Currency Positioning and Technical Outlook: No Comfort Yet for Dollar Bulls

We had anticipated that the market's disappointment with the Federal Reserve would initially weigh on the dollar, but we had thought the focus would shift back toward Europe, especially after the German election.  We anticipated that, by default, this would be more supportive of the dollar against the major currency currencies after it had trended lower since early-to-mid-July.  

However, two things have happened that have kept investors' attention on the US.  First, the dysfunctional US Congress is once again threatening to close down the US government and possibly force a default.   Second, it appears that an increasing number of market participants are moving toward our view that tapering is unlikely this year.  

We continue to expect a deterioration in the political and economic climate in the euro area, and for this lend support to the dollar.  Yet, we were early in our timing and the technical condition warns that further dollar weakness is likely to be seen first.  Already, before the weekend, the dollar slipped to new lows for the year against the Swiss franc, for example.  

The Dollar Index is poised to fall through the 80.00 level and this suggests potential toward 78.70 initially, which corresponds to a 50% retracement of the rally off the May 2011 lows.  It also corresponds to a bit of shelf formed by repeated tests since the first quarter last year.  Initial resistance is seen near 80.60, while a move above 81.00 would take the downside pressure off.  

This bearish view of the Dollar Index is the mirror image of the constructive technical view of the euro and sterling.  After spiking higher in response to the Fed's decision, the euro has been consolidating and appearing to be carving out a pennant or flag pattern.  Such a pattern is bullish and suggests potential toward, and possibly above the year's high set in early Feb just above $1.37.  A break below $1.3450 would be the first technical sign of a potential top, though it may require a move below $1.3400 to be convincing.  

There is little evidence that sterling has topped out either.  Technically, a move above $1.6160-$1.6200 area may spur a move toward $1.6400.  In addition to speculation that the UK will be the first of the major high income countries to raise interest rates, Verizon's $130 bln purchase of Vodafone's wireless unit, of which nearly half ($60 bln) is in cash, appears to also be lending sterling support. The deal is expected to close in early 2014 and market contacts report that the related flows are significant and persistently buying into sterling down ticks.   Chart-based support is seen in the $1.5950-$1.6000 area.  

The US dollar also looks vulnerable against the Japanese yen.  The continued rally in US bonds, with the 10-year yield falling to its lowest level since mid-August (~2.60% having peaked near 3% in early September), has seen the premium the US offers, and to which Japanese investors seem sensitive to six week lows near 190 bp.  The premium was over 220 bp three weeks ago.  

The dollar now is approaching the uptrend line drawn off the mid-June and mid-August lows.  On September 30, it is found near JPY97.65.  It is also possible, that the dollar is tracing out a head and shoulders pattern against the yen.  The left shoulder was finished on August 23 near JPY99.15.  The head was formed in early September and completed on September 11 near JPY100.60.  The right shoulder was formed in reaction to the recent Fed decision.  The neckline is upwardly sloping and comes in near JPY98.15 on Monday.  If this pattern is valid, it projects the dollar falling toward JPY95.00.  

As it did at the start of Q3, the greenback looks better against the dollar-bloc currencies and the Mexican peso, as Q4 begins.  The Australian dollar has completely unwound the post-Fed gains and is flirting with its 20-day moving average ( ~$0.9290) for the first time since the start of the month.  The pendulum of market psychology swung too far in the direction of pricing in a rate hike, while we are still inclined to see another rate cut--not at next week's central bank meeting, but likely before the end of the year.  The MACD's are about to cross to the downside and the 5-day moving average is likely to cross below the 20-day average next week.  The Aussie has carved out a nice A-B-C upside correction and the underlying downtrend looks set to resume.  We see scope toward $0.9200 in the days ahead, though over in the coming weeks a return to sub-$0.9000 seems increasingly likely.  

We see the near-term Canadian dollar technical condition as more neutral.  As long the US dollar holds above CAD1.0240, we are biased toward a stronger greenback.  On the upside, the dollar may find the going tough between CAD1.0370-CAD1.0420.  

Mexico's underlying fundamentals are constructive, even though the economy has slowed and the central bank has cut its key overnight rate by 75 bp this year.  Both times that rates were cut, it took the market by surprise, but the peso rallied through it.  Now, however, the technicals are poor and we think there will be be better buying opportunities.  Initially, the dollar is likely to test the MXN13.46 area, which capped it in both late June and early September.  The 5-day moving average is poised to cross above the 20-day average next week and the other technical indicators we look at also favor additional dollar strength.  

Observations on the Commitment of Traders speculative positioning in the CME currency futures:  

1. In the week after the FOMC decision not to slow their asset purchases, the dollar was generally sold by speculators in the currency futures.  Gross long currency future positions were extended in all the currency futures except the Japanese yen and Australian dollar.  Gross short currency future positions were generally reduced except for the Canadian dollar and the Swiss franc (the latter was essentially unchanged, which given our rounding process was less than 100 contracts).  

2.  There were three position adjustments that we regard as significant, which means a change of at least 10k contracts.  These were all about adding to gross long currency positions and included the euro, the Canadian dollar and Mexican peso.  

3.  In the most recent reporting period, for the week ending September 24, the net sterling position swung to long side for the first time since February.  The net Mexican peso position swung back to the long side after having been net short the prior week for the first time since July 2012. 

4.  The net long euro position is the largest since May 2011.  The net Swiss franc position has been long for the seventh consecutive week and is now the largest since June.   Although the net position in the Canadian dollar remained short, it is the smallest net short position since February.  

5.  The euro has the largest gross long speculative position of almost 130k contracts.  Sterling has the second largest at almost 51k contracts.  The yen remains the largest gross short with 111k contracts. The euro is second with 64k gross short contracts.  

week ending Sept 24		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	65.8	31.9	129.9	28.9	64.0	-5.0
Yen	-92.8	-88.8	18.3	-7.9	111.0	-3.9
Sterling	1.2	-6.3	50.7	6.6	49.6	-0.9
Swiss Franc	5.7	0.6	15.2	5.1	9.4	0.0
C$	-5.7	-18.8	40.3	15.0	46.0	1.9
A$	-34.8	-27.3	20.0	-9.8	54.9	-2.3
Mexican Peso	14.0	-10.2	47.9	19.4	33.9	-4.8