Currency Correction Continues, Greenback Drops

The extreme market positioning leaves many long dollar holders in weak hands. The longs tried making a stand, but it has been rebuffed and the dollar is falling victim to profit-taking and stop-loss chase. Both sterling and the euro have posted new legs higher today to extend the correction that began last week.

At $1.5785 it has retraced a 38.2% of the its slide since Aug 19, when it recorded its last significant high. A move above here will likely target the $1.5950-$1.6000 area. Supportive near-term technicals would include the crossing of the the 5-day moving average above the 20-day today, for the first time since late Aug.

The euro's 5-day moving average is also crossing above its 20-day today for the first time since early Sept. It has convincingly penetrated the band of resistance around $1.3680-$.13700. The next level of resistance is seen near $1.3850 and a break of that could see a push toward $1.40.

In the context of the post yesterday that discussed the correlations between gold, S&P 500 and the euro, it is interesting to note the the S&P 500 5-day moving average is crossing above the 20-day too. Gold is not there yet would its moving averages can cross later this week or early next week. Separately, note that the Australian dollar's moving averages are crossing today also.

The fundamental news stream does not seem as conducive to more risk taking, though the euro zone August industrial production data was much stronger than expected (1.2% vs consensus expectation for a 0.7% decline). The poor Alcoa earnings report, Senate passage of the Chinese trade bills, the dollar fixed 0.18% higher against the Chinese yuan, sparking talk of retaliation, Harrisburg, Pennsylvania apparently filing for bankruptcy, Slovakian government falls trying to push through the EFSF reforms and apparently sharply escalating tensions between the US and Iran do not seem to favor risk. This suggests North American dealers may be more cautious than their European counterparts who drove the dollar a percent of more lower against most major currencies but the Japanese yen today.

European Commission President Barroso speaks to the European parliament today at around 9:00 EST. He is expected to discuss bank recapitalization but hopes for specifics are likely be dashed. Italy will be in the spotlight today. The next ECB President, Draghi speaks about the Italian economy and will be his first such speech since last week's downgrade by Fitch.

Draghi's replacement as governor of the Bank of Italy has not been decided yet, even at this late date. This would seem to underscore Moody's and S&P's argument in their recent downgrade decisions that political instability is contributing to the erosion of credit quality. Indeed, PM Berlusconi rival Finance Minister Tremonti has suggested that fact that Spain called an election and Italy has not helps explain the widening premium Italy pays over Spain--about 63 bp vs say around 5 in early August.

Berlusconi reportedly wants the central bank's director general to run the Bank of Italy, while Tremonti wants the director general from the Treasury department. Meanwhile Bini Smaghi, who is the ECB board, is under pressure to resign to make room for a French representative, has indicated he would go for the right alternative position. He could be a fair compromise candidate for run the central bank. He speaks shortly after Draghi today.

Berlusconi faces 4 criminal charges and lost another key vote in parliament yesterday. It appears he has agreed to a new confidence vote. However, no compelling opposition candidate has risen. In some ways it seems that Berlucsconi, is both cause and effect of the dysfunctional politics and not just the cause that his critics say.

Lastly, on an upbeat note a significant transfer of power to the regions appears likely to finally allow Belgium to form a government.