Beginning in October when the chronic seizure of the financial/credit markets started to explode, it sparked a sense of panic and sent funds on the hunt for safety in the form of liquid, stable and essentially risk-free US Treasuries and consequently make US Dollar higher despite the outlook for growth in the US is particularly threatening and the need for bailouts of large financial institution and industrial firms.
However, the past two weeks, this extreme in sentiment has since clearly been contained - although with caution stance. A sense of stability has allowed investors the luxury of reassessing where their funds would be safest.
This sentiment could be seen in the EURUSD when the euro posted its best single-week performance in eight years, as an outright tumble in the US dollar left the Euro Zone currency as the prime beneficiary of a turn in market sentiment last week. The Dollar weakened as traders flush with confidence that something proactive was being done about the U.S. economy, decided to take on more risk in their portfolios. This negative tone toward the Dollar held most of the week and the Dollar finished on the downside for the week after the Senate killed the automaker bailout plan. The sharp euro recovery stood the test of continued deterioration in global risk appetite; sharp declines in global equity markets were not enough to sink the previously risk-sensitive European currency.
The Japanese yen (the other key flight-from-risk currency of choice) rallied against its liquid counterparts i.e US Dollar upon the problem of the big three US auto makers. (See the USDJPY of chart below ).
As for the EURJPY, The EUR was strengthening in similar fashion as against the US dollar, with 200 period EMA (the red line of EURJPY chart) providing support and approaching the Monthly pivot point by Thursday during the US session. It managed to recover the downtrend experienced the week before. But on Friday during early Asian session, the EURJPY dived to the week low and reversed back immediately, recovering during the European and American session. Looking back to the trigger of the heavy fall, it is clear that the failed US auto industry bailout was the culprit. However, the quick reversal (in all the yen pairs) suggests that this was a false alarm.
On the chart, the Friday dive broke the uptrend line but managed to be contained by the weekly pivot point and the daily S3 (Support pivot point). The psychological level of 118.00 also played the role as a support level.
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. The euro strengtened against the dollar and yen but the yen strengtened against the dollar. Will the dollar be the weakest or strongest link among the three currencies or the dollar dive or rebound be a Euro led or yen led.
-A sharp fall in dollar 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.
-Sharp fall in dollar 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, 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 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.
