The strong US employment report offset some of the disappointing data in recent weeks. It reinvigorated confidence that the Federal Reserve will move to raise rates later this year. This coupled with the confirmation of the ECB's launch of its new bond buying program in the week ahead triggered a resumption of the dollar bull market, which a seemingly growing number of participants feared was getting long in the tooth.
The fundamental case for the dollar bull market was based on the divergence between the US on one hand, and Japan and Europe on the other. Developments in recent days reinforce conviction that the divergence continues. Disappointing Japanese inflation data and a dovish addition to the BOJ underpins market expectations that the BOJ will have to take additional action if its inflation target is to be reached. The ECB's more aggressive asset purchase program will begin on March 9.
On the US side, the 10-Year yield rose above 2.25% for the first time this year. The premium over Germany is the widest since the late 1980s. The prospects of higher overnight money in the current context translates long-term interest rates. At the same time, investor displacement by the ECB's asset purchases and the diversification of Japanese pension funds should prevent a dramatic rise in US yields. Technically there seems to be scope toward 2.30%-2.40%
Yields at the short-end backed up as well. The December 2015 Fed funds futures implies an average effective rate of 57 bp. Currently, the effective rate is near the middle of the 0-25 bp range. Assuming that the effective rate trades in the middle of the target range, if the December contract were to price in two hikes, fair value would imply about a 62 bp yield.
The euro slumped 6.6% in January but stabilized in February, slipping less than 1%. However, the bear hug has resumed. It has lost 3.1% against the dollar in the first week in March. The euro is at its lowest level in more than a decade, making chart-based support seem of dubious quality. Some may point to the possibility of support near $1.07 or $1.05, but it seems there is little to hang one's hat on until the psychologically important $1.00 level is approached.
Even if one is inclined to think that parity represents fair value, the currency markets are prone to overshoot. The euro overshot to the upside and before the bear market ends, we should expect it to overshoot to the downside. The magnitude of the divergence in monetary policy is unprecedented. We expect the euro to test its historical lows by the end of next year.
The immediate outlook for the euro, however, is less clear. At the pre-weekend, post-jobs data low just below $1.0850, the euro was three standard deviations below its 20-day moving average. Bollinger® Bands are set at two standard deviations. In the falling market, resistance may be more meaningful that support. A corrective bounce can extend into the $1.0950-$1.1000 area.
The dollar rose about 1% against the yen last week and pushed through the JPY120.50 area that had been blocking the upside. The high from last December near JPY121.85 beckons. The dollar is stretched against the yen, also trading three standard deviations (JPY121.35) above the 20-day moving average. Old resistance should now act as support.
Sterling slumped 2.6% last week, no fault of its own. The PMIs are consistent with around 0.6% quarterly growth here in Q1. The national election is in May and the polls have shown much change--a potentially unwieldy center-left coalition looks most likely. Still, the main drag on sterling appears to have come from the euro. UK 2- and UK 10-Year gilt yields backed up a little more than Treasury yields.
Sterling is also three standard deviations ($1.5035) from its 20-day moving average. This seems to suggest that it may be difficult to sustain the momentum and push sterling through the $1.50 level to the multi-month low set in late January near $1.4950. Resistance is pegged near $1.5200.
The Canadian was the strongest of the majors, losing only 0.85% against the greenback last week. It was helped by a central bank that was less dovish than the market had expected. However, the strength of the US employment data cut short the attempt to test the lower end of the large triangle pattern that has been carved out. The lower end of it is flat around CAD1.2360. The US dollar found support in front of CAD1.24. The dollar pushed through the top of the pattern that came in near CAD1.2525. The next immediate target is the high from last month in the CAD1.2660-CAD1.27 area. The high from late January is near CAD1.28. The dollar is not as nearly over-stretched against the Canadian dollar as it is against the other major currencies, but it still finished the week two standard deviations from its 20-day moving average (~CAD1.2620).
The Australian dollar posted an outside down day before the weekend, trading on both sides of the previous day's range and closing below that low. Like the Canadian dollar, the Aussie finished at its lower Bollinger Band. It lost about a cent against the US dollar over the course of the week. The next objective is the low from last month, which is found in the $0.7625-50 area. It is not as over stretched as the euro, yen, and sterling, and is nearer the Canadian dollar in testing its lower Bollinger band. While the RBA has cited the $0.7500 area, we suspect that before it is over, the Australian dollar will be closer to $0.7000.
The rising dollar did what the more than 10 mln barrel build in US Crude stocks (DOE estimate) failed to do, namely cap the oil prices. The April contract finished on the lows for the week just above $49 a barrel. The broad range of $45-$55 remains intact. The attempt higher extended to a little above $52 before being pushed back down. It appears trapped in the middle $5 of that range. We remain skeptical of what seems like increasing claims that the price of oil has bottomed.
The back up in US yields weighed on the S&P 500. Last week, we anticipated a retreat in the S&P 500 into the 2080-2090 range. It was overshot as yields rose sharply after the employment data. The technical tone remains weak, and additional near-term losses are likely. The next target is near 2066, but losses toward 2030-2050 seem likely. The five-day moving average is set to cross below the 20-day average for the first time in a month. Resistance is seen in the 2090-2100 area.
Observations based on speculative positioning in the futures market:
1. It was another week of relative minor position adjustments. There were only two gross speculative positions that changed by more than 7k contracts. The gross short yen position grew by 7.3k contracts to 86.5k, and the gross short peso position fell by 7.6k contracts to 74.8k.
2. While these small positions speak to the general consolidation being seen in the spot market, two net position adjustments suggest that in the reporting period that ended March 3, speculators began anticipating the resumption of the underlying trends. The six week streak during which speculators reduced the net short yen position ended with a 10% increase to 52.5k contracts. The net short sterling position had fallen for five weeks through the end of February. It snapped during the latest reporting period with a 20% increase in the net short position to almost 27k contracts.
3. While the gross short euro position of nearly 221k contracts is by far the largest position and near historical extreme, the gross long position of 48.5k contracts is also the largest among the currency futures we track. The nearly 3 cent decline following the ECB meeting and US employment data likely saw many of the longs capitulate.
4. The net short 10-year Treasury note futures grew by 19k contracts to 129k. The gross long position was trimmed by 6.5k contracts to 353.6k. The gross short position grew by 23.3k contracts ahead of the sharp sell-off after the jobs data to 493.1k contracts.
5. The net speculative short light sweet crude oil futures position was trimmed by 6.9k contracts to 262.3k. Bottom picker were still seen with a 7k contracts increase that lifted the gross long position to 498k contracts. The bears, eager to sell into upticks, added 14.6k contracts to their gross short position, giving them 235.6k contracts.
