USDX at 2 year Highs

EUR/USD hit a new low on the year, at $1.2612, down 2.3% year-to-date, and down 6.5% from its February highs.

As long as major central banks refrain from any new liquidity action in the form of FX swap (as in Dec 2) and the IMF remains silent before the Greece June 17 elections, the path of least resistance for traders to continue selling the euro rallies and eventually targeting the 2010 lows under $1.18.

Broadening the USD view into the US dollar index and away from EUR/USD, we find that the USDX is testing levels not seen since September 2010. The importance of the USDX is highlighted in its use by macro hedge funds and Commodity Trade Advisers (small size hedge funds). As the index takes out the January high of 81.78 and hits a new 2-year high of 81.93, it risks extending stops and algos executing sop orders and cascading the ascent into 82.40 (6.18% retracement of the decline from the 2010 high to the 2011 low), followed by 83.50.

As the cyclical waves over the last five years may suggest, a recurrence of 87 and beyond cannot be ruled out for later this year. Fundamental catalysts include
i) mismanaging a Greek exit
ii) lack of resolution and deadlock between Athens & Troika without necessarily a Greek exit
iii) unsuccessful interventions from global central banks (coordinated FX swap, LTRO-3, BoE QE-4 and more BoJ easing) and
iv) the Fed’s reluctance to issue a second round of outright QE. Operation Twist is not deemed a sufficient generation of liquidity and a booster of risk-on trades if on its own.

On the downside, USDX rests on its 200-week moving average, coinciding with the trendline support extending from the August 2011 lows.

EUR/USD retests the $1.2600 figure, where we expect tepid support, coinciding with the 76.4% retracement of the rise from the June 2010 low to the May 2011 high. As the pair enters its fourth consecutive weekly decline (longest losing streak since November), the pattern may prove again similar, whereby a bounce may follow next week (coinciding with hasty informal EU summits).

As long as major central banks refrain from giving any new liquidity in the form of FX swap (as in Dec 2) and the IMF remains silent before the Greece June 17 elections, the path of least resistance for traders to continue selling the rallies. The 1.20 is becoming increasingly a matter of “when” rather than “if”. We expect selling momentum to intensify in late summer and into $1.20. In order for EUR/USD to reproduce the 22% declines in the prior two cycles of 2008 and 2010, the pair would have to reach $1.16, which would be the lowest since 2003.