US Dollar, Japanese Yen Showing Bullish Potential Ahead of US Durable Goods Orders Report

The US dollar and Japanese yen ended Wednesday mostly higher against the majors, though the British pound was by far the strongest, as risk aversion weighed on some FX carry trades. US equities took a hit as the DJIA ended up losing 2.05 percent and closed at 8300.02, while the SPX lost 1.9 percent and closed at 893.06. When looking to daily charts of these indexes, it looks like there is some bearish potential as both the DJIA and SPX have established a set of lower highs, while clear support looms below at 8,250 and 880, respectively. Indeed, a break below those noted support levels would signal further losses, and may also suggest that safe-havens like the US dollar and Japanese yen are in for gains. Another sign of bullish potential for the US dollar: the DXY index bounce from key support at 80 and subsequent rise in daily RSI from oversold levels.

In economic news, US housing market reports suggested that the contraction of the sector may be bottoming out. The Federal Housing Finance Agency said that their purchase-only house price index fell 0.55 percent in Q1, the slowest decline since Q3 2007, which helped lead the year-over-year change up to -7.14 percent from -8.31 percent. Also, the National Association of Realtors (NAR) said that existing home sales rose by 2.9 percent to 4.680 million in April as median prices rose for the third straight month to $170,200 from $169,900. That said, prices are still down 15.4 percent from a year ago and supply levels have actually increased to a five-month high of 10.2 months from 9.6 months.

The upcoming release of US durable goods orders is projected to show that domestic demand may have increased slightly at the start of Q2, as they are forecasted to have risen 0.5 percent in April, but excluding transportation the index is anticipated to fall 0.3 percent. While the headline result will have the most impact on forex trading, the markets should keep an eye on non-defense capital goods orders excluding aircraft, as this number serves as a leading indicator for business investment. The three-month annualized figures remain deeply negative, but the monthly component has improved over the past two months and a continuation of this dynamic would be supportive of outlooks for a slow recovery in the US economy. Ultimately, a disappointing result could spark the selling of risky assets throughout the financial markets, and thus lead to US dollar and Japanese yen strength. On the other hand, better than anticipated result could lift carry trades higher.

Euro Loses Ground as ECB’s Liikanen Refuses to Call 1% Interest Rate the Floor

The euro lost ground against many major currencies as European Central Bank (ECB) Governing Council member Erkki Liikanen emphasized that “fixing some lower bound” is not part of ECB monetary policy. Liikanen went on to say that after cutting interest rates to an all-time low of 1 percent on May 7, the ECB “did not decide that the new level of the interest rate was the lowest level whatever the future circumstances may be.” Adding to this euro-bearish commentary, the German Federal Statistics Office said that the EU-harmonized German consumer price index (CPI) unexpectedly fell 0.2 percent during the month of May, according to preliminary readings, which dragged the year-over-year change down to a record low of -0.1 percent. The ECB has stated in the past that they expected CPI to fall negative in the middle of the year for a few months, but that the Euro-zone is not at risk of deflation. However, with these negative results starting to come to fruition, ECB policy officials may find themselves battling deflation rumors.

British Pound Dominates in the Forex Markets, But Rally May Prove Short-Lived

The British pound was easily the strongest of the majors on Wednesday, as economic news surprised to the upside. According to the British Bankers Association (BBA), UK mortgage approvals jumped to 27,685 in April from 26,671, with the average value of the loan rising to 129,100 pounds from 128,600 pounds. While the status of approvals has been uneven in recent months, loan values have been steadily climbing from their 4-year lows of 116,100 pounds in December 2008, suggesting that the UK housing sector may be embarking upon a slow but steady recovery. That said, with the UK deep in recession and unemployment rising, home values have little chance of even coming close to the record highs we saw in mid-2007.

Looking ahead, the GBP/USD break above 1.60 may be a false one as signs of reversal have emerged. Though FXCM SSI – a contrarian indicator – was still negative at the time of writing at -1.84, the GBP/USD rally seems to have spurred exceedingly bullish sentiment. Indeed, major media news articles whose titles highlight the pair’s push above 1.60 serve as a prime example, since it is at these points that we tend to see reversals due to sentiment “extremes.” Meanwhile, daily RSI for the pair remains overbought, suggesting that the British pound may experience a correction in coming days.

Terri Belkas is a Currency Strategist at FXCM.