By: Kevin Sollitt

Last column’s theme (All eyes on Bernanke in bi-annual address to House & Senate) discussed a likely squeeze in EUR above 1.32 and recommended a long NOK position, both of which we’re glad to see were successful.

Although most text book trading recommends running winning positions, we prefer to take gains while they are there in this new era of volatility and thus will suggest closing long NOK exposure at market (5.96) ahead of payrolls & thus locking-in around 5 percent on that trade, looking to reestablish the position under previous parameters (see above link to the original strategy) if the opportunity arises.

Similarly, EUR/USD looks rich based on the timeline of its recovery and although a look at 1.35 cannot be ruled out, the fact that stress test results are not being taken by markets as a cast iron guarantee that EZ banks will remain solvent brings, for us, the EUR rally into some question, particularly as EUR crosses in many cases are lower than they were a month or two ago.

USD/JPY Contributing to a Weaker Dollar

The USD has started August on the softer side with renewed expectations of more QE measures to be announced at next week’s FOMC decision. We think this is unlikely given the latent prospect of rising inflation caused by higher food & energy costs due to the Gulf of Mexico incident, among other things. Contributing to a weaker Dollar theme is also seen by USD/JPY flirting with the 85 level; a line in the sand that the BoJ recently said would be defended if necessary.

We all know how much the FX market enjoys taking on the Central Banks from time to time so we expect a test of the line and for the line to hold, perhaps just below 85. Somewhat counter intuitively, even if we are wrong and the Fed does announce more QE next week, this may still help USD/JPY rebound as the Japanese official buyers will likely chase what little yield remains on US Treasurys and buy USD regardless.

Time is Close at Hand to Reevaluate Risk Currencies

Although we have been understanding & advocates of strength in AUD, MXN & NZD we think the time is close at hand to reevaluate these views, at least until a clearer picture emerges on the US economy due to so much uncertainty out there. Yesterday for example equity markets in the US made new highs for the year, yet so-called risk currencies like those mentioned above did not react in accordance with recent behaviour, spurring the theme for this week’s column about risk appetite in general.

With this in mind, we are focusing on the Antipodean region as it appears the Australian economy is reaching a near-term peak evidenced by lower inflation numbers and a steady RBA outlook in the face of a looming election. AUD may in fact be overpriced due to political uncertainty alone.

New Zealand witnessed a raft of soft data in mid-July and the RBNZ also signaled that a pause in rate rises is now likely, based not least on a currency that by most measures is overvalued and jeopardizes the export base of a country whose economy relies pretty much on such output.

In each case we note the important absence of new highs being made by these currencies against the USD even as the Greenback remained soft in July and see this price action as a potential sign that investors may be reducing positions in the carry trade by selling these higher yielders.

Trade recommendation of the week is to sell 50% of position in NZD/USD at market 0.7350, add 25% at 0.7390 and another 25% at 0.7430 with a stop above 0.7530, 2010 high is just below 0.7450 so far.

We like this idea based on the crowded short USD trade & softer NZ fundamentals as discussed here and also the likelihood that any stock market rejection of new highs and/or a summer meltdown as we approach the second anniversary of the 2008 crash will have nervous investors scurrying for risk-aversion tools, which we think will translate primarily to a great shorting opportunity in NZD.

If payrolls are a disaster and the USD strengthens again on capital flows we like the idea of remaining short NZD but against a long GBP by buying cable on a dip to around 1.55 thus achieving a cross rate of around 2.10-2.11 subject to getting the respective pairs executed at defined targets.