Forex Market Outlook 10/26/11

Today is the day of reckoning for the Euro as the market is expecting the final resolution to the Euro debt crisis. At this point it is still uncertain at exactly what time the details of the plan will be released so stay on your toes today and pay attention to the news!

Yesterday’s risk aversion and subsequent sell-off non-withstanding, the markets have been moving markedly higher since early October and it looks like we have put in a bit of a “V-bottom”, which I identified in yesterday’s chart of the day. It will be interesting to see if the market can sustain this rally in the face of the Euro announcement.

There are many rumors circling around the details of the plan so I will throw a few out there that I am hearing but take them with a grain of salt as they may be utterly worthless when the plan is announced.

For starters, Greek private bondholders will be taking a “voluntary” 50% haircut on their holdings, meaning losses. How this doesn’t constitute a technical default is beyond the scope of my limited understanding, but If I held bonds and CDS, I would push for default and not voluntarily agree to losses as I can get paid out 100% from the insurance. This may take a while to play out and I am as intrigued as anyone to see how it goes.

Next, the size of the EFSF is rumored to be in the $1 trillion dollar range, though it is uncertain if this comes as a combination of the current EFSF and the ESM (two separate facilities) or if they plan to leverage up the fund through the ECB. Banks will need to be re-capitalized to stem the losses from the haircut on the Greek bonds, and will need to be shored up if contagion occurs.

The idea of an SPV, or special purpose vehicle, is being floated that will allow private investors to invest with some sort of guarantee or backstop from the funds. This may be a way to funnel more IMF aid into the equation.

Lastly, there needs to be increased fiscal austerity, most notably now from Italy as they are the region’s 3rd largest economy and are currently being vilified as the next potential domino to fall. It is amazing to me that no one even talks about Portugal or Ireland any longer.

So what is my outlook? I think that the markets will rise on the announcement, perhaps dramatically, only to begin to fall once the details are released. I think EUR/USD can get above 1.40 today, but resistance up at 1.413 may hold so if the3 situation presented itself, I would probably be looking to short the pair in the high 1.40s with the hope that it could move down to 1.375 where at that point I would be a longer-term buyer.

Other news out there today is that CPI data in Australia came in lower than expected, reducing expectations for further rate hikes and actually putting rate reductions into play. While the RBA will likely hold for a bit to see how this all shakes out, they will be keeping a keen eye on inflation. Later tonight, the RBNZ will be out with New Zealand’s rate decision and a change is unlikely considering their lower CPI data reported yesterday.

Here in the US, durable goods orders fell less than expected which is a positive I suppose, but yesterday’s consumer confidence figures were absolutely atrocious. However it is important to note the discrepancy between what people say and what they actually do. Later this morning, new home sales will be out.

But all eyes and ears will be waiting for the Euro announcement. The markets appear poised to move higher as stock market returns have been flat for the year so if you’re a big-time money manager, you essentially have one quarter to make it happen and earn some cash or even keep your job. In addition, I think global inflation has been somewhat masked by the cloud of uncertainty of the euro debt crisis and we have seen recent big-time gains in commodities, most notably in oil and gold which are back above $90 and $1700 respectively.

The idea that QE3 may be on the table is likely contributing to Dollar weakness, but all of these other factors are important as well. US corporate earnings have largely been better than expected which means that companies gain make money in a downbeat economy and despite barriers created by bad government policies and potential higher taxes.

With a declining US dollar and next to nothing bond yields, the stock market is likely going to be the market of choice for investors to close out the year so I expect the correlations in the forex market to continue to keep up. The Dollar weakness theme is evidenced by a strengthening Japanese yen, which is at new all-time highs of 75.75. While Japanese officials are crying, there may be very little they can do about it.

So stay on your toes today and be quick to react. Don’t try to be a hero in front of these markets, as there is no telling what may happen. Good Luck!

By Mike Conlon,