Currency Positioning and Technical Outlook: Diverging Dollar Performance Set to Continue

The market seemed to get confused last week between the noise and the signal and this confusion gave the dollar a bit of a reprieve.  However, by the end of the week, the market seemed to be back on message.  

Specifically, market sentiment swung from what was perceived as dovish comments at Yellen's confirmation hearing to a view that the Fed can taper in December, after reading the FOMC minutes.  Similarly, speculation of a negative deposit rate in Europe triggered a quick decline in the euro.   Surveys suggest that the perceived odds of Fed tapering this year are still low and Draghi and other ECB officials played down the likelihood of a negative deposit rate (though did not take it off the table entirely). 

The divergent performance of the US dollar makes it difficult to talk about in general.  The Dollar Index itself is really mostly Europe, which accounts for almost 80% of its basket.  Against the European currencies, the US dollar looks heavy.   The Dollar Index can work lower.  

Since the ECB's rate cut on Nov 7 and the stronger than expected US employment , the Dollar Index has been flirting with the 100-day moving average.  After repeated attempts in vain to close above it, the Dollar Index may have to work lower first.   A break of the 80.40 area could signal a move toward 79.50 before better support is found.  

On the other hand, the US dollar's outlook against the yen, Canadian dollar and Antipodean currencies appears more constructive.   These were the worst performing major currencies over the past week, with the former two losing about 1% and the latter two losing about 2.2%.  

From a technical perspective, this divergence is set to continue.  The euro-yen and sterling yen crosses capture the theme.  Both are trading at multi-year highs, even though the dollar remains a few percentage points below the high it set against the yen in May. 

The euro traded down to almost the support near GBP0.8300, but sterling is at 3-year highs against the Australian dollar, while the euro is well below the peak it made in late Aug, just above AUD1.50  Sterling poked through CAD1.71 for the first time since early 2010, and although it pulled back, may not be done.   

Technically, the euro and sterling have scope for additional near-term gains without encountering strong resistance.  For the euro the $1.3600-50 area stands in the way of the 2-year high set last month near $1.3830.  Sterling faces the double top set in early- and late-October near $1.6260.  A convincing break could spur a move to $1.6400.   For the euro, a break of $1.3400 would call this constructive view into question.  A similar level for sterling is near $1.6050.  

The US dollar finished the week above JPY100 for four consecutive sessions.  In the last two sessions it closed above JPY101.  It is at the highest level since July.  Although we are sympathetic to the divergence of monetary policy trajectories, we not that the US 10-year premium over Japan has not risen above the Sept high near 222 bp.    Moreover, the euro gains against the yen may also not have been driven by interest rates.  Over the past month, for example, the German premium on 2-year as well as 10-year money actually eased compared to Japan. 

The immediate target for the dollar is near JPY101.60 and then the May high set at almost JPY103.75.  We remain attentive to 1) the inverse relationship between the yen and Nikkei and 2) the risk that Japanese investors take profits on equities ahead of the doubling of the capital gains tax (to 20% on Jan 1).  The Nikkei made new six-month highs at the end of last week, but had a weak close before the weekend.   While technical indicators are constructive, a wave of profit-taking could buoy the yen.   

The US dollar is near the upper end of its five-month range against the Canadian dollar.  The Bank of Canada has moved away from the forward guidance that suggested it would need to remove some liquidity (i.e. raise rates) next year and the soft inflation figures (headline CPI was 0.7% in October) may keep it on the defensive.  The year's high set in early July just above CAD1.06 is the next immediate target for the greenback, though it probably requires a break of the Q4 2011 high near CAD1.0660 to signal a break out.  

The Australian and New Zealand dollars appear to have carved out a topping pattern that looks like a complicated head and shoulders pattern.  The objective of the Australian dollar's head and shoulders pattern is around $0.8800, which is just below the August low of $0.8850.  Resistance is seen near $0.9280.  The New Zealand dollar closed well below the $0.8200 neckline on a weekly basis.  The measuring objective is around $0.7950.  On a break of $0.8130, the next target is about $0.8030. 

The US dollar peaked against the Mexican peso on Thursday near MXN13.15.  It settled on Friday on the session lows near MXN12.97.  The bottom of the recent range is a little more than another percentage point lower at MXN12.80.  Real sector data has softened, but the bullish case for the peso is 1) anticipation of structural reforms and especially the measure to open up the oil and telecom sectors and 2) the clearing of the previous overhang of positions.  

Observations from the speculative positioning in the CME currency futures:  

1.  The latest CFTC reporting period, for the week ending Nov 19, position adjustment by speculators in the currency futures were generally minor.  The main exception is the rise in the gross short yen position by almost 16k contracts.  This market segment was anticipating the break out that took place two sessions after the reporting period ended.  At 131k contracts, the gross short yen position was the largest since late March.  It has risen from 80k contracts in late October.

2.  The second largest position adjustment was in the rise in the gross long sterling contracts.  Here too the speculators were rewarded.  Sterling finished the week above $1.6200, the best level in a month.  The gross short sterling positions remain substantial and the net position is still slightly short.  It probably swung to the long side during the current period.

3.  The speculative market appeared to get wrong-footed with the euro.  They have been dramatically cutting back on gross long euro position.  Since late October, the gross long position has been slashed by around 55k contracts, driving the net position below 9k contracts from 72k.   The euro finished last week with its highest close of the month (thus far).  The gross long euro position remains considerable larger than in any other currency futures, with sterling's nearly 54k contracts a distant second.

4.  There has been a bit of a tug-of-war in the peso.  The gross short position has doubled since mid-October to 31k, the highest in two months.   The gross long peso position has nearly doubled to almost 41k contracts.  The bulls may have been happy as the dollar slipped to new 3-week lows at the start of the week nearing MXN12.85.  Two days after the reporting period ended, the dollar has rallied back to MXN13.15. The dollar reversed lower on Thursday (Nov 21) and there was good follow through on Friday, where the greenback settled on its lows just below MXN12.97.  

week ending Nov 19		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	8.9	16.8	81.1	-5.1	72.2	2.9
Yen	-112.0	-95.1	19.4	-1.6	131.2	15.6
Sterling	-1.7	-9.3	53.8	9.8	55.4	2.2
Swiss Franc	3.7	3.2	13.1	-1.0	9.4	-1.5
C$	-16.3	-16.1	31.7	2.4	48.0	2.6
A$	-35.8	-35.8	17.6	-2.9	53.3	-2.9
Mexican Peso	9.5	7.0	40.6	8.0	31.0	5.4