Weekly Review and Outlook: Stocks Tumbled on Crisis, Dollar Rally to Take a Breath

The financial markets were dominated by two themes, risk aversion and dollar strength, last week. Global equities tumbled sharply on news of Argentina’s default as its failure to pay bond interests was considered a credit event by the International Swaps Derivatives Association. And that triggered settlement of USD 1b in default insurance. That’s the first soverign bond default since Greece in 2012. Meanwhile, Banking crisis in Portugal is getting more pronounced with the Bank of Portugal ordering Banco Espirito Santo to raise more capital, after it declared a EUR 3.6b loss and the shares were suspended after plummeting 50%. Considering that the markets were still facing geopolitical risks in Middle East and Ukraine, investors dumped equities which triggered a broad based selloff.

SP 500 had the biggest weekly drop since 2012 and declined -53.19 pts, or -2.69% to close at 1925.15. DJIA lost -487.2 pts, or -2.87% to close at 16493.37. FTSE 100 lost -112.37 pts, or -1.65% to close at 6679.18. DAX tumbled -443.93 pts, or -4.5% to 9210.08. CAC lost 0127.77 pts, or -2.95% to 4202.78. There were some important technical developments. Firstly, DJIA and SP 500 broke 55 days EMA decisively. DAX and CAC were even more serious as the 55 weeks EMA were also broken. Taken a closer look at DJIA, it’s getting likely that 17151.56 was a medium term top. Firstly, the 100% projection target of 6469.95 to 12876 from 10404.49 was already met. Secondly, bearish divergence condition was seen in weekly MACD. We’d likely see more decline in near term to 55 weeks EMA (now at 16046). Reactions from there will be closely watched as a firm break will bring focus back to the multi-year channel (now at around 14600 level).

In the currency markets, dollar originally extended recent rally, which accelerated then on much stronger than expected Q2 GDP report. FOMC statement suggested that Fed is in no hurry to raise interest rate and that triggered a brief halt in dollar’s rise. However, the weaker than expected non-farm payroll report on Friday finally triggered a deeper pull back in the greenback. It should also be noted that the sharp decline in stocks towards the end of the week raised some indecisiveness in the bond market. 10 year yield originally jumped to as high as 2.614, extending the rebound from 2.448. But TNX finally closed at 2.505, giving up much of the earlier gains. Such indecisiveness in yield limited USD/JPY’s rally and has indeed inspired a come back in the yen on Friday, in particular against Sterling.

The dollar index jumped to as high as 81.57 last week and breached 81.48 key resistance. While subsequent retreat was deep, there is no clear sign of topping yet. Overbought condition in daily RSI would likely limit rally attempt in near term. We’d expect the index to consolidate for a while. But downside should be contained by 80.99 support and bring rise resumption. At this point, we’re favoring the case for dollar index to sustain above 81.48 key resistance eventually. And that would set up a medium term bull run back towards 2013 high of 84.75. We’ll stay cautiously bullish as long as 80.99 holds.

Elsewhere in the currency markets, Euro was the second strongest currency last week, next to dollar, thanks to recovery in crosses, in particular in EUR/GBP, EUR/CAD and EUR/AUD. Canadian dollar was the weakest one, followed by Aussie, as both were hit by risk aversion. Yen was rather mixed.

Regarding trading strategies, our EUR/USD short continued to perform well as the decline continued. On the one hand, we’d continue to stay bullish in dollar ahead. On the other hand, however, we’re seeing some strength in Euro in crosses. Both EUR/GBP, EUR/CAD and EUR/AUD down trend could be reversing. Hence, we’d prefer to close out the EUR/USD short first. And turn to sell another one against dollar.

GBP, CAD and AUD are three potential candidates. While the respective three crosses are all stuck in consolidative trading, it should be noted that GBP/AUD looks as it in consolidation in a down move, thus, giving AUD and upper hand over Sterling. Also, we’re still favoring strong support below 0.9211 in AUD/USD to contain downside. Thus, we’d look into selling Sterling and Canadian dollar.

Meanwhile, even though, the yen was mixed last week, we’re aware of the potential of a yen come back should risk markets tumble further, in particular, if it’s accompanied by resumption of rally in bonds, decline in yields, on safe haven flows. Thus, we’d also like to buy yen against the Sterling and Canadian dollar to balance out some risks.

So to conclude, we’d buy USD/CAD on break of 1.0960 resistance. And, we’d sell GBP/JPY on break of 172.36 support this week.

GBP/JPY attempted a rebound last week but was limited at 174.21, below 174.54 resistance, and dropped sharply. Initial focus in on 172.36 support first. Break will confirm near term reversal and will target 170.95 support and then 169.53 key support level. Meanwhile, above 174.21 will turn bias back to the upside for 175.36 and above.

In the bigger picture, the up trend from 116.83 (2011 low) continued to lose upside momentum. This could be seen in bearish divergence condition in daily MACD. And, weekly MACD continued to trend down. There is no clear sign of reversal yet but a medium term top should be near. So, in case of another rise, we’d expect strong resistance below 50% retracement retracement of 251.09 to 116.83 at 183.96 to bring reversal. Meanwhile, sustained break of 169.53 support should confirm medium term topping and turn outlook bearish.

In the longer term picture, we’d stay long term bullish in GBP/JPY as long as 156.77 support holds. The up trend from 116.83 is expected to extend to 61.8% retracement of 251.09 to 116.83 at 199.80 and above even though some interim consolidation could be seen.

GBP/JPY 4 Hours Chart

GBP/JPY Daily Chart

GBP/JPY Weekly Chart

GBP/JPY Monthly Chart

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