After wild swings at midweek (October 15), the U.S. dollar spent the last two sessions of the week consolidating. While we expect the Federal Reserve will not be distracted by the recent market turmoil or the softening of some market-based measures of inflation expectations, and will announce the finishing of its asset purchases, we recognize that Bullard's comments cast a greater element of doubt. This doubt may prevent a resumption of the dollar's uptrend. Broad consolidation is more likely in the days ahead.
The dollar's advance sat on two legs: Positive developments in the US, that would lead to a Fed rate hike next year and negative developments outside the US. The second leg remains intact. The first leg has been shaken. We suspect that many have exaggerated the weakness of the US. We accept that the Fed's mandates are being approached, and that the drop in oil prices is a net positive for the US, even though investment in the energy sector may slow.
The markets will learn the extent to which the drop in weekly initial jobless claims to a new cyclical low (264k) was a fluke around the Columbus Day holiday. Any reading below 280k is constructive. The market may also find that although headline inflation in the US may have softened, there may be an upward drift in the core measures, emanating from housing costs.
The $1.2700-$1.2850 band may contain the euro. A break down would signal a re-test of the $1.2600 area. Last week's high was set just shy of $1.2890. If our assessment is correct and the market has exaggerated the dollar negatives, the risk is on the euro's downside.
The dollar looks considerably more constructive against the yen. Last Wednesday's range is important. According to Bloomberg, it was JPY105.23 to JPY107.57. The dollar finished the week on its session highs, just below JPY107.00. The RSI has turned up, and the MACDs are about to turn. We anticipate a test on JPY107.50-60, with penetration allowing for a move to JPY108.00-20.
Sterling recorded new lows for the year at midweek near $1.5875. However, on both Thursday and Friday, sterling recovered with higher highs being recorded, and a constructive pre-weekend close. The bullish divergence in the RSI and MACDs remain intact. The initial target is $1.6150-65 and then $1.6225-50.
The technical outlook of the Canadian dollar did not clarify much. The CAD1.1200 area held. A break of this, and CAD1.1160-70 is needed to confirm a top is in place, and signal a test on CAD1.11. Retail sales and the Bank of Canada meeting on Wednesday Oct 22 may provide the spark.
The Australian dollar is very choppy, and the technical indicators we use do not seem to be particularly helpful presently. Some support appears to have been established just below $0.8700, while the upside appears capped in the $0.8860 area.
The dollar pushed through MXN13.67 on October 16, which is the highest it has been since July 2013. Lower oil prices, and the risk-off theme in the markets took its toll on the peso. The RSI and MACDs did not confirm the new highs, and the dollar-bearish divergence suggests the peso can recover in the days ahead. Initial support for the dollar is seen in the MXN13.42-47 area. A break could signal a move back to MXN13.30.
The low the S&P 500 recorded on October 15 represented nearly a 10% drop from the record high set on September 19. The correction was long overdue. If it is indeed over, the 1900 level should be overcome at the start of the week. Initially this will allow for a move toward 1920, then 1940. The RSI has turned up and the MACDs are poised to turn.
The U.S. 10-Year yield reached a panic low of nearly 1.86% on October 15. We suspect this represented some sort of capitulation. That level is unlikely to be seen again. Overcoming the cap at 2.23%-2.26%, would allow the yield to head back up toward 2.35%-2.40%.
The CRB index reached a low in the second half of last week. The move below 270 on October 16 represents a new two-year low. Technical readings are stretched, but have not generated a convincing signal that a low is in place. The November crude oil futures contract staged a key reversal on October 16, but was undermined by the lack of follow-through the next day. Resistance is pegged in the $85-$86 area. A break below $82.50 now would warn of the risk of new lows.
Observations based on the speculative positioning in the futures market:
1. The latest CFTC Commitment of Traders report covers the week ending October 14, so it does not cover the drama on October 15. Therefore, the positioning data may be less complete then usual.
2. There were three significant adjustments (in excess of 10k contracts). The gross short yen position was trimmed by 13.4k contracts to 124k. In the Australian dollar, both bulls and bears reduced their positions significantly. The longs were more than halved to 14.4k contracts (from 31.6k) and the shorts were culled by 13.4k contracts to 44.6k.
3. All the currency futures we track saw a decline in gross long positions. They were minor (less than 5k contracts), except for the Australian dollar. There was less of a pattern in the gross short positions. As we have seen the gross short yen and Australian dollar were cut, but so were the gross short sterling and peso positions (-1.6k and -5.8k contracts respectively).
4. The net short 10-year US Treasury futures position increased to 123k contracts from 92.3k. This was a reflection of a 47k increase in gross short positions to 543.1k. This represents the largest gross short position since mid-2005. We suspect that the violence of the rally in the middle of last week reflected a powerful short squeeze. The longs felt emboldened and added 16.1k contracts to raise their position to 420k contracts. Some likely took profits on the spike down in yields.
