Written by DailyFX

EURUSD Outlook

2006 Q1 Review, 2006 Preview

The first quarter of 2006 has been marked by a significant drop in volatility in the currency market with a move towards more range bound trading. The EUR/USD traded in a 500 pip range, compared to the 850 pip range that we experienced in the first quarter of 2005. The major reason for the drop in volatility has been the convergence of interest rate policies of the two central banks. While the US Federal Reserve continues to charge on forward with incremental interest rate hikes, the European Central bank has finally joined the ball game as the EZ economic recovery builds momentum. Interest rate or yield convergence has also compressed volatility, which in fact has fallen to record lows in many currency pairs. With both central banks set to continue increasing interest rates for the remainder of the year, the competition of who will keep at it longer will probably be the biggest determining factor of where the EUR/USD is headed. The US dollar and the US economy face many risks that could unfold as early as the next few months, but we will not have a major turn in sentiment until those risks occur. As long as the market continues to revise higher its predictions of when the Fed will cease to tighten the US dollar will be able to hold onto its upside momentum.

It All Hinges on the Fed

The Federal Reserve raised interest rates by 50 basis points in the first quarter, bringing the Fed funds rate to 4.75 percent. At the last FOMC meeting of the fourth quarter and also the first for the new Federal Reserve Chairman Ben Bernanke, the central bank was surprisingly positive on the US economy. The FOMC felt that the slowdown we saw in the fourth quarter was only temporary and that the rebounded growth in the first quarter should moderate to a more sustainable pace. At a time when the market was predicting 5.00 percent money to be the cap, the hawkish comment that "further policy firming may be needed" sent some analysts to immediately revise their forecasts for rates to go as high as 6.00 percent. The market however was far more skeptical sending the dollar lower in the first few days of second quarter trading. Yet no matter how you cut it, the question is still "when will the Fed stop." Most likely it will not be in the second quarter but based upon current market expectations, it could be in the third or fourth quarter. When the Fed does eventually pull the plug on rate hikes, they will take away the solitary support for the US dollar. Based upon a study that we did last year, the end of the Fed tightening cycle, tends to correlate with a major turn in the dollar. How soon this will happen will depend upon how long the housing market holds up, how much further oil prices rise and how much longer US consumers will continue to dip into their savings to fund their spending.

Housing ? A Bubble Ready to Pop

Housing remains the real wildcard. There have been many reports that the housing market is about to tip over, but we have yet to see any clear signs of it doing so. Housing market bulls have been saying that price growth is simply normalizing from double digit back to single digit gains, which means that real estate should still provide solid investment returns in the future. However signs of weakness are emerging. Prices have contracted in key states and inventories are mounting. New home sales have fallen six out of last seven months while pending home sales have fallen four out of the past five months. Nationally, median and average sale prices have remained steady, but when you have some builders offering fire sales such as DR Horton who have been discounting their new homes as well as adding on a lot of free upgrades, you know that trouble is brewing. California based homebuilder William Lyon Homes also said that new home orders in the first quarter fell 26 percent from a year ago. This is not just unique to DR Horton and William Lyon Homes as KB and Pulte Homes are both expected to report double digit declines in new home sales in their next report. With the US savings rate having fallen below zero, indicating that Americans are spending more than they earned, we know that much of that spending has probably been fueled by borrowing. This is a behavior that cannot be sustained for long, especially as Americans are faced with an escalating cost of living. Mortgage rates are on the rise at the same time that energy prices are climbing. Of course, many people have been calling for a burst of the housing market bubble for years now and have been proven wrong repeatedly. Yet the mania is getting more and more dangerous with increasing evidence that the day of reckoning may be right around the corner. When that happens, the Fed will be forced to cut short their tightening, which will have strongly bearish implications for the US dollar.

What about the Rest of the Data?

Not all news is bad news though. The labor market continues to hold up very well with payrolls increasing 211k in the month of March, bringing the unemployment rate down to 4.7 percent. As long as job growth remains plentiful, consumers will probably continue to spend, fueling growth. Tax receipts expected in the month of April and May could also add another boost to spending. Although the manufacturing sector is floundering, the service sector is expanding at a healthy rate. The latest retail sales figures also show that consumers are continuing to spend, which means that no matter how concerned we get about the housing market or the fact that oil prices are less than 30 cents away from their all time highs at the time of this writing, until we see a response by consumers to curb their spending substantially, the impact on growth will remain limited.

Iran ? A Hotspot Worth Watching

The most worrisome geopolitical developments is official news out of Iran that they have successfully "joined the club of nuclear countries" by enriching uranium for the first time. This is in direct defiance of the UN Security Council's calls last month for the country to suspend nuclear research by the end of April. The US responded by calling for "strong steps" against Iran. With two occupations in Afghanistan and Iraq, the appetite amongst US citizens for yet another conflict is decidedly absent. Should this conflict ignite the dollar could suffer not only because of the imminent risk, but also because another war would only exacerbate the already burgeoning budget deficit.

Protectionism ? Not Good for the Dollar

As if the factors already weighing on the dollar were not enough, the US is exercising more protectionism. We first saw evidence of this trend with the rejection of China's CNOOC's bid for Unocal last year and then the rejection of the Dubai Ports Deal earlier this year. The Dubai ports deal prompted the US Senate to create a bill that would force the Treasury Department to notify Congress of all proposed cross border transactions. If passed, this would mark the biggest change to US foreign investment rules in 20 years. Currently, the US is warning China, one of its most important trading partners, that if they do not reduce their trade surplus with the US, they could face more protectionist reactions. At a time when the trade and current account deficits are at record highs, overprotecting the US economy will deter much needed foreign investment to fund the deficit which helps to prop the dollar. Furthermore, there is also an immigration bill looming that if passed, would reduce the availability of inexpensive labor here in the US. Closing the door to inexpensive labor in China while at the same time closing the door to inexpensive labor coming from south of border could cause inflationary conditions here in the US. This may force the Federal Reserve to respond with higher rates, which could tip the economy into a recession given the high levels of consumer borrowing.

Nimble Rate Hikes from the ECB

Since December of 2005, the European Central Bank has boosted their lending rate by 50bp through two separate interest rate hikes. This has kept a bid underneath the Euro throughout the first quarter of 2006 and will continue to do so as the ECB works to stabilize the yield spread between the US and the Eurozone. When the Fed finally completes their tightening cycle and the ECB finds itself as the only one of the two central banks to be raising interest rates, the Euro could enjoy a fresh surge of buying momentum. Given the continued recovery in the Eurozone and the improving employment picture, the ECB is predicted to raise interest rates at least once a quarter for the remainder of the year. In fact, the ECB was expected to be even more aggressive, but they have become are very sensitive to the value of the Euro given the heavily export dependent nature of the region. Therefore, the central bank made sure the market realized early on that they have no plans on increasing interest rates in May, but will instead raise them in June. This announcement came on the heels of the Euro hitting 1.2330 in the beginning of April and goes to prove that if the Euro continues to rise, the ECB will also continue to be more nimble with their rate hikes. This helps us to understand why the ECB is pacing themselves and not being as aggressive as the US, who does not rely as much on exports for growth.

Reserve Diversification ? Still a Big Positive

Slowly, but surely, reserve diversification continues to benefit the Euro. Last year, we heard a lot of talk about reserve diversification by countries like Russia, South Korea and India. This year, the United Arab Emirates joined the group by shifting 10 percent of their own reserves from dollars to Euros. Of course, compared to many other countries, the UAE only has a small portfolio of reserves, but with talk of China still looking beyond US Treasuries, the Euro should find itself as one of the primary beneficiaries, even if it simply means that China will stop accumulating US dollar reserves. East Asian countries own two thirds of the world's US$4 trillion of forex reserves, so their activity is particularly important. China has already been looking beyond the dollar as an investment over the past few months as they assume exposure to more tangible assets such as oil fields or gold.

Politics ? Recurring Sore Point

One recurring wrinkle that has been weighing on the Euro is politics. Last year, we had to contend with the breakdown of the EU Constitution, the stalemate in the German elections and widespread riots in France following the death of two youths living in the country's poorest suburbs. This escalated in days of intense violence and in reaction to that, the Euro slid to its year to date low of 1.1650. By the end of 2005, things had quieted down, but just when you think the uncertainty has passed, it returns once again. In the first quarter of 2006, French citizens were protesting the government's proposed labor reform law. After weeks of protests, the Prime Minster eventually announced plans to drop the controversial law, but even so, the riots and protests over the past year may have had an impact on the country's tourism market. With the end of the protests comes another uncertainty in the Italian elections. Ringing a tone of events that have passed, the vote for the new Prime Minister was extremely tight with Romano Prodi announced as the winner by a very small margin. Current Prime Minster Berlusconi has refused to concede defeat, citing big discrepancies with tallying of the votes and demanding a recount. We all know what happened when the same situation occurred in the US a few years ago and later in Germany between Merkel and Schroeder. In both scenarios, the officially declared winner still became the eventual winner. However, we do not know how long it will take before Berlusconi backs off and in the meantime, Prodi does not plan on forming a government until May, prolonging political uncertainty. Even if the Italian election comes to pass soon, in a region that consists of 12 countries, we would not be surprised if political unrest surfaces once again.

Conclusion

In the first quarter of 2006, the EUR/USD shook off its 2005 trending mode and resorted to trading in an albeit wide range. The fact that both the Federal and European Central Bank are expected to raise rates in the second quarter, should keep this theme intact. However, once the Fed ends their tightening cycle and if the ECB continues to push forward at that time, we could see a more substantial rally in the EUR/USD. How high the Fed will go is contingent upon how much longer the housing market will hold up and how resilient US consumers can be. Yet even if both remain status quo, the US' protectionism measures and rising geopolitical tensions with Iran could still weigh on the US dollar. Over in Europe, growth is increasing at a stable rate, but the European Central Bank finds themselves particularly sensitive to exchange rate fluctuations. They remain hawkish, but if the EUR/USD begins to rise significantly in value once again, they will become more and more nimble with rate hikes. Even though reserve diversification is a long term positive for the Euro, recurring regional political issues frequently resurface to remind the world that it is tough to be a currency that is representative of twelve independent countries.

Technical Outlook

After coming off of a big downtrend in 2005, the EUR/USD spent the first quarter of 2006 trading in a 450 pip range. Taking a look at the weekly charts, we see that the EUR/USD is currently in the midst of forming the right shoulder of a major 2 year head and shoulders pattern. At the same time, it is also forming a symmetrical triangle, which suggests that we are reaching a very important turning point for the currency pair. The presence of higher lows over the past six weeks and a positive MACD indicate that bulls hold a modest lead. ADX is also rising, which suggests that the trend may be picking up momentum. However, since we have yet to reach an apex in the triangle, there could be more consolidation before one of the two key levels is breached. A break of 1.2350, which is slightly above the April 7th high, would open the door for a move back towards 1.35. A break below the triangle support of 1.1890 on the other hand would pave the way for a move towards the head and shoulders neckline of 1.1750 and then a following break below that does not see support until 1.1615, which is the 38.2% Fibonacci support that dates back from the November 2000 low of 0.8225 to the December 2004 high of 1.3670.

USDJPY Outlook

Interest rates and oil pushed the yen to multi-year lows against the dollar in 2005. At the beginning of May, USD/JPY traded at 104.18, but by December, the pair hit 121.38 with the dollar rising a full 1700 points higher turning the yen into the worst performing major against the greenback in 2005. The decline of the yen is a testament to the power of the carry trade as US rates rose in 2005 from 2.25% to 4.25% creating a 425 basis point interest rate differential between the dollar and the yen. The critical question facing traders in 2006 is whether this spread will continue to widen or will it be the end of the great dollar carry trade? As we enter Q2 of 2006 it is becoming imminently clear that the power of the carry trade is losing its punch. Although US rates continued to ratchet upward in Q1 of 2006, rising to 4.75%, the pace of future increases is expected to slow materially with most market participants anticipating one, at most two additional 25bp rate hikes that may take the Fed funds rate to a maximum of 5.25%. Jobs will be the key determinant in just how far the Fed will go before pausing. 200K+ of new jobs per month appears to be the metric that will allow the Fed to be more hawkish. Should new job creation fall significantly below that barrier for several months running Fed tightening will likely cease and along with it so will the salad days of USD/JPY carry trade as the interest rate differential between the two currencies will no longer expand. For its part. Japan finds itself on the cusp of ending its decade long battle with deflation. Japan's Corporate Goods Price Index has increased for 8 straight months in a row while Tokyo CPI has been positive since the beginning of 2006 after declining relentlessly in 57 out 60 months since 2000.

QEP Over is ZIRP Next?

In Q1 of 2006 the Bank of Japan finally abandoned its Quantitative Easing Policy (QEP) ? the practice of flooding the Japanese banking system with more than 35 Trillion yen in reserves in order to maintain liquidity in the system as the Japanese economy finally demonstrated signs of sustained growth and the Nikkei rallied above 17,000 for the first time since 2000. The move away from the QEP was the first step in ending the ultra accommodative monetary policy that has characterized BOJ actions for the past decade. The second and far more powerful monetary change would the removal of the Zero Interest Rate Policy but up to now the Central Bank has offered few clues as to the time table for the eventual increase in repo rates. In fact at the end of the latest BOJ Meeting Governor Fukui remained noncommittal, stating that he had no preconceptions on when to end the current zero interest rate policy. Governor Fukui's reticence stymied some of the expectations of yen bulls for a near] term change, but given the pace of Japanese growth, the market now anticipates that the BOJ will not wait much longer than the July before changing interest rate policy.

Japanese Growth Improving

One of the principled differences in Q1 of 2006 was the continued improvement in Japanese economic growth. While the corporate sector has been healthy for some time with capital spending increasing at near double digit levels, it was the Japanese consumer that has finally awakened from a multi-year slump as the country's growth translated into ultra-low unemployment rates of 4.1% and improved consumer confidence. In fact the Eco-Watcher's survey ? a key measure of "man in the street" sentiment hit a 6 year high registering a reading of 57.5 in the latest poll. The news bodes well for future Japanese consumption growth and in turn BOJ willingness to move off the ZIRP standard. Consumer spending is the last missing link in the story of the Japanese economic recovery. and to that end the data remains mixed. Retail Trade numbers have been steadily improving with positive results in the last 10 out of 12 months. Overall household spending however has been lackluster at best, registering negative year over year readings for every month in Q1 of 2006. This report will be the vital clue to BOJ policy going forward. If rising Japanese consumer confidence can finally translate into positive year on year comparisons in Japanese consumer spending, then the groundwork for the near term lifting of ZIRP will be set.

Revaluation ? Yuan or Yen?

The FX world has been focused on the issue of Chinese Yuan revaluation since the later half of 2005. In July of that year the PBOC actually revalued the Yuan for the first time in 9 years appreciating the currency by 2.15%. As a result, the yen reacted positively with USD/JPY dropping 300 points in a matter of 2 days. The yen of course benefits from Yuan revaluation in two ways. First, as the largest exporter to China, Japan earns more income from its business interests in Mainland China as the Yuan appreciates against the dollar and Chinese companies continue to spend more. Secondly, as the primary trading competitor of China on the world stage, Japan achieves a cost advantage in its products as denominated-denominated goods rise in value. With Chinese exports to the US setting monthly records, the political pressure on the Chinese to revalue remains intense. Senators Schumer (D-NY) and Graham (R-SC) have introduced legislation that would impose a 27% tariff on all Chinese goods. The legislation has been put on hold for the time being but most market observes believe that further Chinese revaluation announcements will take place as a response to increasing pressure from the Bush administration during the sensitive election year in the United States. Already, the Yuan has set nearly daily record highs against the dollar, trading within a whisker of the 8.0000 level. A fall through that psychologically important barrier may produce a more rapid decline for the pair which would be bullish for the yen as yuan appreciates further against the dollar.

More Sensitivity to Exchange Rates

However, while the issue of Yuan revaluation is well known in the currency markets, the idea of yen intervention has not been given nearly as much attention. The recent run up of the dollar against the yen has been a boon for Japanese exporters, as the country has amassed an $80 Billion goods trade surplus versus the United States. Typically, the export oriented nation has only intervened to weaken the yen, but recent statements by President of the Automotive Trade Policy Council, Stephen Collins should make traders take pause and consider the opposite possibilities. Mr. Collins stated that "Japan has played this game (of currency intervention) hard and highly successfully and to our industry's, and we think the U.S. economy's, demonstrable harm. We have pushed hard to get much more attention and something more credible, more serious from the Treasury department. While all of the attention has been on the new guy on the bloc, China, Japan flew under the radar screen and has joined in on pointing fingers at China. The reports from the G7 were extremely discouraging and very damaging to U.S. interests. There is no excuse for the G7 to get together and sit around talking about China when the currency imbalances and Japan's policy of strongly encouraging yen weakness isn't even discussed." In the past Japanese authorities viewed the 100 USD/JPY rate as the critical support barrier. Then the defense line was raised to 110 and finally now many market participants believe that Japan's MOF would not like to see rates decline below the 115 level. As time progressed the level of support for the yen has been ratchet higher and higher but if Mr. Collin's views become popular during the upcoming election season, the pressure on Japan to conduct reverse intervention could send USD/JPY tumbling, regardless of the carry trade spread.

Conclusion

While 2005 was undoubtedly the year of the carry trade which saw USD/JPY soar to multi year highs, 2006 may see many of those same trends reverse. Better economic growth and more importantly steady increase in Japanese consumer spending could finally motivate the BOJ to abandon it's decade long Zero Interest Rate Monetary policy, while the US Fed ? faced with a slowing housing market may terminate its two year long monetary tightening policy. With BOJ already abandoning its QEP as it positions to change the Zero Interest Rate Policy, this major shift could give speculators a good reason to abandon their short yen carry trades as we move forward in 2006. Meanwhile, China, pressured by political outcries for revaluation during the upcoming US election season may be forced to loosen its yuan peg further, sending the USD/JPY lower. On the other hand, if US growth continues its torrid 2005 pace, the Fed may raise short term rates to 5.25% or higher in which case the carry trade will continue, potentially taking USD/JPY to 130 or higher as a result.

Technical Outlook

The USD/JPY spent the better part of Q1 2006 consolidating its gains of 2005. After experiencing a vicious 800 point sell-off from its 2005 highs of 1.2138, the pair made a spike low at 113.41 on 1/12/06 (the 61.8% Fibo of the 108.75-121.38 bull wave) and then spent the rest of the quarter churning higher. All of the rallies however, were capped by 119.00 resistance line while volatility compressed markedly as the quarter wore on. Over the past month the action has become even more contained with most downside moves never extending below the 116.38 level which represents the 38.2% Fibo retrace of the much larger 108.75-121.38 bull wave while upside forays never made it above the 119.00 barrier with several daily candles forming shooting stars and doji's suggestive of quick rejection of that price level

As we move into the second quarter of 2006 the USD/JPY is tracing out a very clear ascending triangle pattern suggesting that the Q1 of 2006 may have simply been a consolidation of the large 108.75-121.38 bull wave of 2005. Ascending triangles typically resolve in upside breakouts but only a clear burst to the 120.00 level would confirm the resumption of the upside trend. A break below the 116.00 figure however would trace out a major distribution top and may target the base of the large 2005 breakout move all the way at 108.00. Indicators however point to further upside strength as MACD has made a series of higher lows, but in and of its self this information provides us with little guidance as price flow could quickly turn the values negative. Finally, the most recent series of lower highs suggests that dollar bulls are losing steam and the ascending triangle formation may well fail to break out.

GBPUSD Outlook

After undergoing a deep slide in 2005 to a low of 1.7048, the British pound has stabilized in the first quarter of 2006, and has spent the first three months of the year range trading. Interest rate spreads have been the dominant reason for the currency pair's trading range, so it is no wonder that the zero spread between the US dollar and the British pound between January 31st and March 27th has prevented the pair from experiencing any meaningful volatility. Additionally, in the past month, we have seen a major shift in balance between the US dollar and the British pound. For the first time since December 2000, the British pound is offering a lower interest rate than the US dollar. The 25 basis point negative interest rate differential is expected to increase even further to the dollar's advantage as the Federal Reserve continues to raise interest rates, which will prove to be a big burden on the GBP/USD. Improving conditions have allowed the Bank of England to lean closer to neutral than in favor of lowering interest rates, but economic data has still been very mixed, which will prevent the central bank from closing the widening interest rate gap by raising interest rates.

Growth Remains Tepid At Best

Believe or not, economic data has, improved in the British economy as housing valuations have stabilized while the manufacturing sector has seen a notable, albeit modest pickup. Over the course of the quarter, consumer spending picked up pace as individuals buoyed by higher wage growth became convinced that the Bank of England had no near term aspirations to increase benchmark rates. Headline wage growth spiked higher by 5.3 percent in the month February. This bullishness has filtered into surveys including the most recent HBOS Plc report. According to the survey of the $6 trillion property market, prices climbed 0.9 percent to an average of 175,215 pounds ($307,038). This places the annual rate of appreciation to 6.2 percent demonstrating continued strength after the slight pullback seen over the last three quarters. Subsequently, this very stabilization in the housing sector has weighed heavily on the decision by policy makers in keeping the current 4.5 percent repurchase rate. Additionally, manufacturing activity has recovered modestly suggesting that the current policy of no rate changes is likely to continue. Accounting for approximately 15 percent of the $2 trillion economy, manufacturing has surprisingly advanced after posting disappointing results for much of 2005. According to the Office for National Statistics, activity in the sector has rebounded to produce growth in the three of the last four months and will contribute heavily to overall growth. Policy makers are agreeing with the positive sentiment as expectations run high that global exports and business investment will foster a growth rate of 2.7 percent this year, above the 1.8 percent rate witnessed last year. Nonetheless, consumer spending remains the key tipping point of the UK economy as individuals continue to be hesitant in the current economic conditions. The employment picture has worsened despite the fact that wages are climbing and this paradox has led to a very competitive retail environment as retailers compete, offering bottom feeder prices in order to attract market share. The Confederation of British Industry's distributive survey improved in the most recent month to a negative 16 reading from the previous negative 18. The fact that the trades survey continues to print a negative difference reflects a major concern for BOE members as domestic demand contributes to over 60 percent of the economy's growth.

Bank of England to Maintain Neutral Policy

The muted consumer spending environment and stable housing market, should encourage the Bank of England to maintain a neutral monetary policy for the remainder of the year even though some proponents are calling for a quarter point cut in the third quarter of this year. Depending upon how the manufacturing and housing sector continue to impact consumer spending, the Bank of England will have to make a decision regarding the need to reduce interest rates. Going into 2006, analysts were predicting two to three interest cuts. At this point, we would be surprised to see even one rate cut over the next two quarters. Nevertheless, the interest rate spread between the British pound and the US dollar will continue to move in the US dollar's favor, which could increase the volatility in the currency pair. If you recall, between February and March, the interest rate spread was zero, coinciding with extremely tight trading ranges in the GBP/USD. If the spread moves from -25bp to -75bp, like it is expected to, ranges could also expand in the GBP/USD. In contrast, the range of EUR/GBP, which has recently become a more trending currency pair could contract with the interest rate spread narrowing as a result of the ECB's much anticipated quarterly rate hikes this year.

M&A And Equity Prospects, More To Come

Throughout the first quarter of 2006, the British pound has received a significant boost from an increase in merger and acquisition transactions in the U.K. Increased protectionism measures in the US have made the UK's business friendly market more attractive to international investors. The most recent acquisition has been US based Nasdaq's 15 percent investment into the London Stock Exchange (LSE). Speculation of additional interest by other global competitors for shares of the LSE has raised the possibility of more M&A activity. Valued at 447.7 million pounds, the acquisition follows on the heels of earlier transactions. Spain's Banco Santander acquired Abbey National making a presence in the U.K. lending arena while Japan's Toshiba picked up Westinghouse. All in all, the current merger wave, rising to levels not seen for six years, has boosted the value of deals that is currently running at $10 billion a day. The effects have underpinned benchmark equities which are higher by 7.3 percent on the year. Ultimately the renewed interest in UK based entities looks to spur further appreciation in the underlying currency as merger demand is likely to continue, bolstering the need for FX conversion.

Conclusion

With conditions in the UK gradually improving and merger and acquisition activity heating up, sentiment may be leaning towards a further appreciation in the British pound heading into the second half of 2006. However, with continued weakness in the retail sector and inflationary pressures just keeping pace with benchmark targets, sterling strength may not persist as the year comes to a close. . Slight downticks recently in manufacturing raised the question that recent up tick in activity may have been simply a flash in the pan, contributing to shrinking growth estimates. Subsequently, this is likely to heavily influence policy makers in reaching a rate cut decision in order to spark consumer spending as the sector's weakness is likely to continue further on in the year, If anything, consensus estimates may suggest a rate cut in the third quarter, feeding into potential spikes in spending for the year end months. However, with focus looming over the weaker U.S. dollar infrastructure and a widening trade deficit, sterling downside may be minimized leading to compressed trading ranges for much of the year.

GBP/USD Technical Outlook

2006 has been a much different story for the British Pound. While market conditions the previous 6 years have been of either the trending or wide ranging variety, Cable has spent most of 2006, February 6th to present, oscillating between 1.7229 (3/10 low) and 1.7624 (3/6 high). The first 5 weeks of the year saw price spend limited time outside of that range, with only the week ending on January 27 trading completely outside of the congestion. Strength for the week ending on January 27 was rejected 8 pips shy of the 61.8% fibo level of 1.8500-1.7046 at 1.7942. Although the pair pierced its 40 week moving average during that week, it closed well below the average and has failed to close a week above the SMA since May 6, 2005. Since February 6th, the pair has been contained by the aforementioned range, bound mainly by the 23.6% fibo of 1.9539-1.7046 at 1.7628 and the 76.4% of 1.7046-1.7934 at 1.7256 with just immaterial breeches of the supporting fibo level.

In projecting direction, it is interesting to note that for the week ending April 14, 2006, the slope of the 40 week moving average has changed from negative to positive. This is the first change in slope since slope changed from positive to negative during the week ended on July 1, 2005. Further, weekly oscillators (RSI, CCI, MACD) are sloping up after illustrating strong positive divergence after making new lows at the end of November 2005. Cable is currently trading within a long term bearish flag with implications from the 40 week moving average suggesting a rally to the confluence of the upper end of the flag formation / 38.2% fibo of 1.9545-1.7042 at 1.8000. Weakness targets the mentioned 76.4% of 1.7046-1.7934 at 1.7256 with a break exposing the December 2005 low at 1.7046. If bears blast their way through, then an assault on the 50% fibo of the 1.3675-1.9548 June 2001-December 2004 bull wave at 1.6610 is a possibility.

USDCHF Outlook

The budding Swiss recovery of 2005 accelerated in Q1 of 2006 as, tiny, staid, Switzerland emerged as the fastest growing major economy in Europe. Low unemployment improving consumer sentiment and a lower franc, which spurred the growth of the nation's export sector have all combined to produce stellar economic results., Switzerland continued to record healthy GDP growth of 2.8% in Q1 while the county's most important economic statistic - the KOF index of economic indicators - has risen to its highest level since 2000 for two consecutive months. The currency's Achilles heel - its ultra low repo rate of only 1% - was its one weakness in Q1 as interest rate differentials made the Swissie vulnerable to carry trade flows especially against the dollar where the spread increased to 375 basis points. Therefore while Switzerland is a model of political stability and steady economic growth, the franc may continue to see pressure due to concerns about interest rate differentials. Nevertheless if the Swiss economy continues to perform as well in the second half of 2006 as it has in the first, the growth rate differentials should begin to favor the franc especially against its much larger next door neighbor.

Peace and Prosperity But No Boost From Gold

Although Switzerland continues to retain its status as the safe haven destination for world's capital in times of geopolitical stress, the country's currency is not longer strongly correlated with that other great safe haven asset ? gold. At one time the currency was 40% backed by the yellow metal but in 2005, the Swiss government sold the nation's vast inventory of gold and returned the funds to the country's cantons. As a result the Swissie has not benefited from Gold's recent rise above the $600 level for the first time in 25 years. Furthermore, given the decoupling that began in 2005, further gains in gold may not produce any additional strength in the Swissie as the currency will most likely trade strictly off its economic fundamentals. However, should the geo-political situation deteriorate significantly, especially if the US confrontation with Iran regarding its nuclear development program, escalates beyond mere rhetoric, the Swissie may well see massive inflows as panicked investors seek the safety and stability of the world's most neutral nation.

Strong Growth Continues

The beginning of 2006 continued to show marked divergence between the anemic economic growth of the European Union and the almost torrid pace of expansion of much smaller but far more nimble Switzerland. With unemployment hovering at an ultra-low 3.8% and Retail Sales racking up a healthy 3.1% year over year gains, Switzerland's growth remains on the fast track. The engine that is leading the economy forward is the country's vital export sector, which has benefited mightily from the relatively low exchange rates of the franc to the dollar. The most recent reading of the SVME Purchasing Manager Index soared to 60.0, far higher than the 58.1 projected and far higher than the 50 boom/bust level. The manufacturing data suggests that global demand for Swiss products remains buoyant, which will likely lead to further job gains and stronger consumer spending in months ahead.

Inflation Absent ? Will SNB Hike?

One of the greater ironies of the FX trading in Q1 of 2006 was the fact that while Swiss economic growth far exceeded its nearest rivals, the Swiss franc itself underperformed both the euro and the pound. The primary reason for the weakness in the currency was the diverging interest rate expectations amongst market participants. While growth in Switzerland continued to percolate, inflation was contained, registering a very modest 1.4% year on year gain. The low inflation in combination with persistent trade and fiscal budget surpluses has provided the SNB with the luxury of not having to raise interest rates. As expected, the SNB raised rates by 25 basis points to 1.25% on March 18th 2006, but SNB President Roth remained coy about the pace of future rate hikes, stating only that the Swiss monetary authorities would pursue "gradual adjustment". As a result, the unit continued to lag the euro as questions of whether the SNB will match the ECB hike for hike remained in traders' minds.

Conclusion

Although the Swiss franc is no longer tied to gold, it remains the predominant store of safe haven value and if the global geo-political situation in 2006 becomes volatile especially in light of escalating tensions with Iran, the franc may attract capital as investors seek safety in its stability. However as 2006 moves forward, the unit may not only benefit from its traditional role as a safe haven refuge, but may rise on economic merits as well. If Switzerland is able to sustain the strong economic growth record as the year progresses, traders and investors may begin to flock to the unit on fundamental grounds. Despite low inflation, higher growth rates may spur the SNB to become far more aggressive in its monetary policy. Some analysts predict that the franc may yield 2% by the end of 2006 as the bank raises rates every quarter by 25 basis points. If such scenario does unfold, the Swissie should perform well not only against the dollar, but also against the other majors as it would compress the interest rate differential against the Euro and the pound and expand the carry spread against the yen to a meaningful 200 basis points. Thus for tactical traders in 2006, the Swissie presents interesting potential for profit on the crosses as well as against the dollar.

Technical Outlook

With the exception of a dip to the 1.2500 level at the start of the year, USD/CHF spent the better part of Q1 trading tightly within the 1.3200-1.2900 zone. The price action has become progressively narrower as ranges have compressed to a near standstill. The pair has traced an unmistakable symmetrical triangle that looks ready to explode. One of the more interesting properties of the symmetrical triangle formation is that it is neutral in terms of direction, offering equal probability of price action resolving to the upside or the downside. With USD/CHF closely correlated to the dollar index, the directionality of the pair may provide clues to the overall dollar trend in 2006.

At present, the technical situation in USD/CHF appears unclear with equal likelihood of price action moving higher or lower. Indicators provide little guidance as MACD remains at a standstill hugging the 0 line, However slow stochastic is beginning to form a lower high suggesting a possible move to the downside. Should the pair trade in that direction, the nearest support comes in the 1.2678-1.2578 region bounded by a series of lows from Q4 of 2005 and the spike low of 1/23/06. Further support does not exist until fully 300 points lower at 1.2385 low of 9/05/05. On the other hand, should the pair break to the upside, it will run into a wall at the 1.3200 level which has formed a massive distribution top after three attempts to penetrate it. Should the pair overcome that barrier, the path is clear all the way to the 1.3700 figure ? a price level that has not been seen in the USD/CHF since 2003.

USDCAD Outlook

Staying within a 500 pip consolidation range following last year's lengthy decline, the USDCAD currency pair remains the object of speculation regarding a move to parity as the underlying spot continues to hover near the 14-year lows seen at the end of last year. Keeping the Canadian dollar a long term favorite in the market has been an array of positive data, bolstering notions that the ninth largest economy in the world is expanding versus global counterparts. Adding fuel to the fire are climbing commodity prices as China continues to advance in the global arena and traders find solace in base metals against worldly price increases. Oil has remained a major positive for the CAD, as prices rise to less than 30 cents away from record heights. This has subsequently added to mounting speculation of increased interest rates as Governor David Dodge and company continue their attempts at remaining preemptive in the fight against inflationary pressures. Already raising rates five times, the market has priced in 4 percent rates and expects the central bank to continue to move beyond that level. Ultimately, this places a lot in favor of loonie bulls as we head into the second half of the year.

Shift in Consumption: Rising Domestic Demand Offsets Export Dip

With the resurgence in global exports over the past year, Canadian economic data has shown great promise when compared to its G7 counterparts. Consumer spending is contributing heavily to the overall growth of the economy as a tight labor market pushes wages and hourly earnings higher, creating a higher standard of living amongst the citizenry . According to the most recent monthly survey published by Statistics Canada, payroll employment created 51,000 jobs in the month of March. Nearly twice the estimated forecast, the figure soars above the four month moving average and reflects a tighter labor market. This, in turn, will ultimately mean more real after tax income for the individuals. In fact, after tax or disposable income is estimated to grow by 5.4 percent in the year and should push consumer spending to an annualized pace of 3.6 percent. Ultimately, this translates into the second consecutive year that stronger consumer spending will carry the economy forward as slower exports dip into growth figures. Subsequently, the boost in full time work has trickled into the housing sector. Having spent a year in the doldrums, the Canadian housing sector has benefited significantly from the impressive growth in Canada, high commodity prices and healthy corporate performance. Housing starts alone in March spiked higher by 252,300 units compared to February's 242,500 according to the Canada Mortgage and Housing Corp. Setting a pace not seen in almost 18 years, the robust housing sector is yet another product of the recent decline in the unemployment rate which gives the Bank of Canada good reason to continue to increase interest rates.

Loonie to See Boost as Oil Targets Fresh All-Time Highs

Energy prices have been a major contributor to rising inflationary levels in 2005 and will continue to in 2006 . Although pulling back from the $70.85 high seen just last year, valuations in the commodity have remained lofty amid supply concerns and geopolitical risk in the Middle East. The trend is already continuing as crude prices look set to make yet another all time high. Coincidentally, the recent appreciation has benefited the Canadian economy greatly. As it stands, a sixth of total exports leaving the region are natural gas and crude oil products. This has contributed to a widening surplus, one of only a handful among industrialized countries, and positive compared to a widening deficit in one of the world's largest consumers. According to Statistics Canada, energy contributed heavily to last year's surplus as it ballooned to C$66.7 billion with energy products constituting 80 percent of the gap, standing at C$53.6 billion. With higher consumption expected from global trade partners, the trend looks to continue indefinitely adding to the overall economy. However, a caveat remains in the appreciation of the domestic currency. Higher prices will lead many partners looking for alternative fuels, ultimately lightening demand. Should this occur, the effects may be limited as Growth falls back of strong domestic demand.

More Rate Hikes in Store

Given the hawkish nature of Bank of Canada Governor David Dodge, investors can be assured that rates are likely to rise higher, at least by 25 more basis points, over the second quarter. Although growth remains tepid, rising only slightly above last year's as declining exports are likely to eat away at overall growth, there are plenty of fundamental factors that will bolster such a move. Notably, inflationary pressures continue to remain a target as policy officials desire a preemptive stance in curbing future price increases. Although rates of inflation are currently hovering below the target benchmark of 2 percent, recent figures seem to only be reflective of crude oil prices and not rising economic factors. One such example can be shown through the most recent Ivey Purchasing Managers Index . which showed that business and government spending in Canada remains formidable as future expectations remain lofty for further expansion. Additionally, scrutiny should be placed on statements issued by the central bank Governor himself. In subsequent statements following the March 7th decision, Governor David Dodge relayed that "some modest" rate increases "may" be needed in the future. Considered rather trivial, the statement changed from "would" to "may," which suggested the continuance of an already established hawkish bias.

Conclusion

Given the optimistic economic data, the current bias still anticipates another 25 basis point rate hike at the upcoming meeting. However, several considerations leave open the potential for a pause shortly after the decision,. In recent official comments., keying in on a potential slowdown in overall global growth, Governor Dodge hinted at a potential change in language for subsequent statements following the upcoming decision. Futures expectations have also receded following the most recent spate of statements issued by Bank of Canada Deputy Governor Pierre Duguay. Although echoing earlier central bank sentiment, traders are pricing in the possibility of a near term halt as inflationary pressures are not forecasted to rise immediately. Currently, the implied yield on June banker's acceptance contracts hover unchanged at 4.2 percent.

USD/CAD Technical Outlook

USD/CAD has traded blows from both bulls and bears so far in 2006, rallying as high as 1.1796 on January 19th and plummeting as far down as 1.1297 on March 2nd, making fourteen year lows in the process. A rally from 1.1297 was rejected by the zone formed from the 40 week SMA and 200 day SMA at 1.1752/73 as the pair made a high on April 3rd at 1.1771. Interestingly, the week that ended on 3/24 closed above the dominating resisting trendline that began in January 2002 and had never before been breached. The pair remained outside the trendline for all of two and one half weeks before retreating back towards the middle of the first quarter range concentrated near 1.1500.

Although back below the long term resisting trendline, the fact that the pair did trade through the line, even if for just a week, reveals that the downtrend is not as strong as it once was. Just as telling is the positive divergence with oscillators on the weekly chart, including but not confined to, MACD, RSI, and slow stochastic. The combination of divergence along with the weekly close above the multi-year resisting trendline gives bulls a reason for optimism. The intersection of the trendline comes in at around 1.1575 at present with a break above ultimately exposing the zone between the 4/3 high and 1/19 high at 1.1771/96. Additional gains point towards a test of the 50% fibo of 1.2733-1.1297 at 1.2015, just above the psychological 1.2000 figure. Still, the possibility remains for additional losses on a break below the 1.1297 (3/2) low. The next point of reference comes in at the November 1991 low of 1.1180. Quite interesting to note is the presence of a monthly morning star reversal pattern completed on the close of the March candle, which supports a long term bullish outlook. Any action below 1.1297 would negate bullish implications from the pattern.

AUDUSD Outlook

The Australian dollar quietly sold off against the US dollar in 2005 and continued to do so in the first quarter of 2006. Even though gold prices are pressing against the all-important $600 an ounce level, the decreasing interest rate spread between the Australian and the US dollar has kept pressure on the commodity currency. Growth has also been tepid at best, giving the Aussie another reason to remain depressed as a slowdown in productivity and continued weakness in the housing market weighs heavily on consumer spending. Furthermore, we have seen the Aussie slide in sympathy for the Kiwi dollar, which has fallen 14 percent since the beginning of the year. The Australian dollar has fallen from a recent high of 0.7585 to the low end of the 0.7000 handle. However as we enter the second quarter, several factors look to be turning the currency bias around, which could help to stabilize the Aussie.

Possible Improvements in Q2 May Force RBA to Reconsider

Since raising interest rates for the very last time in March of 2005, the Reserve Bank of Australia has remained cautious on growth and has left their overnight lending rates unchanged at 5.5 percent, but after a considerable period of slowdown, central bankers may be presented with a different picture. Business investment is showing signs of potentially increasing as optimism has spread thanks to improved conditions according to the most recent manufacturing performance index. Sector performance in the month of March rose 6.5 points on a monthly basis, bringing the measure higher to 53.2 from 51.4 a year ago, according to the Australian Industry Group. What is notably significant, and has powered the higher manufacturing readings, has been the rise in consumer confidence. Although remaining unchanged in the month of April, the consumer confidence gauge published by the Westpac Banking Corp and Melbourne Institute soared to a seven month high of 110.7. This is the fourth consecutive rise fueled primarily by the rebounding housing sector. Housing finance for example increased 1.1 percent. Coincidentally, employment has also posted impressive results. Rising a strong 27,000, the national jobless rate moved back down to 29 year lows as employers retained help in anticipation for rising demand. With a tighter labor market, wage costs are sure to rise through higher earnings. Coupled with rising housing valuations, consumer confidence bolstering spending and potentially higher wage growth, central bankers may be coerced into reconsidering further preemptive inflationary measures.

Soaring Gold Prices Boost Aussie

Along with rising fundamentals, inflation looks to be further stoked by commodities that have come back into vogue. First and foremost, traders have boosted gold prices to record highs in the month of April. Remaining the world's second largest producer of gold, the Australian economy has much to benefit from contracts that are currently trading above 25 year highs and look to rise higher in the coming quarters. Demand from many central banks like China to have some reserves invested in tangible assets like gold has spurred demand for the yellow metal. Pulling back to slightly below the $600 a troy ounce figure, the gold metal hit a high of $603.50 earlier in the month, causing many to speculate that gold prices could hit $800. Also garnering substantial attention by commodity enthusiasts has been the sharp rallies in silver, zinc and copper. Copper contracts alone have risen 79 percent on the year with zinc valuations almost doubling in the year. Although not known for copper and zinc production, but rather for iron ore and steel manufacturing, higher bidding on metals looks to benefit the underlying spot as the group is held guilty by association. Nonetheless, speculation on global inflationary pressures and continued demand from China should keep the sector bid and the Australian dollar should benefit thanks to the currency's 85 percent positive correlation with gold.

China Still Fueling Australian Growth

China is expected to continue its torrid pace of growth this year with officials predicting expansion to continue at an 8.5 percent rate in the first quarter of the year. As a result, massive Chinese demand remains beneficial for commodity export providers such as Australia, New Zealand and Canada. Feeding the nation's demand for iron and steel, as well as machinery equipment and plastics, Australian exporters are expected to focus 25 percent of their attention to the East Asian empire as well as South Korea and Japan. Subsequently, as the world's third largest minerals owner by value of production as well as its near proximity to China, it is only natural that Australia is China's preferred source for imports. Should the pace continue, employment opportunities should expand accordingly.. Bullish for the Australian dollar, the higher prospects will surely push wage earnings higher as the labor market remains tight, forcing the Reserve Bank of Australia to consider moving to a more hawkish bias, which would be positive for the Australian dollar.

Conclusion

Although the shift in monetary bias will surely not be immediate, interest rates are likely to be raised once again in a preemptive measure in order to curb inflationary pressure. Here, policy makers will remain steadfast in keeping lower rates of inflation in the economy, preferably below the 2-3 percent benchmark target. With a tight labor market underpinning consumer confidence and ultimately consumer spending, domestic consumption will likely contribute heavily to overall growth and rising prices. This will leave Governor Ian McFarlane with no other decision than to possibly raise rates by 25 basis points to 5.75 percent in the second half of the year, should economic gains continue their current trend. Coincidentally, should speculation hold onto commodity bids, the Australian dollar would also benefit from the inherent relationship.

AUD/USD Technical Outlook

Starting the year with a bang, AUD/USD rallied over 200 pips during the first week of 2006 before consolidating near the upper end of its descending channel that began in March 2005. The February 1st high of .7585 was turned down right at the resisting trendline of the descending channel and the pair subsequently did a free fall to .7014, holding just above the psychological .7000 handle. The pair did in fact break below the supporting trendline that began in December 2004, at .7200, prompting the wave of breakout selling. However, AUD/USD has recovered in recent weeks, rallying to trade within its former channel.

AUD/USD may be at a turning point. The pair completed a morning star formation at its lower Bollinger band on the week ending April 7th, signaling that additional gains are likely over the next few months. MACD-Histogram displays a positive slope and CCI has turned up from below -100, confirming a bullish bias. Targets going forward sit at the confluence of the 40 week SMA / 61.8% fibo of .7759-.7014 and resisting trendline at .7460/72 with a break above exposing the 76.4% fibo / 2/1 high at .7580/85. An exceptionally strong rally targets the 9/12 high at .7762. In the event that strength fails to play out, then a test of the 76.4% fibo of June 2004-March 2005 .6774-.7988 bull wave / 3/24 low at .7059/63 is possible. A break below the .7014 low made on 3/29 exposes the intersection of the 6/18 low / 38.2% fibo of .4818-.8001 at .6772/87.

NZDUSD Outlook

After rallying over 80 percent in the past four years and becoming one of the darlings of the currency market, the impressive run in the NZD/USD looks to have now come to an end in the first quarter of 2006. In fact, since the beginning of the year, the New Zealand dollar has fallen 14 percent or 1000 pips against the US dollar. Carry trade liquidation hit the kiwi hard, which sold off not only against the US dollar, but also against the Japanese Yen. This is a perfect reason why having one of the highest interest rates in the world is not good enough. The NZD's performance this year proves to carry traders that they need to focus on growing interest rates rather than the absolute value of the interest rate. The Reserve Bank of New Zealand has left interest rates unchanged since 2005, but what really sparked the Kiwi dollar's fall this year were comments from RBNZ Governor Bollard in February. He said that he would be comfortable with a slide in the currency, which served as his endorsement for weakness.

Major Liquidation of Carry Trades

Carry trades have been one of the most popular trading strategies used by hedge funds and individuals over the past few years and the New Zealand dollar was probably the most popular carry trade currency of them all. With the highest interest rate of any nation that has ratings agency Moody's top credit rating, it is no wonder why money poured into Kiwi denominated investments. This even raised the popularity of Uridashi bonds, which in this case were New Zealand bonds sold in Japan. Japanese investors were faced with near zero interest rates back home, so their appetite for foreign bonds was the biggest. This made NZD/JPY not only a popular trade for Japanese investors, but also for foreign investors. Therefore in the first quarter, with the prospects of higher interest rates in Japan and signs of weakness in New Zealand prompting talk of an interest rate cut, traders that were long NZD/JPY for carry headed for the exit. By the same token, there were also many investors long NZD against the US dollar for carry, but with the US also aggressively raising interest rates while New Zealand stood pat, the shift in tone by the RBNZ, gave NZD/USD bulls a good reason to exit out of their own carry trades as well.

Data Takes a Big Hit but Things Could be Turning

The massive exodus out of long Kiwi carry trades stemmed from the fact that the currency's strength over the past few years has finally had a pronounced impact on growth. GDP contracted in the fourth quarter by 0.1 percent for the first time in five years, after having only grown 0.1 percent in the third quarter. As an export dependent country, the 21 year high in the currency has crimped foreign demand and hurt investment. This will keep the central bank on hold for at least the next few months until we see more signs of a recovery in the economy. Many analysts predict little to no growth for the next few quarters unless the central bank cuts interest rates. Governor Bollard however said on March 9th that unless domestic demand also slows, he is unlikely to lower interest rates since inflation still remains above the central bank's 3 percent pain threshold. With economic growth weak, the RBNZ remaining on hold at a time when the US continues to raise interest rates and the Bank of Japan is looking for the right time to drop their zero interest rate policy, New Zealand will find themselves left behind. Their lag in growth should continue to keep the Kiwi dollar under pressure.

Depreciation in Currency Will Boost Growth

Even though the demise of the Kiwi came from the central bank's concern for growth, the same depreciation could also be what saves the country's economy as well. The 14 percent slide in the New Zealand dollar works to combat the tighter monetary conditions presented by the high level of interest rates. As an export dependent economy, the weakness of the Kiwi naturally makes New Zealand exports more competitive once again. We have already seen a tick up in the latest Purchasing Managers Index for the month of March, which rose from 51.2 to 53.3. Additionally, the latest retail sales figures for February have shown the biggest gain in two years. This indicates that domestic demand is strong which is extremely important since consumer spending makes up 60 percent of the $97 billion economy. Should the export sector rebound as well thanks to the weaker Kiwi, then the country will see growth from both domestic and external demand. However, before getting too excited, it seems that the strength in February could have been largely been due to the flat sales in January, which means that we need to see the figure for March to get a better gauge of whether domestic demand is really experiencing a concerted rebound. If so, 0.60 may have been the bottom in the NZD/USD.

AUD ? NZD Decoupling

Another interesting development is the decoupling between the Australian dollar and the New Zealand dollars. Traditionally both of the currencies have had a very strong positive correlation of upwards of 80 percent. However, over the past quarter, the relationship has broken down significantly. The Australian dollar has been lifted higher by rising gold prices. As one of the world's largest producers of gold, Australia stands to benefit significantly from appreciation of the yellow metal. New Zealand, on the other hand, which traditionally also had an extremely positive correlation with gold came under extreme pressure following weak economic data and comments from Bollard. On top of that, New Zealand is not a producer of gold which means that their previous correlation has been due to its sensitivity to growth in Australia, its largest export market in addition to the fact that both central banks were pretty much in sync with their monetary policies. The trade relationship should hold the test of time as there is no reason why Australia's demand for New Zealand exports should change anytime soon. The monetary policy direction however could remain different for some time as growth accelerates quicker in Australia. Therefore even though, the correlation between the two currencies is expected to resume once again, when it does, it may not be as strong as it was before.

Conclusion

The New Zealand dollar is expected to remain under pressure for the next few months as central bank Governor Bollard continues to jawbone the currency in order to spur growth. Given the state of domestic demand, Bollard has shown no intentions of lowering interest rates, which means that if economic data continues to improve thanks to the weakness of the currency, we could see a mild boost in the NZD/USD. However, as the currency appreciates, its benefit to the economy decreases, which means that if we get back towards 65 cents, data could begin to surprise to downside. The real wild card rests not with New Zealand, but with the US Federal Reserve and the Bank of Japan. When the Fed signals the end of their tightening cycle, we could see broad based dollar weakness that brings the NZD/USD pair higher. When the BoJ begins to raise interest rates, we could see broad based Yen strength that takes the NZD/JPY currency pair lower. However neither of these scenarios is expected to happen until the third or fourth quarter at the earliest, which means that for the time, being, Kiwi weakness should still be dominant.

Technical Outlook

The New Zealand dollar broke a very important long term trendline at the beginning of the year. Although the currency continued to trade close to the trendline around the 0.6700 level, the break should have been the first sign to traders that the currency pair was losing momentum. The downtrend has been very strong with perfect order moving averages and MACD in deep negative territory. However despite the clear weakness, we are currently seeing signs of a possible bottom with 3 weeks of the price making higher highs and higher lows. In addition, prices are stalling at a very critical support level served not only by the psychologically important 0.6000 price point, but also the lows dating back from May 2004 and the 38.2 percent Fibonacci retracement of the 0.3895 October 2000 low and the 0.7470 March 2005 high. Therefore if prices continue to hold at current levels, we could see a retracement back towards the former breakout point around 0.6625. If however, the most recent swing low of 0.5990 is broken, the door is open for a continued break all the way down to 0.5700, which is the 50 percent Fibo of the same long term move.

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