FX Positioning and Technical Outlook: Dollar Still Carving out a Bottom

Our big picture view is that the US dollar is carving out an important bottom, after selling off in Q3 as policy makers moved to reduce the extreme tail risks. The position adjustment that that inspired among investors appears to have largely run its course.

This bottoming of the dollar is proving to be a  more protracted process than we initially anticipated, but we think it is continuing to unfold.   Some observers suspect that the uncertainties surrounding the US election, the fiscal cliff and related debt ceiling issues also may be hampering the greenback's recovery.


The US presidential election appears to have tightened (though again we underscore the idiosyncratic nature of the electoral college system, which means that  national polls might be nice snapshots, but the real signal comes from the swing states and here the advantage remains with the incumbent).  Yet, even if one has a high confidence of a particular electoral outcome, the market response is more difficult to anticipate.

Moreover, there is great uncertainty over the implications for the dollar if the US does go over the fiscal cliff.  Would the consequences lead to a dramatic risk-off trade (benefiting the dollar and yen), while those currencies and countries most sensitive to world growth (like the dollar-bloc and emerging markets) suffer? In a risk-off phase, European currencies typically perform poorly.   If the fiscal cliff is somehow averted, minimized or postponed, could risk-on trades, which have typically undermined the dollar, return to favor?

The other key driver in the foreign exchange market is Europe.  The rally in Greek bonds on the back of strong signals that it will receive another tranche of aid so it can service it's primarily official sector creditors, is indicative of the reduced tail risks of a Grexit that many had thought was inevitable and imminent at various points in the past six months.

We are impressed with the success European officials have had essentially talking the market away from the edge of the abyss without spending a single penny.  However, as the recent acrimonious and seemingly unproductive EU summit indicates, many hard decisions have yet be made and the divide between the creditors and debtors remains as stark as ever.

The fiscal cliff/debt ceiling issue in the US will be resolved one way or the other in late Q4 or early Q1.  The time frame of Europe's challenges do not appear as constrained.  Closure there remains considerably more elusive.  We continue to believe the contradiction between relatively low implied volatility and the high degree of uncertainty and the numerous risk events on the horizon will be resolved with higher volatility.

Euro: For the last several weeks, since early September, which ever direction the euro moves on Friday, it moves in the opposite direction on the following Monday (on a NY close to close basis)  Although participants ought not put much stock in these short-term patterns, they are suggestive and cautions against looking for much follow through on Monday.  The euro did accelerate through the down trend, cited last week, drawn off the mid-September and early October highs, only to falter in the second half of the week.  Resistance is seen in the $1.3140-70 band.  Initial support is seen in the $1.2980-$1.3000 area.  

Barring dramatic price action, next week, the 50-day moving average will cross above the 200-day moving average (the Golden Cross).  Sterling's 50-day moving average crossed above its 200-day moving average in mid-September.  The Swiss franc's averages are also likely to cross next week.  The sequence whereby sterling leads the euro and the Swiss franc confirms it, seems to be among the strongest technical signals.   It was precisely this sequence that helped encourage us to anticipate the dollar bottom in late 2007/early 2008.

Speculative positioning at the IMM still shows a large number of short euro positions remain, and whose short-covering could fuel another leg up in the euro.  However, we think the euro has yet to prove itself.  After the initial adjustment to reduced tail risk in Europe, the euro has traded in a $1.2800-$1.3200 range.  Since the euro most recently tested the upper end of the range, the rule of alternation suggests some operators will anticipate a move toward the lower end of the range.  

Yen:  The dollar broke above the four-month downtrend line.  The dollar's resilience against the yen at the end of last week as the stock market melted was particularly impressive.  The dollar is flirting with the 200-day moving average, which comes in near JPY79.45.  Additional resistance is pegged in the JPY79.70-JPY80.00 range.  Support now is seen near JPY79.  The dollar's recovery against the yen reduces even further the risk of intervention.  We had perceived as a low risk event in the first place, but many observers had assessed a greater probability.  

Sterling:  Sterling was turned back from the $1.6180 area which corresponds to a retracement objective and  trend line resistance, despite some observers have second thoughts about the likelihood that the BOE extends its gilt purchases in a couple of weeks.  Initial support is now seen in the $1.5980 area.  Sterling's heavy tone may have also been a function of cross rate losses against the euro,which rose to four month highs against it.  Provide it hold above GBP0.8100-15, the euro can test the early June high near GBP0.8170-GBP0.8200.  

Swiss franc:  The dollar held support near CHF0.9200 and appears poised to move higher, judging from the price action and the momentum indicators.  The initial target is back into the CHF0.9300-30 range.  Frankly, the Swiss National Bank has made the franc a boring currency, however, it is interesting against the Japanese yen.  The franc had been trending higher against the yen since the second half of July and that trend accelerated recently.  However, a near-term reversal appears to have been traced out in the second half of last week, complimented with a weak close on Friday.    There appears to be scope for a 1-2% decline in the coming weeks, even if the longer term trend remains intact.  

Canadian dollar:  The weaker than expected CPI data at the end of the week reinforced the signal from the Bank of Canada's governor suggesting a more neutral and less hawkish  posture at next week's policy meeting.  It sent the Canadian dollar lower, with the US dollar reaching 6-week highs.  The greenback convincingly took out the down trend line going back to early June, but stalled near the 38.2% retracement objective.  A move now above CAD0.9940 could spur further liquidation by the trapped longs and send the greenback toward CAD1.0040.  

Australian dollar:  After posting strong gains early last week, the Australian dollar reversed lower on Thursday and follow through selling on Friday saw it lose a cent from the week's highs.  Technical indicators are mixed.  The 5-day moving average crossed above the 20-day moving average, as it reversed lower, while some momentum indicators have also turned down.  Ironically, the 50-day moving average is likely to break below the 200-day moving average next week.  Stronger than expected Chinese data, coupled with reserve-related flows and the still attractive yields offered (even if, as we suspect the RBA will deliver another rate cut in early November), prevents sentiment from getting more negative.  While some support is seen in the $1.0280-$1.0300 area, stronger support is seen around half a cent lower.  

Mexican peso: The dollar has chopped in a MXN12.75-MXN13.00 range for the past month with a single exception.  On October 3, the dollar briefly broke down to MXN12.66 before rebounding to finish the day in the aforementioned range.  The liquidity, accessibility, yield and the fact that officials are more willing to accept peso strength (within reason) draws speculative and investor interest.  Technically, a push higher in the dollar seems likely in the days ahead and this may give the peso bulls a new opportunity.   

week ending Oct 16		Commitment of Traders
		(speculative position in thousand of contracts)
	Net	Prior Week	Gross Long	Change	Gross Short	Change
Euro	-53.5	-72.6	42.0	2.1	95.5	-17.0
Yen	10.1	12.9	42.8	2.0	32.7	4.8
Sterling	19.6	22.6	54.0	-0.2	34.4	2.8
Swiss franc	-1.2	-0.3	10.3	-1.4	11.5	-0.5
C$	93.8	95.6	106.4	0.7	12.6	1.9
A$	38.4	39.8	77.8	-0.7	39.4	0.6
Mexican peso	135.0	136.0	139.8	0.4	4.3	1.3

**Short covering in the euro continues to dominate position adjustment, producing the smallest gross short since Nov '11.

**The net long yen position is the smallest nearly 3 months.

**New sterling shorts entered, but old longs were reluctant to capitulate, though some did later.

**Shifts in the franc's positioning reflect the pace that both long and shorts are exiting.

**Gross long Canadian dollar position rose first time in four weeks, even if marginally.

**Smallest net long Australian dollar position since late July.

**For three consecutive weeks there has been practically no change in net long peso position.