The US dollar rose to new multi-month highs against several of the major currencies, including the euro, Swiss franc, British pound and the Japanese yen. The BOJ, BOE and ECB met last week and none changed policy. The Swiss National Bank meets on March 14 and is also unlikely to change policy. The Federal Reserve meets the following week and is widely expected to stay its course. It is not monetary policy then providing the new trading incentives.
Nor can the dollar's gains be attributed to political uncertainty in Europe stemming from the inconclusive Italian elections, as was the case previously. The immediate shock has worn off and Italian stocks and bonds have recovered the lion's share of those initial losses. Fitch's downgrade of Italy's credit rating just before the weekend is unlikely to have lasting impact. It is a catch-up move to where S&P has been. Moody's is the outlier at Baa2. A downgrade by Moody's should not be surprising nor providing new information to investors.
The best explanation for this latest leg up in the dollar is growth differentials mediated by interest rate differentials. The US-German 2-year note continues to do a good job tracking the euro-dollar exchange rate, while the 10-year spread between the US and Japan is highly correlated to the dollar-yen exchange rate.
The US-German 2-year differential averaged 18.5 bp over the past week, the highest weekly average since early January. In the past week, the US 10-year yield rose nearly 20 bp, which the Japanese 10-year yield rose 3 bp. The 10-year spread of 142 bp is the largest US premium since August 2011.
Our fundamental and technical analysis suggest additional US dollar gains are likely. Our next target for the euro is near $1.2880 and, over the slightly longer term, a return to the mid-November low near $1.2680. The caveat is more often than not in recent weeks, the euro moves in the opposite direction (NY close to NY close basis) on Monday than it did on the preceding Friday. We suspect the $1.3050-70 area should offer initial resistance. The Swiss franc is tracking the euro with a modest lag. The greenback is posited to move above CHF0.9600 in the day ahead Support is seen near CHF0.9400.
Sterling continues to be a dog, but it has yielded to Japan the dubious honor of having the weakest currency this year. Our next target for sterling is in the $1.4780 to $1.4820 band. Bounces should be capped in the $1.5050 area.
Many participants have their sights set on JPY100 for the dollar and 13,000 for the Nikkei. As we outlined, we are skeptical that Abenomics will be able to push the yen much further. To be sure, this is not to say the top is in place for the dollar, but that the bulk of the move is behind us and the market appears to have discounted more aggressive easing by the BOJ next month (large scale purchases of longer dated JGBs). We see no compelling technical evidence that a reversal is imminent. Previous resistance should now act as support and this is found in the JPY94.80-JPY95.20 area for the dollar.
We remain bearish the Canadian and Australian dollars. Stronger than expected jobs data failed to offer much support to the Loonie. The greenback held support we pegged in the CAD1.0200-20 area, and returned toward the session highs. A convincing move above CAD1.0350 would signal a resumption of the move that we expect can carry the US buck to CAD1.05.
The Australian dollar recovered after falling to five month lows at the start of last week. It stalled near $1.03, which now represents the upper end of the range. Support now is seen in the $1.0180-$1.0210 range. Although the RBA signaled no urgency to cuts further, we do expect another cut later in Q2.
The central bank of Mexico surprised the market with an aggressive 50 bp rate cut before the weekend. The peso quickly dropped, with the dollar rising toward MXN12.785. However, as officials signaled this to be a one-off measure and not the beginning of an easing cycle, the peso rebounded smartly and the dollar fell to new low for the week just below MXN12.65. The resilience of the peso blunts the impact of the modest decline in Mexican bonds (bearish curve steepening) and although long peso positions are crowded, we still like it.
We share the following observations about the latest CFTC report on positioning in the currency futures market.
1. For the second consecutive week, the gross long positions in all the currency futures we trade was reduced. It is not simply a matter of poor news elsewhere and more, but the dollar has responded to positive US economic data.
2. In the previous reporting period, the gross short positions add to except the euro and yen. In the latest period there was an increase in the gross short position in all the currency futures.
3. Of the 14 gross positions we tracked, there was a greater than 10k contract swing in five. The gross long euro position was cut by 11.5k contracts, helping to lift the gross short position to its largest since the middle of Dec. The bears added 12.6k contracts to their short position in sterling, which at 79.9k is the largest since late 2011. There was a 22.6k increase in the gross short Canadian dollar contracts. Over the past four reporting periods, the gross short position has soared from 12.5k to 86.2k contracts. The gross long Australian dollar and Mexican peso positions were cut by around 17.5k contracts. These are the only two currency futures were the net position remains long.
4. The net short Canadian dollar position is the largest since March 2007.
5. Although the net speculative position is still long the Australian dollar, it has been reduced sharply here in 2013. In mid-Dec., the net long position stood at 103k. As of the latest reporting period, it has been cut to a mere 7.1k contracts, the smallest since last July.
week ending March 3
Commitment of Traders
(spec position in 000's of contracts)