Is the Dollar Correction Over, or Just the First Leg?

Last week was of two halves.  The dollar correctly lower through midweek and then recovered.  While the dollar's losses were pared, it still managed to fall against nearly all the major currencies.  However, it finished the week on a firm note, and although it appears poised to move higher in the week ahead, it is not immediately clear that new high is imminent.   

If there is one level to watch, perhaps it is the 20-day moving averages.  The euro, the Australian dollar and the Canadian dollar saw intra-day penetration of this average but did not close above it.   The Dollar Index also briefly fell through its 20-day moving average, but quickly recovered.  It has not closed below its 20-day average for three months.  Sterling stalled within ticks of is 20-day average.

Many currencies, including the euro, Swiss franc and the Australian dollar finished near their session lows, making a gap lower opening in holiday-thin markets (Japan is closed and the US has a partial holiday) on Monday possible.  Depending on the news stream, we would assume that they would be what technicians call "normal" gaps, which is to say they are filled in the short-term, as opposed to a break away gap, which signal an acceleration, for example.

The euro's price action reinforces that resistance near $1.28.   A break of $1.2600 is needed to signal a new push at $1.25.  A break of $1.25 could spur another 2-3 cent euro decline.   Three-month implied volatility is firm in the middle of the 6.5%-7.5% range that has held since early September.   At the same time, the premium for euro puts has increased vis a vis calls equally distant from the forward strike (three month 25 delta risk reversals).  

This suggests that some participants may be rolling short euro spot positions into options, rather than using the options market to hedge the position.      If the underlying position is short euros, a call option could be bought, which would be consistent with higher vol, but not the performance of the risk reversals.  Put options could be sold, but this is not consistent with the increase in volatility or the price action of the risk reversals.  

We have often argued that the dollar-yen pair does not typically trend.  When it appears to be trending, it is often moving from one range to another.  The top end of the range is around JPY110.  The dollar held support seen in the JPY107.30-50 area.  The greenback finished last week with three consecutive finishes below the 20-day moving average, which it had not violated once in the past two months.    

The five-day average has crossed below the 20-day for the first time since late-July.  However, the dollar's downside momentum eased, and the Relative Strength index stabilized.    We also note that the US Treasury market also stabilized, albeit at lower yield levels.    Stabilization of the equity market early next week also would help negate some of the bullish yen technical considerations. 

Sterling looks particularly vulnerable.  It has given back the lion's share of the gains seen earlier in the week that had carried it to almost $1.6230 from $1.5945.  The RSI has turned lower, and the MACDs are threatening to cross down.   A break of the $1.5945 low could signal another 1-2 cent decline.  The driving force is the pendulum of sentiment swinging toward a later rate hike.  Soft inflation reports next week, and miserly wage increases, will likely encourage this shift in expectations. 

Even significantly stronger than expected employment data failed to lift the Canadian dollar.  This seems to be more a reflection of a firm US dollar environment.  Some observers want to attribute the weakness of the Canadian dollar to the drop in oil prices, but it is a stretch.   The correlation on the basis of percent change is 0.27 and 0.21 over the past 30 and 60 days respectively.    The correlation between the S&P 500 and the Canadian dollar is even stronger at 0.34 and 0.29 for the 30 and 60-day periods respectively.  

The greenback is poised to test the CAD1.1280 area, this year's high and also the upper Bollinger band.    A convincing break would target CAD1.1400.  The US dollar tested support just below CAD1.11.  A break of this is needed to take the pressure off the US dollar's upside. 

The short-covering bounce lifted the Australian dollar from nearly $0.8640 to $0.8900.  However, it reversed lower.  It looks poised to return to the lows and make new ones.    The RSI has turned down, and the MACDs are about to. 

The Mexican peso remains heavy, though it gained 0.3% against the US dollar.  The economic news was a bit disappointing.  Industrial output was expected to have risen by 2% year-over-year in August, but rose a more modest 1.4%.  Manufacturing output was half of the 3% the consensus expected.  

As we noted with the Canadian dollar, so too with the peso.  Oil prices do a poor job explaining the currency weakness, and the peso, like the Canadian dollar has a somewhat stronger correlation with the US equities than oil.  Over the past 30 and 60 days the peso's correlation with oil prices is 0.06 and 0.02 respectively.  The peso's correlation with the S&P 500 is 0.53 and 0.51 for the 30 and 60-day periods respectively. 

The US 10-year yield shed 11 bp last week.  The recent peak was on September 19 near 2.65%.  It fell to new multi-month lows just below 2.28%.   The bears continue to be frustrated.  Wasn't Fed tapering and the end of QE supposed to push yields higher?  Wasn't the strength of the US economy expected to push up US yields?    The 2.38%-2.40% area may cap yield increases in the near-term, barring a significant upside surprise in US economic data next week.  The key reports include retail sales (Bloomberg consensus is for a 0.1% headline decline ) and industrial production (expected to recover from the -0.4% decline in August). 

The CRB Index made a new nine-month low before the weekend, gapping lower at the open.  As seen with the currencies, the 20-day average may be an important level to monitor.  The CRB Index has not closed above this average since the end of August.  It flirted with it early last week, but that marked the high, and it proceeded to drop another 2%.    The plunge in oil prices continued.  The $85 a barrel level has been taken out on an intra-day basis.  The next big objective is $80. 

Global equities had a poor week.  Major markets were off 2.6%-4.6%.  The Nikkei fared the best, losing 2.6%, followed by the S&P 500, which lost 3.1%, for its worst week since the middle of 2012.  The key level to watch is the early August low just ahead of 1900, which also corresponds to the 200-day moving average.       A break of that would signal a move toward 1880, and possibly 1845.  The S&P 500 finished on its lows just above that support, increasing the risks of a gap lower opening on Monday. 

Observations on the speculative positioning in the futures market:

1.  There were three significant gross position adjustments among the major currency futures.  The Australian dollar accounted for two.  The gross longs were slashed by 11.6k contracts to 316k.  The gross shorts grew by almost 13k contracts to 58.1k.  The gross short yen position was cut by 13.4k contracts to 137.4k.  

2.  Speculators reduced exposures to the yen, sterling and the Mexican peso as both gross longs, and gross shorts were reduced.  The small adjustment in gross sterling positions was sufficient to turn the net position back to favor shorts.  Gross long euro exposure was cut, though speculators added slightly (about 3k contracts) to the gross shorts.  

3.  Speculators added to both long and short gross positions in the Swiss franc and Canadian dollar. 

4. Speculators are suspicious of the latest rally in US Treasuries.  The longs took profits, culling the gross position by a little more than 10% to 403.8k contracts.  The bears are were intimidated by the rally, and the short position rose by almost 34k contracts to 496.1k.  This resulted in a swell of the net short position to 92.3k contracts from 12.5k.

week ending Oct 7		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-146.0	-138.0	61.5	-5.6	207.7	3.1
Yen	-113.0	-121.0	24.8	-5.1	137.4	-13.4
Sterling	-1.1	3.6	46.5	-7.7	47.6	-3.1
Swiss Franc	-12.4	-12.6	15.5	3.5	27.9	3.4
C$	-7.5	-4.6	39.2	6.2	46.6	9.0
A$	-26.5	-2.0	31.6	-11.6	58.1	12.9
Mexican Peso	-7.6	-7.3	43.8	-5.1	51.4	-4.8