In 2008 and 2009, fluctuations on exchange rates were mostly driven by investor’s sentiment towards risk, including fear and greed. However, the outlook for the world economy is no longer perceived as so uncertain and I expect 2010 to be dominated by economic fundamental factors and not by fear. In particular, I think investors will start using changes in interest rate expectations as a leading indicator for changes in exchange rates. Having said that, the resumption of economic growth in the United States is likely to trigger a change in expectations for inflation and possibly influence the Federal Reserve monetary policy. Eventually, a widening of the interest rate differential between the United States and other countries will help the US dollar, in particular against lower yielding currencies like the yen Swiss franc.

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The US dollar continues its ascent and the GBPUSD, which has held up relatively well, may be next to take a plunge.  As mentioned many times last month, I am looking for short entries as price action since May 2008 may be carving out a diamond top.  The time has come.  There are 5 waves down from 16464 and the rally from this morning’s low should prove corrective.  Resistance should be strong at 16310 (former support).  I am already short as per Goose’s trading video from 2 night ago, but price has not declined that much from that level so there is an opportunity to short against the weekly high.  The ultimate objective is a break below 15700.

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Yesterday I spoke of fairly substantial support for the New Zealand Dollar. The recent breakdown takes it below the confluence of the 20-day, 50-day, and 100-day Simple Moving Averages. The next key support is at the 61.8% Fibonacci retracement of the 0.6980-0.7440 advance at 0.7160, but I think a hold of the moving average support is enough reason to sell into short-term bounces.

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Even before yesterday’s dramatic shake up, the British pound was showing exceptionally high levels of volatility. Interest rate speculation was put into high gear after a round of remarks from a few policy officials and data reported consumer-based inflation had pushed up to the top of the central bank’s tolerance band. Then, this morning, the UK government reported its largest budget deficit on record. Still struggling to shed its economic constraints, the pound is still sporting massive levels of stimulus and the outlook for its benchmark rate is still trailing most of its counterparts. Combined, this leads the currency to the threat of excessive volatility and opens the door to potential trends developing should the outlook tip one way or another.

For trading, I don’t necessarily avoid volatility. Swings in price action are necessary to establish positions that can take profit in a reasonable amount of time. However, the highly senstive and spastic volatility that the sterling crosses have exhibited over the past week doesn’t present many opportunities and it further threatens reversals. For an example of the concerns I have, simply look to GBPUSD. A steady trend in this major was interrupted by an incredible reversal. Many of the crosses are either well into trends or on the verge of a messy breakout. Yet that does not mean there aren’t opportunities. GBPJPY is a particularly interesting pair. Having establishes a steady rising trend line since the beginning of December, we now have a respectable wedge formation. And, given the efforts made towards risk aversion recently, this technical pattern seems dated and constricted. I will wait for a medim- or short-term bar close below the rising trend of lows and look for confirmation that the Dow is falter as well. When that happens, I will place a stop above recent highs and set a target equal to one-and-a-half times risk. Another pair I am looking at is EURGBP. Technically this pair has entered a new, major phase of price action; but I would have to see a meaningful retracement to test the former break level before I would consider diving into this mature trend.

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The upward correction in GBPUSD may have run out of steam. Prices put in an Evening Star bearish reversal candlestick formation and dropped sharply lower to test below 1.62 once again. Negative divergence on the RSI oscillator reinforces the likelihood of a bearish scenario, but risk/reward considerations argue against entering short at current levels with the next level of support relatively close by at 1.6023. I will continue to monitor price action looking for selling opportunities in the near term.

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U.K. inflation accelerating faster than expected pushed the pair above resistance at 1.6355-the 38.2% Fibo of 1.6877-1.5832 which triggered a long position which was quickly reversed minimizing my profits. The resulting shooting star candle confirmed a reversal leading to a short position which generated over 200 pips in profit. The 20-Day SMA -1.6119 has slowed the pair’s descent. I would wait for a break below the technical level to add any fresh short positions. Upcoming retail sales offers event risk and robust consumer consumption could remind markets of the rising inflationary pressures and may raise the outlook for interest rates. If we start to see broader risk aversion wane, then a positive release could generate bullish sentiment.

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The EUR/GBP halted the seven-day decline and pushed higher during the overnight trade to reach a high of 0.8714, with the RSI climbing out of oversold territory, and we may see the corrective retracement continue to play out over the remainder of the week as the pair finds short-term support at 0.8650. However, as the European Central Bank continues to hold a dovish outlook for future policy and expects to see an uneven recovery this year, we may see the euro-pound continue to trend lower over the near-term as the Bank of England looks to conclude its easing cycle. As a result, I will wait for further confirmation before taking on another trade, and will certainly look to short the pair as it breaks the upward trend from the last two years.

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