The US dollar was trading at four month lows into the middle of last week against the euro, sterling and Swiss franc. This was reflected in the Dollar Index, which was also at four month lows. The greenback concluded the week with a strong three day advance that retraced a third to half of its decline since late May. It also moved to new highs for the year against the dollar-bloc and many emerging market currencies, including the Mexican peso, Brazilian real, Turkish lira, Thai baht and Indian rupee.
The impetus came not simply from Bernanke laying out the general strategy of exiting from QE3, which remains dependent on economic data in the coming months and which investors already knew, but also from the Fed's recognition that the downside risks to the economy have diminished over the past six months. Technically, the highs the euro and sterling recorded before the FOMC announcement are significant.
They mark the end of the correction off the year's lows set in late March by sterling in early April by the euro. The euro overshot by a little the 61.8% retracement of the decline seen from the start of the year, while sterling stopped a little shy. Both upside corrections unfolded in a three-leg sequence, which is common for counter-trend moves.
The correction is over and the dollar's underlying uptrend is resuming. While there is some risk of near-term consolidation, we expect the dollar to make new highs for the year against the European currency complex.
Recovery upticks in the euro will likely be capped in the $1.3220-60 range, while sterling's bounce will likely be limited by the $1.5500-50 area. On the downside, the next target for the euro is $1.3060 and then $1.2975. The trend line drawn off the early April and mid-May lows comes in near $1.2850 at the end of next week. Sterling's decline in the recent days retraced 50% of the gains it had registered off the late May test on $1.50.
The next retracement objective is near $1.5200 and the trend lone drawn off the mid-March and late May lows comes in near $1.5100 at the end of the month.
Between late May and mid-June, the dollar surrendered a little more than a third of the gains it had registered against the yen in the Abe-inspired rally. It had been basing near, though below, our objective of JPY95 before the FOMC meeting. Unlike in late May, however, Japanese government bonds were largely stable in the face of the sharp backing up of US yields. The 10-year spread jumped to 165 bp at the end of the week from 130 bp at the prior week's end. This is nearly a 2-year high. and coincided with the dollar's recovery to a little above JPY98. The dollar has tested its 20-day moving average for the first time this month. The dollar needs to resurface the JPY99-JPY100 area to boost the confidence of the bulls that new highs can be seen. Soft inflation and weak retail sales in Canada helped the greenback record its first weekly close above CAD1.04 since June 2012.
Given the economic ties between Canada and the US, reduced downside risks in the latter should help the former. However, the economic cycles are not synchronized currently and Canada can ill-afford higher rates. This is illustrated by house prices. They are rising in the US and falling in Canada.
Technically, the US dollar may encounter resistance in the CAD1.0500-25 area, but there is potential in the coming weeks toward CAD1.0650. The 5-day average crossed above the 20-day average before the weekend for the first time since mid-May. We peg support near CAD1.0350.
The FOMC and developments in China gave the market fresh fuel for its run on the Australian dollar. Losses were extended another 3.7% last week to bring the cumulative decline since mid-April's test on $1.06 to 13.5%. The Australian dollar recorded an inside day before the weekend and a near-term bounce into the $0.9315-40 area may offer a new selling opportunity. The US dollar extended its gains against the peso by 5% in the second half of last week and brings its cumulative advance since the mid-May low to 13%.
The news stream and the increased volatility has forced many investors to liquidate the investments and others to hedge their currency exposure by selling the peso forward.
We continue to think the government's policies are favorable for investors. We have been more concerned about the over-crowded aspects of the trade (which no longer exists) and the broader technical condition. Now it appears that monetary policies are moving in two different directions, with the central bank of Mexico looking for lower inflation to give it scope to cut rates again, while the Fed is looking for continued expansion to reduce its monetary efforts.
That said, technically the peso looks interesting again. There is a dollar-bearish divergence on 14-day Relative Strength Index. The Moving Average Convergence Divergence readings are the most stretched since roughly this time last year, when the dollar had risen to MXN14.60. The inside day recorded on Friday may point to some near-term consolidation. Support for the dollar is seen in the MXN13.15-20 area. A break would signal a near-term test on the MXN12.95-MXN13.00 area. Observations on speculative positioning in the CME futures:
1. Given the sharp moves in the sessions since the reporting period ended, the positioning data is dated. Nevertheless, it may shed some light on the subsequent price action. For the first time since late February the net speculative position was long euros. The net speculative positioning also turned positive for the Swiss franc as well. Like last time for the franc, when the flirtation with the long side lasted a week, the late long franc (and euro) bets were leaning the wrong way. The scale of the moves were likely partly a function of the longs cutting and maybe even reversing to get short. The same generally applies to sterling, but the net speculative short position did not switch though it was more than halved.
2. There were several significant position adjustments (10k contracts changes in gross positions) in the five sessions before the FOMC announcement. Gross long euro contracts were increased by 22.3k contracts to 91.3k, which was the largest gross long position among the currency futures. Sterling players cut the gross short sterling positions by nearly 19k contracts and add almost 15k contracts to their longs. There was 18k short Swiss franc contracts that were covered. The speculators in the peso felts strongly in both directions, with the longs added 29k contracts and the shorts adding 14k contracts.