The US dollar appears to have broken out of the ranges that seemed to dominate since mid-September against the major currencies, except the Japanese yen and Australian dollar.
We had not anticipated the break out, believing that the resolution of the US fiscal cliff and the Spain/Greek issues in Europe were not imminent. Nevertheless, we did recommend that if the break did materialize, the price action ought to be respected, especially if it took place in the direction that was consistent with our understanding of the fundamental backdrop, ie, a stronger dollar.
We did not appreciate the extent to which investors and consumers were looking past the US fiscal cliff. Formal and informal surveys find that many, if not most, expect the fiscal cliff to be averted, even if at the last minute. The fiscal cliff is generally understood to be the creation of Congress and it can be avoided or mitigated. The failure to do so would be significant. The Congressional Budget Office warns that going over the cliff would drive the US economy into a sharp contraction in the first half of next year, and although the economy would recover in the second half, the hit would be severe enough that the world's largest economy would contract overall next year. The recent improvement in unemployment would be reversed and it would return to the 9% area.
Consumer confidence is 4-4 1/2 year highs. US consumers have been impressively resilient. The headline October retail sales due Wednesday, November 14, will likely be depressed by autos and gasoline sales, but the measure that is used to calculate GDP is likely to have risen by 0.4%. At the policy market, Intrade.com, the odds of a recession next year have fallen in recent weeks and this can be seen as a proxy for the fiscal cliff as without it, the US economy is likely to grow 2-2 .25% next year.
Business executive sentiment is less sanguine. Here surveys show that the fiscal cliff is of major importance. However, contrary to expectations, it does not appear to have deterred hiring decisions. US non-farm payroll growth has averaged almost 157k this year and 170k in the past three months. Last year, a little more than 153k net new jobs were created on average every month.
On the other hand, business investment has been considerably weaker. While the uncertainty surrounding the fiscal cliff and tax schedules may be a contributing factor, something else appears to be at work. Durable goods orders have been trending lower since Q2 10. In GDP calculations, gross private non-residential investment has been trending lower since Q3 11. The expiration of government incentives, the still substantial excess capacity and soft world demand may also be weighing on investment.
Given that the policymakers' cards have not changed very much, we are concerned that the market may be under-estimating the ability of Americans to shoot themselves in the foot. As Churchill quipped, Americans can be counted on to do the right thing, but only after they have exhausted the alternatives. Our point is that the alternatives have not yet been exhausted.
While the CBO projects that going over the fiscal cliff would trigger a sharp though brief (a couple of quarters) downturn before growth returned, Europe may be hit harder. As Q3 GDP figures due out at the end of the week will show, the euro area economy is already contracting. A contraction in the US would strengthen their economic headwinds and would likely produce greater fiscal deficits that can only exacerbate their debt crisis.
As Japanese and Chinese trade figures show, access to a growing US market has helped offset or mitigate the weaker demand from Europe. A US recession would have knock-on effects there too. After being bolstered by reconstruction spending, the Japanese economy also likely has entered a new contraction phase.
It looks like a win-win situation for the US dollar. If the US does go over the fiscal cliff, risk appetites will be dashed, which, broadly speaking, tends to be dollar (and yen) supportive. If the fiscal cliff is averted, growth differentials (mediated through interest rate differentials) would also seem to favor the dollar.
The euro area debt crisis will most likely not be resolved any time soon. German Chancellor Merkel has suggested it may take another five years to work through the problems. It has already been indicated that this week's Eurogroup meeting of euro area finance ministers will not result in a new tranche of aid to Greece. That beleaguered country will have to issue bills to raise the funds to meet the redemptions it faces this month. The issue of a Greek exit has resurfaced again.
Spain, the other current focus in the euro area, is still putting new hurdles its way to formally ask for more assistance. Just as many participants expect, by hook or by crook, for the US to avoid the fiscal cliff, many see a larger aid package for Spain to be nearly inevitable. The impact of the establishment of the Outright Market Transaction Scheme has begun to wear off as Spanish bond yields have risen for three consecutive weeks. Over the last 60 days, the euro and Spanish bond yields move in opposite directions about 80% of the time.
As we discuss below, the dollar's technical tone improved markedly over the past week, especially against the European complex. We would be disappointed if there were not follow through gains in the days ahead. The yen is more likely to consolidate its recent moves than trend. The dollar-bloc and peso are less clear technically. In a strong US dollar environment, the Canadian dollar tends to do well on the crosses. We are more inclined to sell the Australian dollar and Mexican peso into strength.
Euro: The technical outlook deteriorated markedly with the break below support at $1.28. It had two outside days in the past week, where it traded on both sides of the previous day's range only to close lower on the session. On Friday, one of the outside days, the euro closed below Thursday's low. This price action may be seen as failed attempts to rally and suggests overhead supply. Perhaps many of those fund managers who moved toward benchmark euro zone exposure in Q3 are beginning to hedge. The next downside objective are found just above $1.26 and then $1.2475. A move back above $1.2825 would be helpful, but it may require a move above $1.29 to be constructive.
Yen: The dollar shed 1.5 yen last week, falling to almost JPY79.00. This corresponds to the 50% retracement of the rally from September 28 low near JPY77.45. The dollar's smart recovery on Friday stabilized the near-term technical picture. The dollar may test the JPY79.70-JPY80.00 area. Consolidation, rather than trending is likely to be the flavor of the yen in the coming days.
Sterling: Like the euro, sterling posted a couple of outside days last week, including on Friday, but failed to maintain any traction. In fact, before the weekend, sterling settled at two-month lows. The break of the October 23 low (~$1.5914) is significant and suggests sterling toward $1.5750-$1.5800. Some may put emphasis on the 200-day moving average, which is found near $15850. However, we find the 200-day moving average to be a better mile marker (where we are) rather than a road map (where we are going--support/resistance).
Swiss franc: The dollar appears to be breaking out to the upside against the Swiss franc and the prospects of a new trending market appears to be drawing fresh interest in the currency after central bank's cap successfully deflected speculative attention. A move now above CHF0.95 would seem to confirm a significant low has been carved out and the greenback can move into the CHF0.96-CHF0.97 range before being seriously challenged. It would require a close below CHF0.94 to negative this constructive technical outlook.
Canadian dollar: The US dollar has been trending higher against the Canadian dollar since mid-September. That trend line support now is seen near CAD0.9900. We have been suggesting a CAD1.0040 target and this was tested ahead of the weekend. A convincing move through this and our next target near CAD1.0135 comes into play.
Australian dollar: The Australian dollar has been fairly resilient and recorded new month and a half highs against the dollar at mid-week. However it reversed low and Friday's close was weak, though still above the 20-day moving average that comes in near $1.0355. It may take a close below the $1.0330 area to force the the bulls to reconsider. On the upside, the $1.0440-50 area looks to be a likely cap.
Mexican Peso: The US dollar rallied 40 pesos in the last three sessions (MXN12.90-MXN13.30) as risk-off dominated the capital markets. Market positioning, heavily leaning the other way, may have contributed to the sharpness of the move. The technical tone is poor for the peso, and the dollar has potential to rise toward MXN13.40-MXN13.44. On the other hand, a break below MXN13.07-MXN13.12 would warn that the upside recovery in the dollar is over.
Week ending Nov. 6
Commitment of Traders
(speculative position in thousand of contracts)
***Gross short euro positions rose by the most since May to stand a 1-month highs.
***Largest net short yen position in nearly five months, but late shorts are in weak hands.
***Gross short sterling position is the largest in two months, but gross longs remain substantial .
***After being long for two weeks, the net franc position reverted back to the short side.
***Gross long CAD position continue to be cut, but remain among the highest since the onset of the crisis.
***The net long AUD position has increased by a third in two weeks.
***This was the biggest decline in gross long pesos in a little more than four months, but still remain large.