Yesterday's action in the U.S. Dollar demonstrated how much of an influence this instrument can have on other markets. Since almost every futures market group was affected by the stronger Dollar, traders have to consider the possibility that a major shift in investment strategy may be taking place. Based on the trading action and the developing chart formations, it is possible that investors could be shifting toward a stronger Dollar/weaker commodities scenario. The fall in equity prices may be indicating that investors are shifting funds out of risky assets altogether.
Because of tomorrow's Non-Farm Payrolls Report, traders may have to wait another day to get verification that a topping formation is developing. This is because there is a chance that yesterday's move was related to trader liquidation ahead of the report. Furthermore, technical chart formations are indicating that a number of markets are in a position to post lower closes for the week which means that Friday's close will be most important.
A combination of technical and fundamental factors helped contribute to a huge rise in the U.S. Dollar against all major currency futures markets Wednesday. This action sent commodity-linked currencies like the June Canadian Dollar into a tailspin as longs scrambled to get out of their positions. The move also triggered liquidation in the higher risk assets like the June E-mini S&P 500 and August Gold.
The biggest surprise yesterday was how fast the U.S. Dollar gained strength given the recent weakness. Gone was the constant chatter of "green shoots" that had peppered financial market commentaries for the past 90 days. Wednesday's action looks as if fear has returned to the marketplace and that the U.S. Dollar is once again being treated as a much sought after safe haven currency. This goes to show investors that markets driven higher on sentiment rather than real numbers are doomed to fail at some point.
Technically, all of the major currency markets had reached 50% retracement levels of their almost yearlong breaks. This is usually an area where sellers feast and yesterday's action was no exception. Looking ahead, the next move up in the U.S. Dollar could be a big one as this market will most likely retrace its entire break. This means huge corrections to the downside for the British Pound, Euro, Canadian Dollar, Swiss Franc and Japanese Yen.
Fundamentally speaking, weaker than expected U.S. economic data helped bring back concerns that an economic recovery would be labored and tumultuous. Wednesday's action was a strong demonstration of the fact that rallies based on positive investor sentiment are no reasons to believe that an economy is turning.
Yesterday's rout gained momentum following the release of the monthly ADP report which showed more than half a million U.S. private sector jobs was lost last month. This news raised concerns that tomorrow's U.S. Non-Farm Payrolls Report will be worse than estimated. The fear that hit the market today demonstrates how nervous traders have become. Although many traders still believe that the unemployment report is a lagging indicator and that looking forward the economy may be improving, yesterday's sell-off shows that they do not always trade their beliefs but rather order flow and market action. Clearly, yesterday's sell-off shows that no one was willing to step in the way of the massive amount of sell orders.
The recent over-exuberant selling against the Dollar was also dealt a blow yesterday when it was reported that Asian central banks have decided to continue to buy U.S. Treasury debt even if the U.S. debt rating gets downgraded. This news gave the U.S. Dollar an additional boost and could have long-term ramifications as it may bring more investors back to the Dollar. Recently selling pressure hit the Dollar after a debt rating service lowered the U.K. rating. Many traders believed the U.S. Dollar was next in line for a downward adjustment.
This news also helped the buoy the September Treasury Notes and September Treasury Bonds. Although the news was not enough to trigger a change in trend, it did help to entice shorts out of the futures markets and reduce some of the upside pressure on yields. At this time, bond traders are in a clash with the Fed over the direction of longer-term rates. The recent rounds of quantitative easing by the Fed indicated that they wanted to suppress longer-term rates. The rise in longer-term yields and mortgage rates, however, showed that they cannot do it. A weaker Dollar may help to support the financial markets especially if it is related to news that the U.S. debt rating will be left unchanged.
The hard breaks in August Gold and July Crude Oil also demonstrated just how much a small shift in positive sentiment toward the Dollar could trigger liquidation. Because of the rapid movement to the downside in these two markets, watch for profit-taking today and the possibility of a snap-back rally. If the next rally fails to make new highs in these two markets then consider the fact that the trend may be changing to the downside.
Although the short-term trend is still down in the Dollar, Wednesday's aggressive rally has put it in a position to post a weekly reversal up. The trading action the next two days will decide whether the Dollar has the buying power behind it to start, at a minimum, a 2 to 3 week rally. Conversely, watch Friday's close in equities, precious metals and crude oil, as these three markets could post weekly reversal tops which would be strong indications that a short-term change in trend to the downside is developing.
