Dollar Decoupling From Stocks And Yield After Mixed Economic Data

Markets had a rollercoaster ride last week, as expectations on the timing of Fed's tapering of the asset purchase program flip-flopped on mixed U.S. economic data. The DOW dived as low as 14844 on concern on the underlying momentum of U.S. economy, but rebounded strongly to close the week higher at 15248. The 10 year treasury yield also dived sharply, as low as 1.999 before jumping on Friday to close at 2.161%. The dollar index dropped as low as 81.07, then recovered to close at 81.69. After a week of mixed data, there seemed to be no conclusion to the timing of Fed's exit. Stocks and bond investors might have returned to business as usual, back to the prior trends. The question now is whether dollar will follow in near term. The relatively steeper fall in dollar index suggested that it might not.

Technically, it should be noted that both DOW and S&P 500 were supported well by the 55 days EMA. The strong rebound on Friday indicates that the recent pull back has completed. The larger uptrend is possibly resuming for another high above 15542.4 in DOW and 1687.1 in S&P 500 respectively And that might happen in the next two weeks. The pullback in 30 and 10 year yields was deep, but no important technical level was broken. Thus, yields are still in a healthy uptrend. However, the dollar index has taken out the importantl level at 81.33 last week, which raised the chance of reversal. We might see the dollar decouple further from stocks and yields ahead. The dollar's outlook against European majors is rather mixed.

Another development to note is that yen crosses followed the treasury yield, and dived sharply during the week. But the rebound late on Friday was far from being impressive. Development in the USD/JPY, EUR/JPY and GBP/JPY pairs are suggesting that deeper pullback is underway to correct the larger uptrend. It's likely to see further fall in these pairs for the near term. However, downside potential is relatively limited by an anticipated rise in treasury yield.

The clearer trend was found in the Aussie and Kiwi, with the AUD/USD and NZD/USD extending recent decline and staying bearish. The USD/CAD, on the other hand, was pressured by strong Canadian job data, and the sharp decline should have confirmed near term topping at least. While our strategy for the USD/CAD long was wrong, the strategy of AUD/USD short was correct. We'll stay short in the AUD/USD for another fall, but will take profit below 0.93 as diminishing downside momentum could help stabilize the Aussie. Meanwhile, we'll patiently assess the timing on going long in yen crosses again.

To recap, the ISM manufacturing index unexpectedly dropped 49.0 in May. That was the first contraction reading since last November. Most components dropped including production, and new orders except inventories. ISM services improved slightly more than expected to 53.7 in May. The Non-farm payroll showed 175k growth in May, slightly above expectation of 168k. However, April's figure was revised down from 165k to 149k. Unemployment rate, on the other hand, rose to 7.6% from 7.5%.

The Fed's Beige book economic report showed that the economy expanded at a "modest to moderate" pace in 11 of 12 districts. The report noted that hiring increased at a "measured pace" in "several districts". Meanwhile, most districts noted "slight to moderate" gains in consumer spending. Manufacturing activity expanded in most districts. Residential real estate and construction activity expanded as a "moderate to strong" pace in all districts. Meanwhile, commercial real estate expanded at a "modest to moderate" pace in most districts. Inflation pressure remained limited.

As expected, the ECB left the main refi rate unchanged at 0.5%. The deposit rate stayed at 0% and the marginal lending rate at 1%. Policymakers also raised the economic outlook, indicated in the latest staff projection. President Draghi rolled out "a range of different instruments" to stimulate the economy. But the intermeeting economic data "were not enough to grant immediate actions.

The RBA left the cash rate unchanged at 2.75%, the lowest level in 50 years, as policymakers assess the impacts of previous cuts. The central bank has reduced the policy rate by -200 bps since November 2011. Policymakers reiterated that the stance of monetary policy remains appropriate for the time being. They also noted that while the exchange rate has depreciated since the last meeting, it remains too high for exports to stay competitive. The Australian dollar has dropped modestly against the U.S. dollar after the announcement.