Fear that China may Overheat Triggers Surge in U.S. Dollar.

The U.S. Dollar surged overnight as traders took protection against a shift in China’s expansionary monetary policy.

The U.S. Dollar surged overnight as traders took protection against a shift in China’s expansionary monetary policy. The overnight announcement, that China’s economic growth and inflation figures exceeded expectations fueled speculation that it was poised to begin restricting loans and ending stimulus. Fear that the economy may overheat is triggering demand for lower yielding assets at the expense of higher risk assets.

Overnight the Cash Dollar Index rallied to its highest level in 5 months and now seems well on its way to retrace its 2009 range of 89.62 to 74.17. This makes 81.90 to 83.72 the next valid upside target.

The EUR USD weakened further overnight as the cost to protect Greek bonds from default soared to a new record. Losses were limited, however, by a rumor which said the European Union was preparing to loan money to the country. The rumor was denied, but investors, nonetheless, took protection against a possible massive short-covering rally by lightening up positions.

The chart pattern suggests the EUR USD is holding the psychological level of 1.4000; however, 1.3800 remains the next valid downside target. Short-covering today could send this market back to the old bottom at 1.4217.

The GBP USD weakened further overnight on the news that the U.K. budget deficit widened. A lack of confidence in the economy could also be a driving force behind the recent weakness as investors fear that the U.K. may be falling behind its peers in the midst of the economic recovery.

The current two-day break has created two key ranges: 1.5832 to 1.6457 and 1.5895 to 1.6457. These ranges create retracement zones at 1.6144 to 1.6071 and 1.6175 to 1.6108. The overlap of these two retracement zones suggests possible support developing inside 1.6144 to 1.6108. In addition, uptrending Gann angle support is at 1.6132 today. Watch for a possible technical bounce in this zone.

The USD JPY is rising again overnight on speculation the Japanese Yen is poised to once again become the world’s carry currency. Additional weakness hit the Yen following a report that demand for lending dropped. This news could raise fears of deflation and is definitely a signal that the Bank of Japan will keep interest rates at historically low levels at its January 25th meeting.

Investors seem to believe that Japan will be the last country to exit its stimulus plans. This line of thinking was backed by a comment from Bank of Japan Governor Shirakawa who said the central bank “is aiming to maintain an extremely accommodative financial environment”.

Based on the short-term range of 93.77 to 90.31, traders should continue to look for the USD JPY to rally to 92.04 to 92.45 before finding sellers. Additional resistance is at a downtrending Gann angle at 92.65. Up trending Gann angle support is at 91.31.

The USD CHF continued to soar overnight. The next upside target is the December high at 1.0507. Gann angle support is at 1.0450. This angle has to hold or the profit-taking stops will trigger a collapse. Traders have been buying the Dollar against the Swiss Franc in anticipation of an intervention by the Swiss National Bank because of its appreciation against the Euro.

Technical factors could pressure the USD CAD now that it has retraced greater than 50% of its recent break. Based on the main range of 1.0745 to 1.0224, the key retracement zone is 1.0484 to 1.0546. This market is currently testing this area. A failure to hold uptrending Gann angle support at 1.0424 will be another sign of weakness. Downtrending Gann angle resistance is at 1.0515. This price was tested early last night when the market rallied to 1.0524.

Fundamentally, the recent action by the Bank of Canada suggests that it will defend against a rapid rise in the currency. This creates a potentially long-term bullish scenario. Short-term conditions are overbought, which may trigger a mild correction.

The AUD USD is trading slightly better following its attempt to test a major 50% price level at .9031. Short-term conditions appear to be oversold which could trigger the start of a short-covering rally back to .9189 especially if it closes higher today.

The recent actions by China to tighten up its lending policies could have long-term implications on the Australian economy. The formation of a secondary lower top will be a strong sign that a top has been formed. The next Reserve Bank of Australia meeting is February 2nd. Traders are leaning toward another rate hike, but have cut down the probability of the hike now that China has begun tightening.

A reported slow down in the New Zealand economy coupled with monetary tightening in China led to the huge sell-off on Wednesday. Last night, there was additional selling pressure but nothing compared to yesterday’s weakness. This could be suggesting that conditions are oversold.

Technically, the NZD USD completed a .618 retracement of the .6970 to .7442 range to .7150. Additional support is being provided by the uptrending Gann angle at .7160. Regaining .7206 will be a sign of strength. This move could trigger the start of a retracement back to .7292 to .7327.