Greenback Looks Vulnerable

Fed Chair Powell struck a responsive chord for investors by indicating that officials can be patient and can respond to changing economic dynamics.  Powell, who had been previously praised for his straight-talking manner, was able to ease angst among investors without negating the Fed's assessment that the economy is strong enough to allow the central bank to gradually hike rates and continue to reduce its balance sheet.  

The markets also respond to the economic data.  The yield on the 10-year note jumped 11 bp ahead of the weekend, the most since October 3 when Powell had noted that Fed policy was still accommodative and a long way from neutral.  The S&P 500 jumped 3.4%, which is a larger advance than any session last year, except for the day after Christmas when it rallied 5%.  The pessimism that had such a powerful grip that the investors had begun pricing in a cut in rates in H1 19.  This was taken back before the weekend, and the implied yield of the June Fed funds futures contract settled at 2.40%, the same as the current average effective rate (which is also the rate that the Fed pays interest on reserves).

The dollar was mostly softer last week, falling against most of the major currencies but the euro, and Swiss franc and Danish krone that move in its orbit.  The big development in the foreign exchange market was the dramatic surge in the yen, a powerful short squeeze ostensibly sparked by Japanese retail investors in holiday-thinned markets on January 3, but spilled over, causing collateral damage.  The "flash crash began with the dollar a little below JPY109.  It finished last week near JPY108.50, after spiking to around JPY104.85, according to Bloomberg.  

Dollar Index:  A marginal new high for the year was set on December 14 (~97.70).  Since then, it has trended lower to reach 95.65 on New Year's Day, which had not been seen since late October.  The technical indicators are mixed, and sentiment is poor.   The three-week losing streak is the longest since August.   If a sense of the impending crisis eases in the aftermath of the stronger US service PMI, the jobs data, and Powell's comments, the dollar may continue to move lower.  We see near-term downside risk toward 95.00-95.30.  

Euro: The economic and political news from Europe is not good.  The economy is slowing, and price pressures are falling.  The Yellow Vest demonstrations in France continue.  Spain's minority government is being handcuffed by parliament.  The risks of an election are rising.  Brexit uncertainties are as great as ever.  The single currency itself remains in a $1.13-$1.15 trading range that has prevailed since late October, with a few false breaks to the downside.  Both ends of the range were tested last week, and they held.  The 100-day moving average is found just inside the upper end of the range (~$1.1480), and the euro has not closed above in more than three months. On balance, the technical indicators favor the upside.   A move above $1.1500 would likely trigger stops, but above $1.1520, and could likely signal an advance that could carry it another cent.   

Yen:  Although flash crashes may have become more common, it is difficult to draw many conclusions from limited occurrences in the foreign exchange market.  The dollar appears to have rebounded quicker than other cases, but it still needs to resurface above JPY109 to confirm it.  Even then, it would seem weak below JPY110, the old shelf.  Less volatile equities and higher US yields may provide the fundamental impetus for a move the technical indicators suggest is likely.  The lack of BOJ intervention make speak to both the acceptance of the new best practices of limited intervention and inability to react quick enough, even if it wanted.  That said, the OECD's model puts the yen about 9% below fair value. 

Sterling: Amid the disruptions on January 3, sterling fell to a low since April 2017 near $1.2440.  It had traded as high as $1.2815 on New Year's Eve.  Technically, sterling looks poised to re-challenge the high, although it has not closed above $1.2800 since late November.  There may be a cent potential on a break, which is also where the 100-day moving average is found and the retracement objective (61.8%) of the leg lower than began in early November.  Separately, the price action reinforces the technical significance of the GBP0.9100 area for the euro.  Support is seen near GBP0.8880.  

Canadian Dollar: The US dollar reversed lower on January 2 and did not look back, through the flash crash and the equity market and oil gyrations.  The US dollar fell nearly 2% against the Canadian dollar last week, for only the second weekly loss since the end of September.  The sell-off is was sufficient to push the five-day moving averable below the 20-day moving average for the first time since early October.  The US dollar is testing a trend line from the late September and November lows that comes in near CAD1.3360 at the start of the new week.  Additional support is seen near CAD1.3330.  The move looks exaggerated, and we suspect a dovish tone from the Bank of Canada when it meets on January 9. 

Australian Dollar:   The flash crash saw the Aussie drop from just below $0.7000 to about $0.6740 according to Bloomberg, and then it proceeded to rally strongly to close higher on January 3 and follow-through buying on January 4 brought it above $0.7100 and the 20-day moving average in a month.  The $0.7145 area corresponds to a (61.8%) retracement objective of December's slide that began near $0.7400.  The technicals look more constructive than the fundamentals, and a move toward $0.7200 cannot be ruled out.  

Oil:    Front-month Brent and WTI oil futures contracts are starting to the new week with a five-day rally in tow.  The key to the February WTI contract is the $50 mark.  A move above it would complete a bottoming pattern that projects into the $57 area.   The five-day moving average has been below the 20-day moving average since mid-October.  It could cross above toward the end of this week, with a little luck.  The drop in price will curb new investment, while the Saudi's seem intent on fulfilling its commitment despite the risk of being targeted with new tweets from Trump.  

US Rates: The latest forecasts by the Fed indicated that officials could be patient and raise rates twice this year after four times last year.   No fewer than seven Fed officials, including the Troika of Powell, Clarida, and Williams, the leadership, speak in the days ahead.  When they say patience now, they appear to be signaling that it will not raise rates in March.  The Fed funds futures strip reflects a market that thinks the Fed cycle is complete.   We are not convinced that the Fed agrees with that assessment.  While officials are willing to reconsider the unwinding of the balance sheet, we suspect there will be material change until later this year.  We would pencil in an end of the balance sheet unwind this year or early next year.  The drop in US yields leaves bonds rich, and this could impact the participation in the upcoming auctions.  The March note futures looks set to fall toward 121-00, which would put the generic yield closer to 2.80%.  

S&P 500: The benchmark closed at its best level in ten sessions ahead of the weekend, encouraged ostensibly by the economic data and Powell's comments.  The idea that Powell signaled that the Fed may not raise rates is difficult to reconcile with the 2.5 bp increase in the implied yield of the April Fed funds futures contract and an 11 bp increase in the yield of the US two-year note.  There is scope for additional recovery gains in the S&P 500.  The 2550 area offers the initial hurdle, but above there, gains into the 2600-2625 area looks reasonable.  On the downside, a break of 2500 would likely be the first sign of a return toward 2440, the low from last week.  

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