The US dollar turned in a mixed performance in the last week of January. It slipped against the euro, yen, sterling and the Swedish krona, while rising against the other G10 currencies. The Swiss franc was the weakest of the majors, losing about 4.5% of its value against the dollar, encouraged by signs the Swiss National Bank may have intervened.
The dollar also rose against most of emerging market currencies, except for a handful of eastern and central European currencies. The Russian ruble depreciated by nearly 10% following the S&P's removal of its investment grade status, and a compromise struck with Greece to discuss further sanctions given the increase in hostilities in east Ukraine.
In addition to technical factors, which we pointed out last week, an important consideration that has stalled the dollar's upside momentum are the doubts about a mid-year rate hike. The FOMC statement had upgraded its economic assessment, but did recognize the important of international developments. Whereas we regarded that as a prudent addition, many others viewed it as an escape clause of sorts.
The implied yield of the December Fed funds futures contract fell 3.5 bp on the week to 41 bp. It finished 2014 at 71 bp. The same general pattern was evident in the December 2015 Eurodollar futures. The implied yields fell 5 bp on the week to 66.5 bp. It finished last year at 91.5 bp.
Our fundamental views have not changed. We continue to think that a Fed hike in June is the most likely scenario. We would not place much emphasis on the sub-3% Q4 '14 preliminary print on Fed policy for the middle of 2015. The preliminary estimate for GDP is subject to statistically significant revisions, especially as a third of the trade (December trade balance will be released next week) and inventory data is not yet available. Moreover, the 2.6% pace of expansion is probably closer to what the Fed views as trend growth in the US than the 4.8% growth in April-September period.
In addition, the FOMC statement drew attention to the divergence between market-based measures of inflation expectations and surveys. The survey have shown much greater stability than the market-based measures, like the break-evens (comparing the TIPS yield to conventional bond yields). This was underscored ahead of the weekend as the University of Michigan's survey found the long-term (5-10 year) inflation expectation unchanged at 2.8%.
Our dollar bullish outlook also remains intact, though the consolidation phase against the euro, yen and sterling may continue for a few more days. The euro has spent the last three sessions within the roughly $1.1225-$1.1435 trading range established on January 27. Last week we suggested potential toward $1.1460.
The dollar has traded in a JPY117.20-JPY118.80 trading range for nearly two weeks. It has not closed above its 20-day moving average (~JPY118.20), which has capped upticks over this period. The decline in US Treasury yields and the heavier tone in equities (S&P 500 -2.0% on the week) can see the dollar move lower against the yen. The key support of the broader range is JPY115.50.
Sterling is interesting from a technical perspective. It has slipped below $1.50 four times over the past seven sessions. The RSI is neutral, but the MACDs are gently trending higher since bottoming in the early January. The top end of the range comes is in the $1.5225-50 area. No inspiration is likely to come from the BOE meeting, which is most unlikely to change policy at this juncture. More incentives will come from the three PMI reports. The service and manufacturing PMIs are expected to show modest improvement.
The dollar-bloc currencies remain under pressure. After the Swiss franc, the New Zealand dollar (-2.4%), the Canadian dollar (-2.1%) and the Australian dollar (-1.7%) were the weakest of the major currencies. They have been crushed during January. Encouraged by soft data and the surprise Bank of Canada rate cut, the Canadian dollar fell 8.4% against the US dollar in January.
The New Zealand dollar, weighed down by the end of the RBNZ mini-tightening cycle, stepped up rhetoric about the over-valued currency, and falling commodity prices (including milk), lost 6.8% against the greenback. The Australian dollar fell almost 5% in January. Expectations have increased that the RBA will cut rates as early as next week.
That said, the US dollar's advance to almost CAD1.28 before the weekend may have exhausted the near-term move. A consolidative phase would not be surprising. If such a phase does unfold, we see initial support for the US dollar in the CAD1.2540-80 area.
The Australian dollar shed nearly three cents in the second half of last week. If the RBA does cut interest rates and suggests room for additional easing, the Australian dollar could spike lower, toward around $0.7640. However, the failure to cut and provide dovish guidance could see the Aussie back toward $0.7900.
Before the weekend NYMEX's March crude oil futures contract briefly traded above its 20-day moving average (~$47.60) for the first time since the end of last September. It did not manage to close above it, though the June contract did. The day before prices set a new contract low. While the downside momentum has stalled, we would not want to exaggerate the pre-weekend price action. Given the price action, it is surprising to see how much the RSI and MACD has have corrected. There is no compelling technical evidence that an important low is in place.
The U.S. 10-Year Treasury yield finished at new lows for the move near 1.66%. The next technical support is seen in the 1.57%-1.61% area from 2013. However, given the likely decline in CPI and some disappointing data (durable goods, GDP), the political storm in Europe, and the low international yields, investors should be prepared for the 10-year Treasury yield to fall to new record lows. That means below the 2012 low near 1.38% recorded the same month that the euro zone's existential crisis had appeared to peak.
The S&P 500 lost about 2.7% in the last week of January, which is nearly the year-to-date loss. Support in the 1988 area has been tested. A convincing break signals a move toward 1972 on the way to 1957. A break of that lower level would open the door to a move to 1924 and the old gap from mid-October 2014 found roughly between 1905-1909. The technical tone is poor and the pre-weekend close on its lows warns of the risk of a gap lower opening on Monday.
Observations from the speculative positioning in the futures market:
1. The increased volatility in the foreign exchange market has not encouraged increased position taking in the currency futures. In the Commitment of Traders report for the week ending January 7, there was only one gross position adjustment more than 10k contracts, and it was to reduce risk. The gross short yen position was pared by 13.2k contracts to stand at 91.2k, the smallest in since the summer. Since early December when the dollar peaked against the yen in the spot market, the gross short yen position has been cut by 62k contracts.
2. Of the remaining 13 gross currency positions we track, nine were adjusted by less than 5k contracts. The four that were adjusted by more than 5k contracts were accounted for by two currencies the Australian dollar and Mexican peso. The speculative gross long and short Australian dollar positions increased by 6.3k (to 16.1k contracts) and 8.6k (to 65k contracts) respectively. The speculative gross long peso position increased by 7.7k contracts to 26.7k. The gross short position rose by 6k contracts to 71.3k.
3. Overall, bottom picking in the currency futures was evident. Only the euro saw a cut in the gross long position. It fell by 1.6k to 50.5k contracts. It remains the largest speculative gross long position. The increase in gross long positions, given the downtrend and net short position reflects anticipation of a pullback in the US dollar.
4. US Treasury bears have been punished by the continued rally. The net short position fell to 108k contracts from 146k. It is the smallest net short position since early December. The gross short position was chopped by 67.3k contracts to 454.6k. The bulls took profits, trimming their longs by 29.6k contracts to 346.7k. 