Dollar Technicals Not As Strong As Fundamentals

Leaving aside the World Cup defeat, last week was good for the US. Auto sales and US jobs data were stronger than expected. These provided a nice sedative for some anxiety over the steep contraction in Q1 and the decline in real consumption in April and May.

On the other hand, the euro zone PMIs were, well, meh. The ECB continues to emphasize its policy divergence from the US, though it will take on more organizational qualities, like meetings every six weeks rather than monthly, some record to be published afterward, and a modest rotation of central bank voting.

A collapse in overall household spending in Japan in May and BOJ Kuroda's warning that inflation will likely ease over the coming months means that Japan's monetary spigot remains wide open for as far as the eye can see. The BOJ is buying twice the dollar amount of assets as the Federal Reserve to aid an economy a third of the size.

The yen appreciated by almost 4% against the US dollar in H1. Despite the clear reminder that the size of base money growth, or central bank balance sheets, does not simply translate into foreign exchange prices, many still expect the euro to decline through this channel. The ECB met last week with the euro actually higher against the dollar than when it met in May and announced cuts to its rate corridor, including a negative deposit rate. In May, the ECB estimated that its TLTRO facility could add around 400 bln euros initially. Last week it was the overall program that was emphasized and this was estimated to be around one trillion euros.

The dollar rose against most of the major currencies last week. The Dollar Index held important technical support near 79.70 early in the week. By the end of the week, it was approaching the lower end of a band of resistance that extends from 80.30-80.45. A move above there would signal scope toward 81.00.

Sterling and the Canadian dollar were the two exceptions to the dollar's firmer tone, gaining about 0.7% and 0.3% respectively. Sterling was helped by strong PMI data and conviction that the BOE will be the first to hike rates. Many economists seem to be over-correcting. After seeing the first hike in H2 2015, as the BOE had seemed to guide, a number of forecasts now call for late 2014.

Given that sterling's appreciation on a trade-weighted basis (~4.3% in Q2) is tantamount to some tightening, average earnings growth that is practically non-existent, and a CPI that is likely to fall in the coming months, we continue to think Q1 '15 offers the most likely window for the first hike.

Against the dollar, sterling has rallied a nickel in five weeks and reached its best level since 2008. It rose each of the five sessions last week against the euro to trade at two-year highs. It is in need of some consolidation.

Initial support is seen in the $1.7090-$1.7100 area. A break of this support area, which contains retracement targets and a two-week trend line, could shake out some of the weak longs. Buyers can be expected to emerge on dips, and this may limit the pullback to another half cent.

Sterling does not appear as stretched against the euro as it is against the dollar, from a technical perspective. Long sterling against the euro is a high confidence trade among leveraged participants. The euro is expected to continue to trend lower to reach the low from July 2012 near GBP0.7755. It had reached GBP0.7920 before the weekend. A bounce toward GBP0.7960-80 would offer a new entry opportunity.

The Canadian dollar's advance was partly continued momentum from the stronger than expected retail sales, and CPI reports the previous week (June 20). It also was a question of market positioning as the stale bears capitulated. It did not appear that the Canadian asset markets were the primary attraction.

The US dollar set a base last week in the CAD1.0620-30 area. The technical indicators we use suggest a low is near, but they would not rule out another push that could extend toward CAD1.0580-CAD1.0600. On the upside, a move back above CAD1.0720-40 would likely confirm a low is in place.

The strong US data and the push from the ECB made the euro's downside the path of least resistance, especially given that the euro reached a 6-week high (just above $1.3700). Our reading of the technical condition is consistent with our assessment that neither the US jobs data nor the ECB meeting was game changers. This means the euro will likely remain range bound. The narrow range may be something like $1.3570-80 to $1.3630-45. The broad range is $1.3500-$1.3700.

U.S. 10-Year yields rose last week, and this appeared to encourage dollar buying against the yen. The 10-year yield approached 2.70%, its highest level since late April. The dollar resurfaced above its 200-day moving average (~JPY101.80) to almost reach JPY102.30, its best level in two weeks, However, US yields fell back off and finished the week just below 2.64%. This sucked the momentum from the dollar, and it was left straddling the JPY102.00 area. That might be the range in the days ahead: JPY101.80-JPY102.30.

An evaporation of domestic and foreign demand, as evidenced by the larger than expected drops in both retail sales and exports, coupled with the continued jawboning by the central bank, managed finally to turn back the Australian dollar, but not before it reached new 7-month highs just above $0.9500. The RSI is neutral, and the MACDs are crossing down. The 5-day moving average is poised to cross below the 20-day average in the days ahead.

We suspect there are many late longs that are trapped amid recent talks of a move back to parity. This suggests that bounces will be sold, but a break of $0.9320 may force selling in the hole. Even if, as we suspect, the Australian dollar is in a broad trading range, the lower end of it is still at a distant (given the low volatility) $0.9200.

The head and shoulders pattern that the dollar has carved out against the Mexican peso in June remains intact, though it is not looking particularly promising. The month-end/quarter-end, the US jobs data followed by the US holiday clouded the price action. To strengthen this pattern, the dollar needs to fall back below the neckline near MXN12.96. A move now above MXN13.05 would likely negate the pattern, whose price target is back in the MXN12.80 area.