Currency Positioning and Technical Outlook: The Trend wants to be Your Friend (Again)

The US dollar moved lower over the past week against the major currencies, with the notable exception of the Japanese yen.  The greenback's technical tone has deteriorated.  The euro and sterling appear to have convincingly broken above significant down trend lines.  With the holiday season upon us, there seems to be no compelling technical reason not to look for a continuation of dollar weakness into the end of the year.  Few are incentivized to fight the trend.

The extent of the Fed's easing, and the implication of its guidance, suggests an even more dovish posture than the expansion of QE3+ (remember it was purposely open-ended, unlike QE1 and QE2). While the euro zone economy appears to be contracting this quarter at a slightly faster pace than in Q3, the slowdown in the US is more dramatic.  Growth may be more than cut in half from the 2.7% annual pace seen in Q3.   The fiscal cliff is the main cause of consternation at the moment.  Although there is private negotiations taking place, the public posturing is what investors have to guide them, and it is not particularly flattering.

The immediate wild card comes from Japan, when the election is widely anticipated to produce an LDP-led government that seems intent on debasing the currency through aggressive monetary policy, with the purchase of foreign bonds mentioned and an expansionary fiscal policy.  This is nothing secret about its intent.  This contrasts to the US, where despite the official rhetoric that a strong dollar is in the US interest, many observers divine a hidden intent to drive the dollar lower.  Speculators have amassed one of  the largest short yen positions in the futures market in history.

Foreign asset managers recognize the significance of the LDP's intent. They have been pouring money into Japanese shares.  Consider that from the start of the year through early November, foreign investors bought a net $2.73 bln of Japanese equities.  Since then, they have bought roughly $8.63 bln worth.  The weekly MOF flows suggest that the equity purchases were not a switch out of Japanese government bonds.  Despite the threat of currency devaluation and a fiscal policy that will add to the country's 200%+ debt/GDP, Japanese 10-year government bonds have outperformed Treasuries and bunds over the past month.

We are wary that the speculative community sold the yen on "rumors" that the LDP will win and may buy the yen on the "fact".  The Nikkei would then also be vulnerable to a setback.  It is not just the election either.  The BOJ meets Wed and Thurs and given the poor stream of economic news and signs that deflation has not loosened its grip, an additional JPY5-10 trillion expansion of the asset purchase plan is widely anticipated.  As good bureaucrats, the BOJ should be expected to defend its nominal independence from encroachment by the new government, but that might be an early 2013 story.
 

Euro:  The combination of favorable developments in Europe and a very dovish Federal Reserve clarified the euro's technical picture.  The euro broke through two key trend lines.   The first is the longer-term trend that goes back to May '11 high near $1.4940 and the Aug '11 high near $1.4550 and catches the Oct high of this year.  I pointed it out here on Dec 6, but then the euro sold off on the Italian political story and it had clouded the technical outlook.   The second trend line that appeared convincingly violated was drawn off the Sept 14, Oct 17, and Dec 5 highs .  It is so a flat trend line that technically looked like a triple top.  That trend line comes in around $1.3120 and should offer support.  On the upside a reasonable target for the bulls is near $1.35, which corresponds to a retracement objective and a measuring objective.  Bullish technical outlook.  

Yen:  The anticipation of an LDP victory has seen the yen sell-off sharply in recent weeks.  The dollar also closed the week above 18-month old downtrend against the yen.  It can be drawn off the April '11 highs and the March '12 highs.  It has appeared to check recent gains.   The dollar appears stretched, looking at Bollinger bands and RSI signals.  As we show below, the trend followers and momentum players have amassed a significant short yen position.  The market seems vulnerable to a "buy the rumor, sell the fact" type of activity.  One way this can play out a rally to new highs into the JPY84-JPY85 area.  The JPY85 area corresponds to last year's high, the 200-day moving average and, of course, is a nice round psychological level.  A failure there could be significant.  Initial support may be seen near JPY83.20, but it may take a convincing break of JPY82.40-60 to cause the yen bears much grief.  Cautious about the establishment of new yen shorts without a bounce.  

Sterling:  The trend line drawn off the year's high of almost $1.6310 on Sept 21, the Sept 28 high just below $1.6275 and the Nov 1 high near $1.6175 was violated at the start of the month, but then sterling retreated at the end of last week back below it.  It has now convincingly broken it and a retest on the $1.6300 area looks likely, and possibly $1.65 before the move exhausts itself.  Support may be seen in $1.6080-$1.6100 area.  Technical indicators appear supportive.  That said, in the advance envisioned here, sterling is likely to continue to lag behind the euro. Favorable outlook against the dollar, but not against the euro.  

Swiss franc:   Like the euro, the price action suggest the Swiss franc has broken out of some kind of consolidation pattern and is headed higher.  The pre-weekend dollar high near CHF0.9250 is likely to prove significant.  The measuring objective of the break of the pattern suggests a return to the CHF0.9000 area and possibly a bit lower.  Bullish technical outlook.  

Canadian dollar:  Although the US dollar sustained the break of CAD0.9900, the price action was disappointing.  The Loonie lost ground to most of the major currencies, but the Japanese yen and Swedish krona.  The pre-weekend price action was poor and is suggestive of a potential reversal.  The CAD0.9880-CAD0.9900 may offer initial resistance.  A small shelf for the dollar is in the CAD0.9825 area.  Neutral to slightly bearish the CAD.  

Australian dollar:  The Aussie bulls continue to shrug off poor domestic news, rate cuts and a government clearly desiring a weaker currency.  The Australian dollar's resilience is notable.  The slow grind higher suggests it is working through offers, but there is no technical reason why the Australian dollar cannot continue to move higher with the $1.0625-50 the next target.  This year's high, above $1.08 still seems far away.   Additional near-term Australian dollar gains are likely.  

Mexican peso: The dollar lost another 1% against the peso over the past week and is poised to continue to gradually drift lower in coming period.  The next objective is near MXN12.66, the spike low in early Oct and then MXN12.55,  the low for the year, set in mid-March.  The MXN12.85 area may cap dollar upticks.  Retain a favorable outlook for the peso.  

week ending Dec 11		Commitment of Traders
		(speculative position in 000's of contracts)
	Net	Prior Week	Gross Long	Change	Gross Short	Change
Euro	-31.6	-32.8	51.5	3.2	83.1	2.1
Yen	-94.4	-90.3	16.4	-4.6	110.1	-0.5
Sterling	28.0	27.3	64.8	-1.3	36.8	-2.0
Swiss Franc	3.2	0.6	11.2	-0.5	8.0	-3.1
C$	62.5	57.1	74.2	7.9	11.7	2.4
A$	103.0	92.2	139.5	3.3	36.2	-7.8
Mexican Peso	149.0	119.0	155.3	28.3	6.0	-2.0

***The net short euro position is the smallest in 15 months.  The gross longs are approaching the high for year.   The gross shorts are the second largest in the futures market, with only the  gross short yen larger.  

***The net and gross short yen position is the largest in five years.  

*** The gross long sterling position is larger than the gross long euro and Swiss franc positions put together, yet sterling is lagging on the crosses.

***The net long Swiss franc position is the largest in 15 months.  

***The net long Canadian dollar position is the largest in one month.  

***The increase in net long Australian dollar positions to a new record high is more a function of shorts covering than new longs being established.  

***The new record net long peso position was almost solely a reflection of the continued accumulation of a record large gross long position.