Fundamentals fail to offer a clear picture

EVERY day there seems to be further bad news from the Eurozone’s periphery. Only yesterday Moody's rating agency warned it might downgrade Irish bonds. Yet the euro continues to rally against the dollar, reaching $1.3833 yesterday at 6.45pm. The market just does not seem to care what trouble the Eurozone stirs up. All eyes are fixed on the US and the dollar. “The market is like a typical man, it can only focus on one thing at a time – and at the moment that’s further US quantitative easing (QE2)” says Michael Hewson of CMC Markets.

The market certainly expects QE2 and the Federal Reserve has all its indicators pointing in that direction. The anticipation in the lead to the announcement seems to have lodged euro-dollar into a range. We may have to wait until the Fed’s meeting on 3 November – the earliest occasion that it could realistically be announced. Should QE2 occur, analysts predict a serious plunge for the dollar. The chart below demonstrates what happened last time QE was announced. Many expect a retracement of that dive.

But in the meantime, how should the trader select a position? Neil Mellor of The Bank of New York Mellon says traders tend to turn to technical analysis when the economic fundamentals do not offer a logical picture.

The charts certainly offer patterns for euro-dollar: for instance, despite the euro’s strength it is struggling to find buying momentum to carry it above $1.3800. Yet it has established a support level at $1.3635. Every time the euro drops, the bounce-back carries it slightly higher, maintaining the upward trend. This channel pattern emerges on the 240-minute time frame. But Raghee Horner of Autochartist warns that this rally has the potential to retrace itself, suggesting that: “If the $1.3808 high holds, look for a possible retracement on the daily chart down to the 23.6 per cent Fibonacci level at $1.3535.”

QE2 UNCERTAINTY

But beware, Hewson warns that doing precisely the opposite to consensus can often offer the golden ticket: “Just look what happened in Australia on Monday: 75 per cent of analysts predicted a hike in interest rates but the Reserve Bank of Australia were kept on hold with no intention of raising them.” Mellor expresses the same concern: “Nobody really knows whether the Fed are actually going to go through with QE2. I’ve heard people suggesting that the Fed are entertaining the idea to weaken the dollar so they don’t have to go actually through with it.”

With so much uncertainty surrounding the prospect of QE2, technical analysis could be the surer bet in the near-term – at least until Friday’s non-farm payrolls figures shed a little more light on the state of the US economy.