Fade the Break?

There is a generally shared view that growth differentials will lead to wider interest rate differentials that will spur the long awaited dollar rally.   The markets are anticipatory in nature, and many observers suspect that dollar rally has begun.  

The Dollar Index rose to a one-month high before the weekend, extending the push through the 200-day moving average that had occurred earlier in the week.  At midweek, the 50-day average moved above the 200-day average in what some technicians refer to as the golden cross.

Despite the disappointing housing starts, other economic data suggests the US economy not only expanded by a little more than 3% in Q2, but the positive momentum has carried over into the start of Q3.  The Bloomberg consensus expects the world's largest economy to expand at a 3.1% annualized clip in both Q3 and Q4.  

However, the US 10-year yield has no traction.  It dipped below 2.44% last week, as stock market fall, housing starts crumbled (only in the south, but enough to drag the national aggregate dramatically lower) and geopolitical tensions rose.  The yield is off seven bp in the past week and 14 bp in the past month.  The 2.48% close was the lowest weekly close since the end of May.  

Some of the factors that drove US yields down also drove the yen higher, like the geopolitics and the sharp sell-off in stocks on July 17.  The dollar successfully tested the JPY101 level for the second time in two weeks.   There is a band of resistance in the JPY101.50-65 area.  It needs to be overcome to take the pressure off a re-test.  

Before the weekend, the euro broke below the $1.35 level for the first time since February.  It is approaching a trend line on the weekly bar charts that comes in near $1.3470.  Although technical indicators, like the MACDs, are trending lower, and the 5-day average is below the 20-day, we are not convinced this is the long anticipated breakout.     

We suspect the euros's break of $1.35 was a bit of a fluke, perhaps driven by the cross against the yen.  The break took many by surprise, but strong bargain hunting quickly emerged and the euro finished  net-net little changed from the previous session, which itself was little changed from its previous session.  Essentially the euro has been unchanged on a closing basis since July 16. 

A combination of an upside surprise on US inflation and a downside surprise of the euro area flash PMI readings could give the market the incentive to push the euro through the weekly trend, in which case the next target is $1.34.  Nevertheless, we suspect the $1.35-$1.37 trading range will remain intact, even if it frays a bit.  

Sterling technical tone has deteriorated, and the 5- and 20-day moving averages are set to cross over the next couple of sessions.  Sterling spiked to new highs in response to the CPI's upside surprise.  However, that high was not confirmed by the technical indicators.  This has created a bearish divergence. 

We do not think that sterling has peaked yet, but the technicals and market positioning suggests caution is warranted.  New buying is likely to emerging on a further pullback into the $1.6950-$1.7000 area. 

Within a narrow consolidative range, the Australian dollar staged an outside up day as the government seemed more relaxed about the currency’s strength than the central bank.  The technical tone is favorable.  The RSI has turned up, and the MACDs are about to.  The next target is near $0.9460. 

The technical tone of the Canadian dollar is not as favorable.  The Aussie looks set to outperform the Loonie.  It is flirting with CAD1.01, which it tested three times last week.  A break of this would signal a move toward CAD1.0200-50. 

The US dollar spiked to CAD1.08 on the central bank’s statement indicating that although the CPI has not peaked, the gains are likely to prove temporary and full capacity utilization was pushed out again.   As if on cue, before the weekend the June CPI figures were stronger than expected and the greenback fell to almost CAD1.07.

We suspect that the quick move to CAD1.08 was a shakeout of weak late longs.   As of July 15, the speculators in the futures market had a gross long Canadian dollar position that was the largest in nearly 18 months.  It has doubled in the past month. A consolidation phase would not be surprising in the near-term. 

The US dollar closed just below MXN12.95 before the weekend.  It is the lowest weekly close in six weeks.  The net long position in the futures market has been essentially unchanged for the past four-reporting periods.  However, what appears to be the driving force is the demand for peso-denominated government debt.  Foreign holding of official peso debt is at a record. They are anticipating the opening up of Mexico’s energy market, with draft rules approved by Senate committees last week. 

The next level of support is seen near MXN12.90.  We still look for a retest on the MXN12.80 area, even though the previous head and shoulders pattern did not unfold as hoped.    

Lastly, given the anticipated growth and price pressures, we continue to think that US 10-year yields below 2.5% are not sustainable.  A move back above the 2.56%-2.57% area will help stabilize the tone.  

Observations from the speculative positioning in the futures market:

1. Position adjustments were minor in the latest Commitment of Traders report for the week ending July 15.  Of the 14 gross currency futures positions, 11 were adjusted by less than 5k contracts. The only significant position adjustment  (we define as more than 10k contract change) was the 11.5k contracts added to the gross short position.  It now stands at 112.4k contracts, which is by far the largest short position among the currency futures.  The gross short yen position of 71.3k is is the second largest.  

2.  Speculators continued to accumulate Canadian and Australian dollars.  The gross long Canadian dollar position edged 2.1k contracts higher to 60.4k.  This is twice as much as a month ago.  The gross long Australian dollar position rose 4.2k contracts and has grown 7-fold since mid-March to 70.9k contracts.  

3.  Although gross sterling longs slipped fractionally, at 86k contracts  it is still larger than the gross long euro, Swiss franc and yen futures positions combined.  

4.  There was a sharp reduction in the net short 10-year Treasury futures.  This was not a function of short covering.  In fact, the gross shorts edged higher by 5.7k contracts to 479.2k.  The reason the net short position fell to 53.6k contracts from 96.8k is because new longs came into the market. The gross long Treasury position increased by more than 10% to 425.6k contracts 

week ending July 15		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-62.8	-59.3	59.5	7.9	122.4	11.5
Yen	-62.9	-66.4	8.4	-2.8	71.3	-6.2
Sterling	38.8	41.6	86.0	-0.6	47.2	2.2
Swiss Franc	-6.3	-6.8	8.8	-0.3	15.1	-0.9
C$	15.6	10.3	60.4	2.1	44.7	-3.2
A$	39.7	36.6	70.9	4.2	31.1	1.0
Mexican Peso	69.6	68.8	86.7	3.9	17.1	3.1