commodities on Friday. The CRB commodities index rose further to as high as 301.83 last week but failed to sustain above 300 level and retreated sharply to close at 296.06. It’s likely that the index has made a short term top and pull back could be seen to 290 and below in near term. Also, while gold made another record high of 1388.1 last week, it’s mildly losing some upside moment. We might seen gold struggles below 1400 psychological level for a while and that could give some support to dollar.

Looking at dollar index, it’s dropped further to as low as 76.15 last week but is trying to draw some support above medium term trend line and recovered. Downside momentum is clearly diminishing with bullish convergence condition in 4 hours MACD. Some consolidations should be seen initially this week. It’s early to call for a bottom yet. But a break of 77.93 will indicate that a short term low is formed and bring stronger rebound back towards 80 psychological level. Though, break of 76.15 will bring fall resumption towards 100% projection of 88.70 to 80.08 from 83.56 at 74.94.

The Week Ahead

Markets would possibly trade in some volatile manner this week as traders are searching for new theme. The Fed QE II theme is getting a bit old. A number of Fed officials are scheduled to speak this week but would probably have little impact to the markets. Nonetheless, there are still a lot of market moving events ahead. BoC rate decision is one of the focuses. While the bank is expected to stand pat this time, focus will be on the bank’s view on how US slow down would impact Canada. From UK, a lot of attention will be on the Spending Review to be announced by the government on October 20. This will be a key to establish credibility on the government on its ambitious austerity plan to cut the worrying budget deficit. BoE minutes will also catch a lot of attention on the possibility of more QE from the bank. Last but not least, there will be a number of data from China which would move risk sentiments.

• Monday: New Zealand CPI; Japan Tertiary industry index; US TIC capital flow, industrial production, NAHB housing market index
• Tuesday: RBA minutes; German ZEW; US new residential construction; BoC rate decision
• Wednesday: BoE minutes, UK public sector net borrowing; BoC Monetary Policy Report; Fed Beige Book
• Thursday: Japan all industry index; RBA annual report; Swiss trade balance, ZEW; UK retail sales; US jobless claims, Philly Fed index, Leading indicator; Canada leading indicator
• Friday: German Ifo business climate; Canada CPI, retail sales

EUR/USD rose further to as high as 1.4150 last week but lost upside momentum. A short term top might be in place and initial bias is cautiously on the downside for deeper treat to 1.3775 support and below. Though, we’d expect strong support from 38.2% retracement of 1.2587 to 1.4150 at 1.3553 to contain downside and bring another rise. Above 1.4150 will target medium term trend line resistance at 1.4572 next.

In the bigger picture, price actions from 1.6039 is a correction to long term rally from 0.8223 and could have finished with three waves down to 1.1875 already. Short term outlook will remain bullish as long as 1.3330 resistance turned support holds and further rally should be seen to upper trend line resistance (1.6039, 1.5143, now at 1.4572) next. Break there will target a new high above 1.6039.

In the long term picture, considering the five wave impulsive structure of the long term up trend from 2000 low of 0.8223 to 2008 high of 1.6039, price actions from 1.6039 are viewed as a correction only. Hence, we’d expect another high above 1.6039 eventually, after correction from 1.6039 is confirmed to be finished.

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