Weekly Review and Outlook Euro Strengthened in Volatile Markets, Dollar Sharply Lower ahead of FOMC

While the headlines might be dominated by the automaker bailout drama, risk aversion or dollar's loss of its safe haven status last week, it's Euro's strength and momentum that should be paid most attention to and most closely watched. Dollar's index's sharp decline to as low as 83.22 last week was inline with the head and shoulder top scenario that indicates a medium term top is at least in place at 88.46. However, Dollar's weakness was indeed not too severe except version the yen which saw USD/JPY dived to 13 year low of 88.54 before rebounding. GBP/USD, AUD/USD and USD/CAD are still kept by near term levels only, without significant technical breakthrough. On the other hand, while much volatility was seen in yen crosses, most of the are still held by near term low and thus there is no confirmation of a another round of massive yen buying yet.

The Euro, on the other hand, was supported by the speculations that ECB will pause the policy easing cycle in Jan and surged across the board. Indeed, the top movers chart was occupied mostly by Euro crosses last week. EUR/GBP regained momentum and soared to near record high of 0.8996, just inch below 0.9 psychological level. EURJPY managed to hold well above 115.88 support despise yens' intra week strength and the cross indeed closed nearly 3% higher. The view that another rise is to be seen in EUR/JPY to complete the consolidation from 113.63 still holds. EUR/CAD's rise accelerated further to as high as 1.6735 and is set to taken on 1.7 psychological level. Meanwhile, EUR/AUD is on the verge of break out from triangle consolidation which should send the cross through 2.1126 high.

While strength in Euro in crosses is still expected to continue in the short term, the tricky part of the overall outlook is on the relative strength in dollar, euro and yen. Firstly, as mentioned during the week, while it's highly likely that dollar index has completed a head and shoulder medium term top (ls: 87.87, h: 88.46, rs: 87.68), it's still not 100% confirmed until 83.11 support is decisively taken out. Strong rebound from current level will argue that it's merely unfolding as triangle consolidation instead. Secondly, at this moment, EUR/USD's rise from 1.2549 is still viewed as part of and a-b-c consolidation that started at 1.2329 only and if this is correct, EUR/USD's rally should be near to an end. However, thirdly, as mentioned above, EUR/JPY's development is still inline with the view that another strong rise is to be seen before completing the consolidation from 113.63.

Having said that, the key is whether dollar index will dive through 83.11 or rebound and whether that is Euro led or yen led.

    * Another sharp fall in dollar index, accompanied by strong rally in EUR/USD and EUR/JPY will suggest that the Euro is gathering strong momentum and in such case, strong rally should be seen in EUR/JPY. Also, it will be likely that EUR/USD is indeed bottomed out at 1.2329 and 1.3768 resistance will likely be taken out by a strong medium term rally.
    * Sharp fall in dollar index, accompanied by sharp decline in USD/JPY and EUR/JPY will probably drag the EUR/USD down, which is consistent with the consolidation case in EUR/USD. While Euro crosses might remain firm, this will be taken as a signal that another round of massive yen buying is underway.
    * Strong rebound in dollar index, accompanied by steadiness in USD/JPY and sell off in EUR/JPY will suggest that markets are back to the prior state where safe haven flows are going into dollar and yen again and should see other major currencies, including Euro, dragged down by such flows.
    * Strong rebound in dollar index, accompanied by sell of in EUR/USD and rebound in USD/JPY will indicate that dollar is gaining back momentum and should see the greenback retest prior highs against other major currencies.

The Week Ahead

FOMC rate decision will take center stage on Tuesday. A 50bps cut in the federal funds rate from 1.00% to 0.50% is fully priced in. Interest rate futures are pricing in more than 70% chance that Fed will cut by 75bps to 0.25%. Another main focus will be the development in the Automaker bailout drama. The $14bill was passed in House by voted down in Senate last week. White House evaluating different options for preventing a collapse in the auto industry and could have some announcements this week. Other focus include CPI, regional fed survey from New York State and Philadelphia , industrial production, NAHB housing market index, new residential construction and TIC capital flow.

From Eurozone, main focus will be on Germany Ifo and Eurozone PMIs. Nov HICP final will also be released. From UK, MPC minutes will be the main focus with CPI , employment, retail sales featured. Swiss combined PPI, industrial production, retail sales will be released. BoJ is widely expected to keep rates unchanged at 0.3% this week. Quarterly tankan survey will also be released. From Canada, main focus is on retails sales and CPI.