Correction or Trend Change?

The US dollar closed lower against all the major currencies last week but the Japanese yen.  The Swiss franc's 0.25% gain was the smallest of the majors.  The move against the dollar was led by the Swedish krona, whose 2% gain was aided by a less dovish than expected central bank.  Other currencies, like the dollar bloc, which often trades better as risk appetites improve, also did well.  Sterling was lifted by the perceived likelihood that a no-deal Brexit had been averted.

The dollar fell against nearly all the emerging market currencies, including the Chinese yuan, which gained about 0.5%., and is the largest weekly advance since late June.   Even the beleaguered Argentine peso got into the action.  It ended a seven-week ~30% plunge with a 6.1% advance.    The Turkish lira gained 2.1% to break a 6%-slide over the previous three weeks. The central bank is expected to deliver another large rate cut on September 12.  The median estimate in the Bloomberg survey is for a 275 bp cut after a 425 bp cut in July.  With CPI running closer 15% and falling, we suspect the clearly politicized decision risks being larger than the consensus expects. 

The question facing many traders is whether last week's price action marks the end of some trends, or is it a technical correction.  Many see last month's soggy reception to the German auction of a zero-coupon 30-year bond, the pushback against new asset purchases by the ECB, the relatively disappointing US coupon sales, and the deluge of investment-grade bond sales as an indication that a bottom in yields is being forged.  Last week the Bank of Canada alongside Riksbank resisted the dovish slant of most of the other major central banks.

We think prudence and logic require that the price action is initially viewed as a correction.  It dovetails with our sense that the relief that some geopolitical developments did not deteriorate is fragile.  The lull after the latest round of US-China tariffs should not be confused with peace or a de-escalation.  It is almost as if after shooting oneself in the foot, we ask the neighbor if they have had enough.  We see little in the public space that suggests that either side's pain threshold has been reached.  And the US-Japanese trade deal is being rushed for later this month.  It wants to be officially excluded from any auto tariffs, which the US is still threatening for November.

Dollar Index:  The Dollar Index reached new highs since May 2017 on September 3 a little above 99.35 before reversing lower.  Follow-through selling over the next couple of days brought it to around 98.10 before consolidating ahead of the weekend.  It met the (61.8%) retracement (~98.00) of the last leg up that began on August 23.  It nicked the 20-day moving average but did not close below it and has not done so since August 23.   Initial resistance is seen around 98.60 and then 99.00. The MACDs and Slow Stochastics are rolling over.  The initial target if 98.00 is offered is the trendline off low set in late June.

Euro:  The euro reversed higher from new lows on September 3 and left a bullish hammer candlestick in its wake.   The hammer left formed on August 1led to about a 2.25-cent rally over four sessions.  This time the euro gained a more modest 1.5-cent.   It held resistance seen near the 20-day moving average and the (61.8%) retracement objective of the losses since August 26 ($1.1075-$1.1080).  The MACDs and Slow Stochastics have turned higher, and if the $1.1080 area can be overcome, there may be another important hurdle in the $1.1120-$1.1125 area.  The looming ECB meeting may dampen enthusiasm in the first part of next week.  In the somewhat larger picture, it may require a rally through the $1.1250 area to give some technical evidence of an important low.  As the euro recovered, implied volatility has fallen at a little below 5.60% it is below August's low.

Yen:  The dollar traded above JPY107 in the last two sessions for the first time since August 1.  It failed to close above it.  On an intraday basis, it reached a little past JPY107.20.  That was enough to poke through the upper Bollinger Band but still shy of the next resistance near JPY107.50.  The five-day moving average crossed above the 20-day for the first time in a month. The technicals allow for additional gains, but the air seems thin above JPY107.  Initial support may be around JPY106.30-JPY106.50.

Sterling:  All of the UK was worth about 1% more last week as sterling was bought as the threat of a no-deal Brexit receded.   It has risen in three of the past four weeks, its best showing in six months.  As Prime Minister Johnson was dealt one defeat after another sterling climbed through last month's highs to reach a little more than $1.2350.  It consolidated ahead of the weekend in a narrow range.  The Slow Stochastics look more constructive than the MACDs.  A move through $1.2370 would see as much as another cent advance.  On the downside, support is seen near $1.2200 and $1.2160.  After falling for 14 weeks through August 9 against the euro, sterling has climbed back for the past four weeks.  Its corrective bounce may have run its course, the ECB meeting may allow it to extend.

Canadian Dollar:  The US dollar's seven-week advance against the Canadian dollar ended with aplomb.  In three days, it met the (61.8%) retracement objective of the rally from the year's low in July ahead of the weekend near CAD1.3155.  Technically, it recorded a potential key reversal on the weekly bar charts by rising above the previous week's high and then closing below the previous week's low.  The five-day moving average crossed below the 20-day moving average for the first time since July 23.   We also note that the US premium over Canada to borrow two-year money has fallen to four basis points, the smallest in almost two years.  It had recorded the cyclical peak in March near 85 bp.  It is poised to become the high-interest rate country in the G-7, and still, about 13 bp of easing by year-end has been discounted (or about a 50% chance a 25 bp cut).

Australian Dollar:  While the Canadian dollar rallied a little more than 1% last week, the Australian dollar gained almost 1.7% and without the help of a less dovish central bank and a robust jobs report.  The Aussie rose for the first time in seven weeks and will take a four-day rally into the new week.  Last week's advance was the most since last September.   The technical indicators are trending up, and the five-day moving average moved above the 20-day moving average for the first time since late July.  The Aussie also posted a potential bullish key reversal on the weekly bar charts.  It approached the 50% retracement of the roughly four-cent slide in late July and early August near $0.6880.  Above there is $0.6925 and then the bigger $0.6980-$0.7000 cap.   A move back below the $0.6800-$0.6820 area would undercut the upside momentum,

Mexican Peso: The dollar's seven-week climb against the Mexican peso ended last week with a 2.65% decline, the largest in over a year.  This reflected the dollar's broad setback and the peso's function as a proxy for emerging markets.  The JP Morgan emerging market currency index rose (1.4%) last week, its first increase in eight weeks. Mexico's domestic economic developments seemed of marginal importance.  That may change in the week ahead, as soft inflation and weak industrial output likely fan expectations of a rate cut, for which the market seems roughly split over at the next Banixco meeting on September 26.  Last week, the dollar's August gains were more than halved (which would be ~MXN19.60 and actual low ahead of the weekend was almost MXN19.52).  The next retracement objective is near MXN19.45, and then there is the MXN19.30-MXN19.35 area that derives from a shelf from August and the 200-day moving average.   A move above MXN19.77 would signal a renewed dollar strength. 

Chinese Yuan:  The dollar eased a little more than 0.5% against the Chinese yuan last week.  The PBOC's fix was little changed.  What did change was the general dollar tone.  The market suspects that the upper end of the near-term range is in the CNY7.18-CNY7.20 area.  This begs the question of the lower end of the approved range.  The market may fish for it a bit.  We suspect it is around CNY7.10.  The cut in reserve requirements ahead of the weekend was modest (0.5%), though some country commercial banks will see get another 100 bp cut in two steps (mid-October and mid-November).  The timing of the reserve requirement reduction will help blunt the tax-date pressures.  The move also raises the likelihood that when the new Prime Loan Rate is set on September 20, another small cut is likely. 

Crude Oil:  The price of WTI for October delivery rose nearly 2.6% last week after rising a little more than 1.7% previous week.  It tested the August high near $58 a barrel on September 5 before pulling back below $55 briefly ahead of the weekend after the US reported a drop in inventories nearly twice as large as expected.  Since the end of May, US crude inventories have risen in only three weeks, and two were in the first part of August.  After the strong close at the end of last week, the technical indicators do not appear to block another test on $58.  However, the 200-day moving average (~$57) has held back gains, and even last week, it did not close above it.  The last time, it was violated on a closing basis was the July 1.  The lower end of the recent range is a little below $53. 

US Rates:  The US 10-year yield rose six basis points last week to 1.56%, ending a five-week drop that took the rate down almost 60 bp.  A near-term base has been carved near 1.40%.  It managed to finish above its 20-day moving average (by less than a basis point) for the first time since late July.  The December Treasury note futures contract closed strong and formed a potential hammer candlestick.  The 2-10 year yield curve was inverted in the last week of August and spent last week mostly with a positive slope, albeit slight.  We think it is best to consider this part of the curve flat.  The implied yield of the September fed funds futures contract rose half a basis point last week to 2.03%, while the implied yield of the October contract rose two basis points to 1.865%.  The CME tells us that this means little more than a 91% chance of a cut and a little more than an 8% chance that the Fed stands pat.  Bloomberg calculations see it as almost a 96% chance of a 25 bp cut and a little more than a 4% chance of a 50 bp move.  

S&P 500:  The benchmark spent August moving back and forth in a range of roughly 2820 to 2950.  The index gapped high to test the upper end of the range on September 4 and then gapped above 2950 on September 5 before consolidating ahead of the weekend.  While the momentum is strong, the gaps may have to be tested before the market is ready to make a fresh run at the record high (~3028).  The 1.8% rally after a 2.8% gain the previous week lifted the S&P 500 to test the upper Bollinger Band (~2980).  Support may be seen between 2938 and 2950.  

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