King Dollar: Not Just the Driest Towel on the Rack

The US dollar remains king.   It continues to be supported by the divergence in growth and interest rate differentials.  Even though the ECB did not take fresh action this past week, there is little doubt that it will in early 2015.  The aggressive monetary policy in Japan, where the BOJ is expanding its balance sheet by 1.4% (of GDP) a month for as long as the eye can see, also stands in sharp contrast to the US, where the market has largely priced in a hike in Q3 15.    In the coming weeks, it is difficult to envision anything that will undermine this general theme.

There are three main events before the end of the year for global investors.  First, is next week's second TLTRO.  Disappointing participation (less than 125 bln euro take down) would boost confidence that the ECB will take more action early next year.  In turn this would likely weigh on the euro and underpin European bonds and stocks.  

Second, on December 14, Japan goes to the polls.  There is little real challenge to Abe. The DPJ has been poorly organized, and has not been able to tap into the popular anxiety over Abenomics and the controversial political issues, like nuclear power and allowing military involvement to defend other countries.  The LDP and Komeito coalition enjoys a super-majority and polls suggest it will retain it.  

Third,  the FOMC concludes its last meeting of the year on December 17.  The statement could modify or remove the reference to "considerable period" in the forward guidance. This would be seen as a hawkish development, would likely lift the dollar.  The economy has performed well, which the Fed will likely recognize.  Its perspective on oil's impact has already largely been presented by Fischer and Dudley.  The Fed will see the slide in prices are positive for household consumption, and will see the downward pressure on prices as temporary.  

Euro:  Look for another leg down.   The MACDs have lower after approaching levels since in October.  The RSI is turning down from 50.  The next target is near $1.2150-$1.2200, but the $1.20 level, approached in 2012, and $1.1880, the low from 2010 are more significant objectives.    Counter-trend bounces are likely to run out of steam now in the $1.2350-$1.2400 area.  The only note of caution is that the euro is trading below its lower Bollinger Band (~$1.2315), and while new lows were made in the second half of last week, the newest downticks were hard to sustain.

Yen:   The dollar shot through the JPY120 level, and there appears to be only weak efforts, thus far, too slow its ascent.  The dollar is also trading above its upper Bollinger Band (~JPY120.90).  We suspect the JPY120 area should now act as support.  Initially, short-term participants may turn less aggressive as the next round figure is approached (JPY122), but many have high conviction that the dollar is on its way to JPY125 and JPY130, if not beyond.

Sterling: The $1.5600 level has been frayed in recent weeks, and it finally closed below it ahead of the weekend.  Technical indicators are consistent with further losses, but the pendulum of market sentiment, pushing out rate hike expectations appear to have largely run its course.  Stronger economic data helped put in the top for the December 2015 short sterling futures, pushing up the implied rate about 10 bp lower on the week.  The place to express a bullish sterling view is not so much against the dollar, but on the crosses, especially the yen.  It is trading a little above JPY189, which is a six-year high.  There is potential toward JPY200.

Dollar-bloc:  Contrasting employment data and further weakness in oil prices pushed the Canadian dollar to marginal new multi-year lows.   We continue to look for CAD1.1670-CAD1.1725 on a medium-term view.   Immediate support is pegged near CAD1.1325. Losing less than 0.1% against the US dollar in the past week meant the Canadian dollar was the strongest of the majors against the dollar.  The Australian dollar was the second weakest, losing  almost 2.2% against the US dollar. The Aussie finished last week on its lows and with a seven-day losing streak.    The $0.8400 area should act as resistance as the Aussie make its way toward $0.8200 and then $0.8000.

Mexican peso:    The peso lost almost 3% against the dollar last week.  It was third worst performing emerging market currency behind the Russian rouble (-6.5%) and the Colombian peso (-4.2%).  The dovish central bank statement, falling oil prices, and skepticism over the PRI's reform agenda have encouraged foreign hedge funds and international investors to reduce exposures.  The dollar appears headed toward MXN14.60.  The dollar did finish the week above the upper Bollinger Band (~MXN14.245), which may inject a cautionary note into the activity at the start of next week,but the central banker's call for a weaker real exchange rate is likely to override technical considerations.  

US 10-Year Yield:  Strong economic data is giving US bonds a bit better traction.  After starting last week near 2.15%, it finished the week at 2.32%.  The 2.40% area is key.  We remain  sensitive to the  a return of the so-called Greenspan Conundrum.  This refers to a period in which the Fed was raising short-term interest rates, but the long-term interest rates were stable or declining.  From non-dollar investors point of view, the total return may be attractive even if one anticipates somewhat lower prices going forward.  The yield is better than most other major countries, and the expected appreciation of the dollar will offset some price erosion. 

S&P 500:  New record highs were recorded before the weekend despite the higher US yields.  The modest pullback at the start of the week filled the downside gap we had previously drawn attention to from the sharply higher opening on November 21. While the RSI is suggesting scope for additional gains, the MACD has been flagging.  That said, the S&P 500 has been moving broadly sideways for the past couple of weeks.   Since November 22, we have been warning that European stocks can outperform the S&P 500.   It is working, and of course, it works better on a currency hedged basis.

Oil:  The January light sweet oil futures contract broke below $64 a barrel on December 1, but generally consolidated last week.  It failed to make a new low despite Saudi Arabia's decision to increase its discount to US and Asian customers to $2 below the official price.  Technical indicators are not generating strong signals; warning of the risk of near-term consolidation before the next leg down.  Already, reports indicate that given the discounts, the price of some US shale oil is near $50 a barrel already. 

Observations based on speculative positioning in the futures market:

1.  To the extent there was a pattern in the latest Commitment of Traders report for the period ending December 2, it was that there were only minor position adjustment.  Of the 14 gross currency positions we track, only two changed by more than 5k contracts.  The gross short euro position was reduced by 6.5k contracts to 216.6k.  This is about 23k contracts lower than the recent peak in early November.  The bears grew their gross short peso position by 14.3k contracts to 73.2k.  This is a record gross short peso position.  The peso fell about 3% in the three sessions since the Commitment of Traders report on the back of weak data, official comments, the drop in oil prices and the resurgent dollar.  

2.  Whereas the market has marginally reduced its short euro position, it has continued to extend  gross short yen positions.  They are short 152.7k contracts.  This is a new high for the year, though still below (~4.5k contracts) the high from the end of last year.  

3.  The speculative net short US 10-year Treasury futures position more than doubled over the last reporting period to 163k contracts from 73.3k the prior period.  The bulls took profits on 42k long contracts.   Recall that yield fell to 2.15% on December 1.  They are still long 344.4k contracts.  The bears added 45k contracts to bring the gross short position to almost 507k contracts.  The yield finished the week just above 2.30%.  

week ending Dec 2		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-159.0	-165.0	57.3	-0.7	216.6	-6.5
Yen	-111.0	-104.0	41.5	-4.8	152.7	2.0
Sterling	-31.0	-30.1	38.6	0.0	69.6	0.4
Swiss Franc	-22.9	-23.4	8.6	0.5	31.6	0.0
C$	-18.4	-16.3	28.5	-3.6	46.9	-1.5
A$	-41.1	-40.1	13.6	1.5	54.7	-1.5
Mexican Peso	-43.0	-32.6	30.2	3.8	73.2	14.3