Dollar Correction may be at Hand, but likely Brief and Shallow

After a three-week rally, the dollar bulls finally showed signs of tiring ahead of the weekend.  Technical indicators have begun rolling over from over-extended conditions. Nevertheless, the dollar's pullback is limited in time to the first part of the week ahead, and in scope to only modest retracement targets ahead of the US employment data, the Italian referendum, and the Austrian presidential election on December 4. 

We have suggested that the dollar's advance was fueled by the divergence that had little to do with the US election.  It is clear from Fed comments and the minutes from the November FOMC meeting that officials were prepared to hike rates regardless of the election outcome.  Moreover, subsequent data has been mostly better than expected.   

Trump's promise of significant fiscal stimulus with the world's largest economy already grown near or above trend, the inflationary implications are clear.  Nominal rate differentials have widened significantly in US favor.  We are cautious are extrapolating too much from the inflation-linked securities as the liquidity premium tends to exaggerate the movement.  Also, Fed funds futures strip has not fully priced in two hikes next year, suggesting potential room further adjustment.  

Since November 4, a few days before the US election, the Dollar Index rose about 5.35% at last week's peak just above 102.00.  The RSI has rolled over, as has the Slow Stochastics.  The MACDs may turn next week.  Initial support is seen in the 101.00-101.20 and then 100.65.   

The euro put in a low a little below $1.0520 while Americans were celebrating Thanksgiving.  Like the Dollar Index, the RSI and Slow Stochastics have turned, but MACDs, as often the case, are lagging. Nearby resistance is seen in the $1.0650-$1.0660 area.  Above there, and the euro can test the $1.0725 area.  

To the extent the widening of the U.S. premium is a critical driver for the dollar, we note that both the two-year and 10-year premiums continued to widen ahead of the weekend, despite the greenback's pullback.  The US two-year advantage reached 1.90% bp at the end of last wee the most in 16 years.  It finished at 1.86%, a 13 bp gain on the week.   The US 10-year advantage widened eight basis points to 3.10% before the weekend.  It has been as much as 3.20%, which is the largest since 1992.  

Since November 4, the dollar has risen 11% against the yen, reaching almost JPY114 in Asia on Friday before profit-taking emerged.  The RSI has rolled over, and the Slow Stochastics is about to turn, while the MACDs are still trending higher.  Dollar buying re-emerged ahead of JPY112.50 and support extends toward JPY112.30 A break could see another yen decline that pushes the greenback toward JPY111.60.  The US rate premium continued to widen.  The two-year advantage rose to 1.31%, which is the most since 2008.  At 2.31%, the 10-year premium is at a five-year high.  

In the bigger picture, it looks the drop in the dollar from last year's high (almost JPY126) to this year's low (circa JPY99) was corrective in nature, meeting a little more than the 50% retracement target of the Abenomics induced rally.  This suggests further dollar gains against the yen lie ahead over the medium-term.  Near-term, the JPY114.35-JPY114.65 may offer some resistance on the way to JPY115.00-JPY115.60.  

Sterling is a horse of a different color.  Since the flash crash on October 6, sterling has been in two ranges.  The first was between $1.21 and $1.23.  It largely confined prices until early November. Most of this month, it has been in $1.23 to $1.25 range for the most part.  The technical indicators are not generating strong signals, but the Slow Stochastics have turned higher.  In an upside corrective phase for the euro, sterling may underperform. 

We note that the US two-year premium over the UK widened by 17 bp last week to 1.03%, which is the largest divergence since at least 1992.  The US 10-year premium widened to 96 bp last week. It finished last month near 58 bp.  The US premium is approaching the late-August extreme near 1.06%, which was the widest since 2000.  

Since reaching almost CAD1.36 on November 14, the US dollar has been consolidating its gains against the Canadian unit.    Here too we note that the US interest rate premium continued to widen even though the greenback failed to extend its recent gains against the Loonie.  Both the two and 10-year premiums are moving back toward the extremes set at the start of the year. 

The sharp drop in oil prices ahead of the weekend weigh on Canada, and helped lift the greenback to test a short-term down trend line drawn off the November 14 and November 18 highs. It came in near CAD1.3540 ahead of the weekend and caught the high  It caught the high, which was recorded late in the session.  We note that the CAD1.3575 area represents a 50% retracement of the US dollar's slide since the multi-year high was set in January.  That slide looks corrective in nature, but in any event, the next major upside target is near CAD1.3840.

The Australian dollar was the strongest of the major currencies last week, gaining nearly 1.4% against the US dollar.  The Aussie had bottomed at the start of the week in front of $0.7300 after toying with the ceiling above $0.7700 as recently as November 10. If Aussie's correction began earlier than most of the other majors, it ought not to surprise if it ends first.  A move back below $.0.7380 would like signal a top is in place.   It ran into some selling before the weekend as it had approached the $0.7480 area, a retracement objective of the last leg down that began in the middle of the month from near $0.7580. If that $0.7480 is not a sufficient cap, look for more sellers to emerging near $0.7520.  

The January light sweet crude oil futures contract's 14% rally since November 14 appears to have run out of steam.  Optimism about the ability of OPEC and non-OPEC countries faded in recent sessions. The people playing up the likelihood of an agreement came from parties that might not participate in output cuts like Iran and Russia (reports suggested Iraq could participate).  

Then before the weekend, Saudi Arabia indicated that it would not attend a key meeting at the start of next week between OPEC and non-OPEC members amid disputes with Iran and Iraq over output cuts.   At the same time, reports suggest Libyan output is set to increase markedly, and several non-OPEC producers also appear likely to boost output. Late longs were peeled off as the price dropped 3.6%, retracing 50% of its rally since November 14.   A break of $47.50 may signal a move back to $45, if not lower.  

The 10-year US note yield poked briefly through 2.40% and pullback back toward 2.36% ahead of the weekend  Congestion is seen a little below 2.30%.  The December futures contract made a new low ahead of the weekend before reversing higher, leaving a potential bullish hammer in its wake. The 126-00 area offers initial resistance.  However, the technical indicators still point to weakness ahead.  Broad sideways consolidation over the next few sessions may resolve the situation.  

The equity bull market continued with the Dow Jones Industrials, NASDAQ and S&P 500 reaching new record highs before the weekend.  Indeed, after the Thanksgiving holiday, the S&P 500 gapped higher and closed on new record highs.  The gap is found between 2204.72 and 2206.27.  While the technical indicators are getting stretched, they do not appear to preclude additional gains.  Resistance is of little meaning with the index at record highs.   The gap may offer initial support, but better support is seen near 2190.  

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