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The US dollar generally consolidated, with a modest downside bias, over the past week. The risk is for more of the same in the week ahead. A relative light economic and political calendar during the summer in North America and Europe will make for thinner participation. At the same time, Bernanke has driven home the conditional nature of the Fed's willingness to scale back on its purchases of long-term assets.

This view is consistent with a further decline in implied volatility. In late June, 3-month euro volatility approached the year's high near 9.5%, but has been pushed back, and before the weekend, traded near 8.15%, the lowest in a little more than a month. Dollar volatility against the yen has also fallen. It spiked above 16% in mid-June, and this week, fell below 13% for the first time since early June. The implied volatility of the other major currencies also fell and we expect a further decline in volatility in the week ahead.

Given that the short-term speculative market is long dollars, there is some risk that the lower volatility phase coincides with a softer US dollar. If part of the dollar's Q2 gains were fueled by expectations of Fed's tapering, then the less intensive convictions of it would be consistent with a softer bias in the dollar.

Euro: After recovering from $1.2755 on July 9 to $1.3200 on July 11, the single currency has been consolidating. In that consolidation, it has been carving out what appears to be a flag, which is understood as a continuation pattern. However, we are skeptical of the pattern's validity as it is getting too close to the apex. Nevertheless, the relative strength index and the MACDs are constructive and the 5-day average crossed above the 20-day average early in the week, suggesting trend followers may be getting nervous. In addition, the euro finished the week well above the 100-day average (~$1.3035) and the 200-day average (~$1.3080). We see scope toward $1.3250 in the week ahead, with support in the $1.3050-80 area.

Yen: Before the weekend, the dollar traded at a 7-day high against the yen, but it was stopped by a trend line, drawn off the year's high near JPY103.74 and recent high near JPY101.55, that came in near JPY100.90. The governing coalition is widely expected to secure a solid majority in the upper house elections, whose results will most likely be known before the markets open on Monday. The technical tone is constructive the dollar. A convincing break of the JPY99.50 area would undermine the outlook for the greenback.

Sterling: While the euro failed to rise above the previous week's high, sterling managed to do so and close above it on a weekly basis. The 5-day average crossed above the 20-day average just ahead of the weekend. The gains approached the 50% retracement objective of sterling's losses since the mid-June peak near $1.5750. Other technical indicators are also supportive. The upside potential extends toward $1.5400. Support is pegged near $1.5170.

Swiss franc: The dollar has spent the last six sessions largely confined to a CHF0.9365-CHF0.9520 trading range. We note that the lower end of the range corresponds with the 200-day moving average (~CHF0.9360). Technical indicators are consistent with further dollar weakness. Once through the lower end of the recent range, there is not much support until closer to CHF0.9200. The 5- and 20-day averages crossed in the middle of last week.

Dollar-Bloc: Our technical reading of the near-term outlook for the Canadian and Australian dollars is also modestly constructive. The US dollar looks capped around C$1.0450. Trend line support, drawn off the mid-May lows comes in near C$1.0260 by the end of next week, which corresponds roughly to the 100-day average. The Australian dollar bears appear to have run out of steam on the brief dip below $0.9000 on July 12. The firmer tone of the Aussie was partly a reflection of the larger dollar move, but also the market is having second thoughts about an RBA rate cut in early August. The CPI data is due early on July 24 in Sydney and this is seen a pivotal for market expectations. We expect that despite the 12.3% decline against the US dollar in Q2 and a depreciation of around 10% on a trade weighted basis, price pressures likely did not accelerate. We suspect that Aussie gains toward $0.9300 may mark a cap in the first part of the week, with the CPI (if we are right) renewing speculation of a rate cut, which would see the Aussie reverse lower.

Mexican Peso: We suggested a favorable outlook for the peso last week, but it was even stronger than we anticipated. However, the dollar's move almost MXN12.40 seemed to have exhausted participants. We see risk of a corrective bounce in the US dollar that could carry it back through MXN12.60 to MXN12.70.

Observations about the speculative positioning in CME's currency futures:

1. It was another week of minor adjustments in gross speculative currency positions. Three quarters of the gross positions tracked (8 of 14) changed by less than 5k contracts. In the prior reporting period, 9 gross positions were adjusted by less than 10k contracts. Five of these gross positions were adjusted by less than 2k contracts in both periods.

2. Gross long positions were mostly trimmed, with the exception of the euro and Mexican peso. Gross short positions were more mixed.

3. The largest gross shorts are in the yen, euro and Australian dollars.

4. The largest gross long positions were in the euro and Mexican peso.

Source: Softer Dollar Amid More Consolidation