The US dollar rebounded smartly at the end of last week as the realization that it was increasingly likely the US would go over the fiscal cliff. This has been our base case, but many seemed to expect it to be averted and were looking past it.
The collapse of Boehner's so-called Plan B, due to the lack of sufficient Republican support, would not have passed the Senate, where the Democrats enjoy a slim majority, in any event. The entire negotiations are now in disarray, as is the national Republican Party.
After a holiday break, new negotiations will begin on December 27, giving officials five days to reach an agreement. A fall back plan - an interim agreement - aimed at avoiding the tax increases and spending cuts that would drive the economy over the cliff, risking new increases in unemployment, will also being discussed.
The dollar's recovery, ironically, was a product of the heightened concerns about the US political dysfunction and market positioning. We have noted in our recent weekly reviews that the speculators in the futures market were reducing short currency positions and building on the longs. Respecting the holidays and the lighter market participation, we offer an abbreviated review of currency positioning and technical outlook. We share the following six observations.
1. The recent trend lower in the dollar against the major foreign currencies began in mid-November. A correction to that move is underway. Price action is often exaggerated in thin markets. We will look to fade this year-end sell-off come the New Year. In particular, of the currencies reviewed here, we like the Canadian dollar and Mexican peso. While the losses in the Australian (and New Zealand) dollar may also be exaggerated, offering opportunities for short-term participants, value investors must recognize the Australian dollar is among the most overvalued currencies tracked by the OECD.
2. The break down in the currencies (excluding the Japanese yen) took place after the reporting period reviewed below. That said, in most of the currency futures, there was an increase in both gross longs and shorts. This means that while many participants were positioning for a continuation of the recent trend, top pickers were also positioning for a reversal or correction.
3. Given the lower participation, we suspect that the sell-off in currencies at the end of the week was more a function of long liquidation, on stop loss selling, rather than the establishment of new shorts.
4. The price action at midweek, with the shooting star in Japanese candlestick terms we noted in the euro and sterling, signaled the pullback seen in the second half of the week. It could simply be a case of some position squaring, profit-taking ahead of the holidays. Thin markets exacerbated the move with stop-losses being triggered. Euro support is seen near $1.3140 and then $1.3060. Sterling support is seen initially in the $1.6110-25 band.
5. Many technical indicators look stretched for the yen, but nothing to suggest a recovery is in the offing. Rather than correcting lower, which we had thought likely on a "buy the rumor sell the fact" after the election, the dollar has moved broadly sideways. After the initial response to the election and despite the BOJ expanding its asset purchase program by another JPY10 trillion, most of the dollar's price action was confined to the range set on Monday, December 17 immediately following the election (roughly JPY83.60-JPY84.50. A break of this range should be respected.
6. The dollar-bloc underperformed even before the risk-off in the second half of the week. The poor closes on the week warns of the risk of follow through selling in the holiday-shortened week ahead. The Australian dollar closed on the low, just below $1.04. More stops probably lie below $1.0390 and $1.0370. The US dollar finished the week above its 20-day moving average against the Canadian dollar for the first time since November 16. It stopped just ahead of the CAD0.9970 area, which if taken out, would signal technical potential toward the upper end of the H2 range that extends into the CAD.10050-85 area.
Week ending December 18
Commitment of Traders
(speculative position in 000's of contracts)