The dollar finished last week and last month on a firm note against most of the major and emerging market currencies, with the exception of the Japanese yen. The key central bank meetings (RBA, ECB, BOE) and important data (PMIs and US employment) pose substantial event risk.
The dollar's strength is being driven by ideas that the US is closer to exiting its extraordinary monetary policy before many other countries. The backing up of US interest rates, anticipating that the Fed will soon be easing up on the accelerator by slowing the pace of QE purchases, has seen the US premium over Japan and Germany increase.
Bond markets in emerging markets, where depth and liquidity is less, have sold off sharply. The rising yields there are a sign of capital leaving through a small door, and this is also reflecting in emerging market currencies. The magnitude of the moves and the accompanying volatility has forced even some passive investors to adjust positions as well.
Technically, the dollar looks to be in a strong position. The Dollar Index is firm, holding above $0.8300, a retracement objective, and remains near the 2 1/2 year high set on May 23rd near $0.8450. The big trend line connecting DXY's peak in 2009 and 2010 comes in between $0.8620-$0.8640 and is important for the longer-term technical view.
It is noteworthy that the euro was turned back, just when the dollar bears thought they were gaining the edge, in front of the downtrend line drawn off the early-Feb's and May's highs, which came in near $1.3080. The euro's low thus far this year is about $1.2745, it has only closed once below $1.2800.
We suspect the euro bears may be frustrated by the fundamental developments in the form of upticks in the final reading of the May PMIs and an ECB that refrains from pushing the deposit rate below zero. Nor do we expect US non-farm payrolls to re-accelerate significantly from the 152k of the previous two months, which is marked slower than then the 240k pace seen in the prior two-month period.
The dollar did make new lows against the yen for the move, slipping to almost JPY100.20. Although we think the bulk of the yen's decline is well behind it, tactically, it may be worth selling. Good dollar bids have been seen on intra-day pullbacks. The JPY99.50-JPY100.00 area was difficult to break on the way up and resistance is turning into support. We suspect that under political and economic pressure, the BOJ will continue trying to stabilize the JGB bond market.
For the second consecutive week, sterling successfully tested the $1.50 level and recovered, the second time even more than the first. Still, sterling stalled at the 20-day moving average and the minimum retracement objective (~$1.5230). Sterling is likely to be sensitive to three PMI reports due this coming week. The last BOE meeting for Governor King is highly unlikely to see a change in stance.
The dollar held support near CHF0.9500, The bulls cannot feel secure until the greenback resurfaces above the CHF0.9680-CHF0.9700 area. We note that the short-term (30-day) correlation between the Swiss franc and yen is at 0.82, a nearly five year high. We tend to think of the Swiss franc moving in the euro's orbit, but the correlation with the yen is nearly as high (euro-franc correlation is about 0.86).
The pendulum has turned against the dollar bloc. The US dollar held support near CAD1.03 and quickly returned toward its recent high set near CAD1.0420. We continue to suggest potential into the CAD1.05-CAD1.06 range.
Meanwhile, the pace of the Australian dollar's descent has slowed, but upticks are minimal and brief. Technical support is difficult to find much above $0.9400. Australia reports a slew of economic data this coming week, but we suspect that after the RBA meeting (no rate cut, scope for lower rates if necessary), the data will be less significant than the market environment. A move above $0.9700-$0.9730 is needed to lift the technical tone.
The US dollar's gains against the peso accelerated in recent sessions and blew past the MXN12.60-MXN12.80 technical target we suggested last week. The peso's weakness appears to be more a function of global developments and market positioning. The dollar approached the MXN13.00 level before the weekend after finishing the previous week near MXN12.44. It began the month below MXN12.15. We still think the Mexican story has legs and look at the position adjustment under way to provide a new opportunity to participate in what is still a good fundamental story.
Observations on speculative positioning in the CME currency futures:
1. Position adjusting was minimal in the reporting week ending May 28. On the gross long peso position was adjusted, liquidated in this case, by more than 10k contracts. In fact, including it, there were only three gross positions adjusted by more than 7k contracts.
2. Generally, speculative positions in the currency futures were adjusted by trimming gross longs, except for sterling and the Swiss franc, and edging up gross shorts, except for the euro and Canadian dollar.
3. The increase in the net short Australian dollar position was more a function of gross long liquidating than new shorts being established. This cannot be appreciated by only looking at the net figures.
4. The late short yen positions seem vulnerable given the strength seen at the end of last week. Though it is noteworthy that the gross euro position at 121.6k contracts is larger than the gross short yen position of 118.2k. Sterling is not far behind at 110k gross short contracts.