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Summary

  • The fundamental basis for a strong dollar is being questioned.
  • A modest extension of the euro's gains may be expected ahead of the ECB and US jobs data.
  • The dollar closed below the 200-day moving average against the yen on a weekly basis for the first time since before Abe was elected.
  • The dollar appears to have formed a head and shoulders top against the peso.

The constructive outlook for the US dollar was predicated on two beliefs. First that growth and interest rate differentials favored the US over the euro area and Japan. Second that this would be the key driver in the foreign exchange market.

The nearly 3% contraction of the US economy in Q1 (at an annualized pace) is simply shocking. It has shaken the faith. The US 10-year bond yield fell back under the downtrend line drawn off the January and June highs.

This news was followed by disappointing consumption data (contraction in real terms for the second consecutive month in May). Some economists revised down their estimates for Q2 GDP and some even talked of the probability that with more than 2/3 of the economy contracting for 2/3 of the second quarter, the entire economy probably contracted.

The decline in the US 10-year yield did seem to be a critical factor behind the dollar's fall below its 200-day moving average against the yen on a weekly basis, for the first time in more than a year and a half, but monetary policy is still diverging. The BOJ is buying two times the amount of assets the Federal Reserve will until August when it will be buying nearly three times more. Moreover, the Japanese economy is about a third of the size of the US (on both nominal and PPP terms, according to IMF data).

Similarly, the ECB has just cut its deposit rate to zero and warned investors its balance sheet may expand by as much as 400 bln euros by the end of the year (assuming full take down of the TLTROs) The euro has shown itself to be fairly resilient and finished last week in the upper end of its recent trading range.

The euro is close to its best level since Draghi announced the ECB's new initiatives (just shy of $1.3680). The 200-day moving average comes in near there and does the top of the Bollinger Band. The 5-day moving average is above the 20-day average. The RSI is neutral, though the MACDs have turned up. The record low volatility means that sustained upticks may still be hard to come by. The $1.3735 area may be the most that can be reasonably hoped for ahead of the ECB meeting and US jobs data (Thursday, July 3rd for each as the US Independence Day brings forward by a day the employment report). Above there, $1.3800 may prove formidable and, if it is approached, look for official rhetoric to be dialed back up.

Just as telling of the deterioration of the dollar's tone is the heaviness of the Dollar Index. Important technical support is seen between 79.70-80.00. A break of this would signal losses toward 79.00. The 200-day moving average, just below 80.30, offers initial resistance.

Although the Dollar Index is mostly the euro and currencies that move within its orbit, a little more than a fifth of it is accounted for by the Japanese yen and Canadian dollar. They were two of the strongest major currencies last week, appreciating about 0.65% and 0.85% against the greenback respectively. Indeed, this quarter the Canadian dollar is the strongest, advancing 3.6% and the yen is in third place with a 1.8% gain (after sterling's 2.25% rise).

The technical indicators for dollar-yen, like the RSI and MACDs are not generating particularly strong signals, but the break of the 200-day moving average (~JPY101.70) is notable, and if it sustained in the coming days, more yen shorts might be forced to cover. The dollar also finished the week just below the lower Bollinger Band (~JPY101.44). While the JPY101.00 may offer some support, the May low was set closer to JPY100.80 and the year's low has, thus far, been set just below there in early February.

The Canadian dollar has been on a run since early June. On June 5, the US dollar was testing CAD1.0960, and it is now testing support near CAD1.0650. It is below its 200-day moving average for the first time since the Q3 13-Q1 13 period. The recent CPI and retail sales reports provided extra fundamental impetus behind the move that was already underway. The next level of support is seen near CAD1.06, which was a congestion area last December and into early January. The market is a bit over-extended, and that support area may not be easily violated on the first attempts.

Sterling is looking a bit tired, and BOE Governor Carney is giving investors indigestion. Still, investors believe that the BOE will be the first of the G7 to hike rates and the market still appears to be more inclined to buy dips. Initial support is seen in the $1.6950 area and then $1.6900-20. It may require a break of the $1.6850 area to spur talk of a top in the $1.7050-60 area.

The Australian dollar seems stuck around $0.9400. Support is seen in the band between $0.9350 and $0.9370. The RBA can be expected to try some more jawboning at the policy meeting next week, but clearly it has marginal impact at best. On the other hand, weak retail sales data may provide fodder for those who are not convinced that Australia will make the transition away from mining very smoothly, especially, with the tightening of fiscal policy.

The Mexican peso is particularly interesting from a technical point of view. The dollar appears to have carved out a head and shoulders pattern this month, and it finished last week at the neckline (~MXN12.9660). The head was formed by the spike to MXN13.12 on June 17-18. A convincing break of the MXN12.96 area would project dollar losses back toward MXN12.80.

Ahead of expectations for another 200k rise in non-farm payrolls, it may be difficult to justify a move below the 2.50% level in the 10-year US Treasury. Some consolidation is likely ahead of the report, with the downtrend line capping the upticks in the 2.56%-2.58% area.

Observations from the speculative positioning in the futures market:

1. Position adjustment in the reporting period ending June 24 were mostly minor. Only the gross short Canadian dollar positions were adjusted by more than 10k contacts and just barely at that. Some 10.2k short contracts were bought back, leaving a still substantial 45.9k contracts. At the same time, gross longs rose by 6k contracts to 40.6k, which is the largest of the year. The gross short position of 5.3k contracts is the smallest since last October.

2. The net long Swiss franc position swung back to the short side (5.4k contracts). This was a reflection of 6.2k contract reduction of gross long positions to 9.1k contracts, and the addition of 2.7k short contracts to 14.4k.

3. The euro, Australian dollar and Canadian dollar futures saw a similar pattern of speculators adding to longs and reducing shorts. The yen and peso saw both long and shorts reduced. Sterling and the franc saw longs cut and shorts grown.

4. The net short speculative position in the 10-year Treasury futures fell to 27.3k contracts from 85.8k in the previous week. The longs were feeling their oats and this was before the GDP shocker. They added 37k contracts to 402.7k. The shorts may have gotten nervous and cut 21.5k contracts (to 430k).

week ending June 24

Commitment of Traders

(spec position in 000's of contracts)

Net

Prior

Gross Long

Change

Gross Short

Change

Euro

-57.5

-61.8

55.1

3.7

112.6

-0.7

Yen

-71.2

-68.0

10.3

-7.5

81.5

-4.3

Sterling

49.8

52.6

98.1

-2.3

48.3

0.5

Swiss Franc

-5.4

3.5

9.1

-6.2

14.4

2.7

C$

-5.3

-21.5

40.6

6.0

45.9

-10.2

A$

33.5

27.0

65.6

4.5

32.1

-1.9

Mexican Peso

69.0

69.1

84.9

-6.3

16.0

-6.2

Source: Dollar Shakes, But Will It Break?