Dollar and Dow Breaks Down: Is This the Beginning of a Global Unwind?

The financial markets have taken traders on a rollercoaster ride this past week. The Dow, bond yields and the US dollar went from being up strongly yesterday to being down strongly today. Concerns for more hedge fund and sub-prime blowups has been the driver for the move but today?s announced bailout by Bear Stearns suggests that the reaction in the financial markets may be a bit exaggerated.

After having seen many prior liquidation days of the same magnitude turn into nothing more than a corrective buying opportunity, we are highly skeptical of whether this is the beginning of a global unwind especially since carry trades hit fresh highs today. The possibility of a rebound next week is further supported by the fact that many of the major dollar pairs are at key technical levels. The EUR/USD for example is right below the psychologically important 1.35 level, which also happens to be where the 50-day SMA and major Fibonacci resistance lies. Even the GBP/USD is having a hard time breaking above its resistance at 2.0 while USD/CHF is trading not far from its own moving average and Fibonacci support. Fundamentally, next week?s data has a strong chance of being positive for the dollar as well. The marquee events are the housing market reports and the FOMC interest rate decision. Although both new and existing home sales are expected to be weaker, do not underestimate the potential for an upside surprise. DQNews, a firm that tracks real estate sales in key areas like California, Florida and Nevada reported a 5.8 percent increase in California home sales in May. A weak housing market report would only confirm what the market thinks they already know while a stronger report will catch everyone by surprise since it will mitigate concerns about the problems in the sub-prime sector spilling into prime. As for the Fed, the up tick in oil prices and the still lofty level of the Dow should prevent them from making any major changes to their monetary policy statement. Expect them to continue to be hawkish about inflation risks, regardless of whether they see bigger problems in housing.