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Thursday 11 November 2010

The US Dollar Bounce

So much market forecasting nowadays comes down to the direction of the US dollar, and that's the main issue this week too as I see it. USD has bounced, eventually, off triangle support on the weekly chart and more importantly off declining channel support on the daily chart. The obvious target is the top of the channel and the question today is the likely path it will take to get there. Here's the declining channel on the daily chart and, for the benefit of anyone who is still skeptical about the effect of USD on equity prices, I have used my daily chart with SPX as the background, and with the wave relationships between USD and SPX marked on the chart:

EURUSD is 55% of the USD index of course, and so acts as a good inverse proxy for USD for charting purposes. I chart this directly from the forex markets as those markets are very deep and liquid, and not therefore prone to the strange short-lived spikes up and down that appear on the USD futures chart from time to time. On the EURUSD daily chart the rise from the June low  is in the form of a broadening ascending wedge, which is normal for EURUSD, which generally trends in a wedge of one type or another. Wedge support is in the 1.32 area and EURUSD has fallen back to the strong support level at 1.37. The question is what happens here?

There are two paths for EURUSD to take from here in my view. The first path is to complete the H&S pattern that appears to be building, by bouncing back over 1.40 over the next few days to make the right shoulder for the pattern, and then to fall to wedge support. The second is for EURUSD to break support at 1.37 on a daily close basis and then head straight towards wedge support:

For that reason I also have two scenarios for ES / SPX over the next few days, and they are directly linked to those two EURUSD scenarios. If EURUSD doesn't break support and makes the right shoulder on that H&S, then I'd expect ES to make a new high, with negative divergence on RSI, and we'd see an interim top made there that should last two to four weeks in all probability while ES / SPX and EURUSD both correct. If EURUSD breaks support at 1.37 then we should see both go significantly lower over the next few days. If we're taking the second path, then there's a declining channel on ES that I'd expect to see hold, and here it is on the 15min chart. Resistance is just under 1213, and I'm short until that breaks up. If we make it to the lower trendline of the declining channel today, then that should be hit in the 1194 - 1195 area:

I've been watching XLF with interest since the break up a few days ago. It has returned to retest the broken rectangle in recent days and that has held so far. The next obvious target is the rectangle target in the 16.8 area, but I'd be reluctant to play that unless ES breaks up from the declining channel. If ES continues to correct from here, then I'd be wondering about a possible retest of the broken declining channel and that would look like a very attractive long entry if XLF reached there:

I mentioned at the beginning of September that one stated purpose of QE2, to support treasury prices, was a polite fiction, and that the real intention and effect would be to support equity prices while treasuries would trend sideways to down at best. Looking at the chart for 30 year treasuries today, I'm not seeing anything to change that opinion, although I might eliminate the word sideways from my forecast. Expect more downside, though treasuries could well bounce here as they are at the lower trendline of a possible declining channel:

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