The powerful divergence theme re-emerged and effectively ended the dramatic correction throughout the capital markets. The FOMC statement strengthened conviction of a mid-2015 lift off, even if pace of tightening may be somewhat slower than previously anticipated. At the same time, the Swiss National Bank's decision to move to negative interest rates, partly in anticipation of the ECB expanding its asset purchases as early as next month, underscores that Europe remains well behind the US in the credit cycle.
Rather than attribute the down draft in the dollar and equity markets to a shift in underlying fundamental drivers, we had seen the hand of a technical correction, driven by short-term market positioning, and aggravated by year-end portfolio adjustments. Indeed the euro peaked within a few ticks of the 50% retracement objective of its losses from the October 15 high near $1.29. For its part, the dollar's dramatic slide against the yen stopped just shy of a key retracement objective of its rally from both October 15 and October 31, which was found near JPY115.50.
We expect the dollar's higher trend to continue. However, the lack of participation over the next two weeks could obscure this trend. The Dollar Index made a new high before the weekend near 89.65. A move above 90.00, which has held back previous dollar bounces since the onset of the Great Financial Crisis, would signal an acceleration of the dollar 's advance. Initial support is pegged in the 88.80 area.
The euro recorded a new low for the move just before the weekend near $1.2220. A break of $1.2200 would suggest losses toward $1.20. It has not been able to resurface much above $1.2300 since breaking below in response to the SNB's decision.
Technical indicators suggest the dollar's uptrend against the yen will resume. The move above JPY119.50 strengthens the conviction that the greenback is on its way back to the December 8 high near JPY121.85 and beyond. Initial dollar support is seen in the JPY118.50-80 area.
Sterling is not particularly interesting at the moment. It caught between the strength of the dollar and the weakness of other currencies, including the euro, Swiss franc, yen and Australian dollar. Against the greenback it has been confined largely to a $1.56-$1.58 trading range since mid-November. There have been a handful of violations of the two-cent range, but it has largely held. Technical indicators suggest risk remains to the downside. Sterling set a low near $1.5540 on December 17, but the snap back into the range seemed halfhearted. Resistance is seen $15680-$1.5700.
The dollar-bloc currencies are still headed lower. They did not participate in the bounce that the euro and yen enjoyed. Resistance in the Australian dollar is now pegged near $0.8200. Out next important target is near $0.8000, ahead of that are the lows from 2010 around $0.8060-70. The US dollar reached a high of roughly CAD1.1675 on December 15, this was the lower end of the range we have been suggesting the greenback had near-term potential toward. The upper end of that range is near CAD1.1725. Since recording the highs, the US dollar has not been below CAD1.1560.
The dollar peaked against the Mexican peso on December 12 near MXN14.95. Five days later it had slumped to MXN14.37. By the end of the week, the dollar's bull move appears to have had recovered to above MXN14.70 In the days ahead, the dollar may consolidate its gains. It could pullback toward MXN14.50, though over the medium term, it appears the dollar can rested the 2009 high near MXN15.60.
The U.S. 10-Year bounced off of the 2.0% level to near 2.25%, where the rally faded. Economic data out next week are expected to show stronger capex (durable goods orders) and stronger growth momentum (upward revision to Q3 GDP to above 4%). This may limit the pullback in yields.
At the same time, we note that the premium the U.S. pays over Germany widened out to almost 160 bp this week. This is the largest premium since mid-1999. It began the year near 110 bp. The widening was a result of German bund yields falling further than U.S. yields fell.
Although the U.S. 10-Year yield remains relatively low, the 2-Year yield has firmed and at 65 bp is 1-2 bp below the five-year high set earlier this month. The U.S. premium over German at this tenor is about 73 bp, which represents a new three-year high. These relative interest rate developments are understood to be constructive for the dollar.
The S&P 500 gapped higher December 18 following the strong close the previous day after the FOMC meeting, and seemingly aided by the Swiss National Bank's move to negative interest rates. That gap is 2016.75 to 2018.98. We do not look for this gap to be filled in the near-term. Rather the gap signals the end to the corrective losses and the resumption of the bull advance that will likely carry it to new highs.