Trichet Softens Concerns about Stress Tests; Euro Takes Direction from U.S. Equities

The Euro rallied early, traded in a range thenmade a move to the upside in a lifeless trade on Thursday.

The Euro rallied early, traded in a range then made a moveto the upside in a lifeless trade on Thursday. Volume appeared to drop offthroughout the day following the European Central Bank’s policy statementannouncement shortly before the start of the New York session. For the most part, theEuro seemed to be taking its direction from the U.S. equity markets.

Earlier this morning the European Central Bank said thatinterest rates would remain at a historically low level. While this wasexpected, traders turned their focus toward ECB President Trichet’s pressconference.

Trichet mentioned that the ECB will continue to provideunlimited stimulus and liquidity to the financial system but the news thatreally helped move the Euro higher was his “lack” of comments on the bankstress tests. The fact that he didn’t say anything negative about the tests mayhave actually instilled confidence in investors.

Investors have been pessimistic about the bank stress testsbecause they feel that they may not be stringent enough to reveal any seriousproblems with the bank balance sheets. They had been expected Trichet to reveala little more about the scope of the tests but had to settle for limitedcommentary. Since he didn’t say much other than investors should wait and seethe results before judging, traders decided to take the “no news is good news”approach and rallied the Euro. The only negative that could have been construedby investors was his comment that banks may have to recapitalize after thepublication of the stress tests.

This morning’s friendly U.S. Weekly Initial Jobless ClaimsReport helped bolster stock index futures before the opening, sending the Euroand commodity-linked currencies higher. As stocks began to weaken as thesession approached its mid-session, traders began to take profits in the Euro.The strong finish in the stock futures markets helped drive the Euro up intothe close.

Technically the Euro main trend is up on the daily chart.This market has entered a key retracement zone at 1.2609 to 1.2782. Holding thelatter number is considered a sign of strength.

Based on the current trading action in the market, it looksas if the direction of the Euro will be determined by the movement in the U.S.stock market. As long as demand remains firm for equities, traders should lookfor continuing strength in the Euro.

Despite the pick-up in demand for higher yielding assets andthe generally weak tone in the Dollar, the British Pound finished lower.

This morning the Bank of England left interest ratesunchanged as expected. The BoE is most likely going to leave interest rates atthese low levels for a prolonged period of time because of the new financialausterity measures proposed by the new government. The BoE is concerned abouthigh inflation but cannot risk a double-dip recession by hiking interest ratesprematurely.

Today the U.K.reported an increase in industrial production in June but traders ignored thisnews saying the increase merely was an offset of the sharp sell-off inindustrial production during the height of the recession. Today’s weakness wasattributed to another drop in housing values. This report indicates that theeconomy is still weak and could trigger a curtailing of spending by theconsumer.

The sharp rise in U.S. equity markets helped boostdemand for higher yielding currencies. All three commodity-linked markets –Australian Dollar, New Zealand Dollar and Canadian Dollar – experienced substantialgains on Thursday.

Technically, the Aussie and the Kiwi closed near previousmain tops which put them in positions to change their main trends to up on thedaily chart. Watch for an acceleration to the upside in the AUD USD on a movethrough .8858 and a similar move in the NZD USD on a trade through .7159.

The USD CAD is still in an uptrend, but downside momentum isbuilding which could help trigger a change in trend to down in the short-run.The bigger picture still indicates that this market is rangebound between .9929and 1.0853.

Risk appetite could get strong if U.S. equity markets can overcomenearby retracement zones. This increased demand for risk should continue tounderpin the Euro and the commodity-linked currencies while putting pressure onthe lower yielding U.S. Dollar and Japanese Yen. Clearly, traders don’t likethe low yields being offered by the Treasuries and are willing to take on morerisk to get a better return at this time.