Forex Outlook This Week: Beware Dollar Vulnerability

Between the Greek and French elections, the G20 meeting and an FOMC meeting that follows a string of disappointing data, this coming week promises to be among the most significant as one can imagine from a fundamental point of view. At the same time, speculative positioning and the technical condition of the market offer an alternative (sometimes complimentary and sometimes competing) framework to anticipate future price action.

Although there is much talk about the Greek election leading to the disintegration of the euro zone, and many pundits see no outcome that is supportive of the euro, technical factors warn that the correction of the foreign currencies' sharp losses in May is not complete.
 
Since the euro and Swiss franc's key reversals on June 1, following the disappointing US jobs data, we have recognized the improved technical tone and the unfolding of a corrective phase. We had expected the technical correction to continue last week, but did not expect that many of our initial targets would be achieved in Asia on Monday on back of the initial euphoric reaction to the EU's willingness to grant Spain a 100 bln euro loan to recapitalize its banks, only to be followed by a sharp decline.
 
Nevertheless,  leaving aside one's view of whether the eurozone survives or whether the Federal Reserve announces a new effort to expand its balance sheet (QE3), the technical condition underscores the vulnerability of the dollar. 
 
Euro:   The net short speculative position was trimmed for the first time in six weeks in the last CFTC Commitment of Traders report that covers the week through June 12. At 195.2k contracts, it is still a record short except for the recent period. Last week set the record at 214.4k contracts. The decline reflected some profit-taking by shorts (16.6k contracts) and some bottom picking (longs grew by 2.6k contracts). 
 
The gross shorts are 234.4k contracts and while this is important, it is also instructive that the gross long position is 39.2k contracts. This is the largest gross long position among the currency futures. Ironically, the euro has both the largest gross short position and the largest gross long position, something that simply looking at the net position, which is what the traditional approach does, fails to grasp.
 
On June 15, the euro recorded its highest close since May 22. In the week that saw the market show utter disdain for the EU's attempt to ring fence Spain and a three-step downgrade of Spain's credit worthiness by Moody's,  the euro closed a full cent higher. The 5-day moving average crossed above the 20-day for the first time since early May.
 
Momentum indicators suggest that the $1.2670 area that was last week's high and a retracement objective of the May slide will likely be taken out. There is potential toward $1.2780-$1.2800. To undermine this constructive technical outlook, the euro would need to break back below the $1.2500 area.
 
Yen:  The net speculative position was essentially unchanged at 12.3k contracts (vs 12.1k the previous period). It is the second week that the net speculative position was long yen. The gross longs rose a few more than 800 contracts to stand at 38.2k contracts, just below the euro. The short rose about 575 contracts to 25.9k.
 
The technical condition of the dollar against the yen is less clear than against the euro. The yen strengthened before the weekend, with the dollar posting its lowest close of the week. There is modest support near JPY78.40. The market may grow more fearful of intervention if the dollar moves below JPY78 with a head of steam. While recognizing the importance of the JPY80 area, we had suggested potential  toward JPY81. However, the recent price action has reinforced the significance of the JPY80 cap.
 
The IMF recently made two concessions to Japan. The first was to recognize that the yen is over-valued on a medium term basis and the intervention is an acceptable policy in the face of disorderly markets. Both seem to offer some sanction for intervention. 
 
Sterling:  After switching to the short side last week, the net speculative short position jumped to 23.1k from 2.9k. This is the largest net short position since mid-March. The longs were cut by almost a quarter to 28k contracts. The shorts added 9.2k contracts to 51.1k.
 
Yet the real takeaway from the recent price action is the resilience of sterling. How a currency responds to fundamental news is important. The fact that sterling rallied in the aftermath of the announcement of new unorthodox measures to ease credit conditions and signal of the likely resumption of QE is telling. The new shorts are in weak hands and are vulnerable.
 
Sterling also finished the week at its best level since May 22 and the 5-day moving average has crossed above the 20-day average. The net immediate target is $1.5785 and assuming that is surpassed, look for a move to $1.5900. A move below $1.56 would call into question this constructive technical outlook.
 
Swiss Franc: The net speculative position in the Swiss franc was essentially unchanged in the week ending June 12. It was net short 33.3k contracts, a decline of some 300 contracts. Longs and shorts were trimmed (527 contracts and 874 contracts respectively).
 
The Swiss franc remains confined to very narrow ranges around the SNB-imposed cap against the euro. The technical outlook is similar as the euro, with the 5- and 20-day moving averages crossing and the franc finished the last session ahead of the Greek election at its best level since May 22. A convincing break of CHF09500 could signal a move toward CHF0.9400 and possibly CHF0.9320.
 
Canadian dollar:  The net speculative long position fell by about a third to 9.6k contracts. This is the smallest net long position since mid-February. Longs were cut by 8.3k contracts to 31.3k, while shorts were reduced by almost 3k contracts.
 
The key technical formation in the US dollar against the Canadian dollar is a potential head and shoulders topping pattern. The neckline comes in at CAD 1.02. The importance of a technical pattern is the measuring objective. The measuring objective of this pattern would project to  CAD 0.9950. On the way there, retracement objectives come in near CAD 1.0125 and CAD 1.0050.
 
Australian dollar:  The record net short position was trimmed by about 10% to 45.5k contracts. Bottom pickers scooped up 8.6k contracts, while the bears added on 2.9k contracts to 66.6k.
 
The shorts are vulnerable. The 5- and 20-day moving averages crossed to the upside on June 8 and on June 15 recorded its first weekly close above $1.00 in more than a month. Momentum indicators a constructive. The Australian dollar has not closed above its 50-day moving average since early March. It comes in now near $1.0075, which the Aussie flirted with but did not close above. Assuming it does, there is potential toward $1.0130 and possibly $1.0260 in this corrective phase.
 
Mexican Peso:  The net short peso position was reduced by about 8.5k contracts to 22k. This entirely reflected new longs being established. The gross short position grew by 36 contracts.
 
The 5- and 20-day moving averages crossed to the downside for the US dollar against the peso. However, the peso did not participate in the move against the dollar at the end of the week. It failed, then, to generate as strong of a signal as say the euro or sterling or Australian dollar. Indeed a range of technical indicators we review are decidedly mixed for the peso. As long as the MXN14.10 area contains dollar gains, the shelf the greenback has been carved out just ahead of MXN13.80 may comes under attack. A successful break could signal another 1 percent dollar decline.