The Rubber Band Snaps Back: Dollar Correction Begun

An exogenous shock disrupts relationships and patterns.  It may be a useful reminder the correlation does not mean 100% co-movement.  The strongest currency in the world last week was the Swiss franc, a safe-haven that rose by almost 0.5%.  The weakest major currency, and third weakest overall, was the Japanese yen, also a leading safe-haven.  The second strongest currency was the Canadian dollar.  Our reading of the charts gave us the most confidence in it.  Its modest 0.35% gain contrasts with the performance of the other dollar-bloc currencies that fell by around 1.25%.  

The dollar raced higher for most of the week.  It was if, in this giant card game, the coronavirus provided an opportunity to change cards.  And after a quick review, investors doubled up on the long US card.  The sense of a new divergence lifts the dollar.  New highs since April 2017 were seen against the euro.  The US dollar rose to fresh 10-year highs against the Australian dollar.  The dollar visited levels not seen since 2001 against the Norwegian krone.  On February 19, the dollar rose a little more than 1.3% against the yen, reaching a seven-month high.  The single-day advance was larger than any weekly gain since the middle of July 2018.  

The dollar's gains came to a halt as the fuel for the rally, the economic divergence, was called into questioned into question, ironically, by the diverging flash PMI reports.  The somewhat better than expected EMU composite helped stabilize the euro, but it was not until the weaker than expected US report got the ball rolling.  This looks like the end to this leg up for the US dollar and barring new shocks, a consolidative/corrective phase may be at hand.  

Dollar Index:  The century level was almost seen as the rally was extended to fresh highs since Q2 17.  The loss ahead of the weekend was not signaled by any reversal pattern or drop in the momentum indicators.  Nevertheless, the impulsive nature of the decline, with a modification of the macro narrative, and the turning lowe the said momentum indicators warn that additional near-term losses are likely.  With the conservative assumption that the move that is being correct is this month's, not the December 31 low, the first retracement objective is near 98.95. More significant support is in the 98.60 area, which houses a retracement objective (50% around and the 20-day moving average).  A move back above 99.60 would call this more bearish into question.  

Euro:  The euro recorded a single advancing session in the first two weeks of February, and even before the weekend's punctuation, it had posted two gains last week.  The roughly 0.65% rally ahead of the weekend was the largest of the year so far.  A shelf has been carved that extends to around $1.0780.  Both the MACD and Slow Stochastics are turning higher from over-extended territory.  Initially, initial potential may extend back into $1.0935-$1.0975.

Japanese Yen:   The dollar exploded higher against the yen in the middle of last week,  jumping almost 1.4% to a seven-month high near JPY111.60.  Follow-through buying the next day lifted it closer to JPY112.25. It broke through a multi-year downtrend that is found near JPY110.  If the high is in place, then the conservative assumption is that last week's move from about JPY109.65 is being corrected.  A break of JPY110.65 would signal a deterioration of the dollar's technical tone.  

British Pound:  Relatively firm UK data and fading ideas of a rate cut might have been more supportive for sterling if it had not been for the pesky dollar and Brexit, the other gift that keeps on giving.  It had begun the week with a four-day slide reversing in full the previous week's five-day rise.  The streak was snapped ahead of the weekend with around a 0.65% rally that took it back to ~$1.2980. A move above $1.30 would be helpful, but a foothold above $1.3070 would be significant.  It is the recent high, and it is the neckline of a potential double bottom ($1.2850-$1.2870) that would project toward $1.3250-$1.3270.  

Canadian Dollar:  A favorable outlook for the Canadian dollar was our highest confidence call last week.  It was second among the majors (behind the Swiss franc), with about 0.25% gain against the US dollar.  One-week volatility jumped, and that absorbed the risk-off shock, not the exchange rate so much.  The US dollar slipped to a new low for the month near CAD1.3200 ahead of the weekend.  Even though the US dollar failed to close below its 200-day moving average (~CAD1.3215), the technical indicators still point to greater downside potential.  A break of CAD1.3185 could target the CAD1.3100 area again.  

Australian Dollar:  After being sold to new decade-lows below $0.6600 in Asia ahead of the weekend, the Aussie reversed higher amid broad US dollar weakness. It reached almost $0.6640 before consolidating.  After unable to sustain upticks for the past six sessions, the Aussie's gains of less than 0.2% seemed begrudging.  The technical indicators are not showing that a bottom is in place. An increase above the $0.6660 may help stabilize the tone, but to be anything meaningful, a convincing move above $0.6700 is needed.   

Mexican Peso:  The peso had a bad week, but it ended on a good note.  The US pushed above MXN19.00 ahead of the weekend, which it has done a handful of times since breaking below it in the middle of last December.  It has, however, consistently failed to close above it, and February 21 was no exception.  Some of the carry-trades in which the euro and/or Swiss franc are used to fund a long peso/cetes position unwound.  Consider that the Swiss franc appreciated by 2.25% against the Mexican peso last week.  The peso is bought to invest in short-term peso bills that yield close to 7% annualized (3-month cetes).  This is why the carry trade has been described as picking up pennies in front of a steam roller.   

Chinese Yuan:  The dollar rose in the past four sessions against the yuan, and stopping ahead of the weekend a little short of the CNY7.05 target we suggested (at around CNY7.0425).  The PBOC did set the dollar's reference rate higher several times last week than the bank models suggested, which appears to signal a comfort level with a weaker yuan.  With the shocks China is facing, and the easing of monetary and easier fiscal policies, a weaker currency would be the result even for less managed currencies.  Chinese officials would have political cover, too, if it wanted to pursue a weaker yuan.  The US played its currency manipulation card last year and took it back.  Playing it again now would weaken its value.  With the dollar pulling back ahead of the weekend in the North American session, the yuan may begin off the new week on a firmer tone.  The dollar may consolidate and straddle the CNY7.0 area.  

Gold:  The increasingly precious metal sparkled last week, gaining 3.75% or almost $60.  It has rallied alongside the dollar, though some suggest it is an alternative.  It was the biggest advance though came before the weekend (~1.5%), as the dollar fell.   Since gold broke above $1400, we have suggested a medium-term target near $1700, which not seems somewhat cautious.  It reached $1800 in 2008 and may offer a stronger hurdle.  However, the fact that gold finished above its upper Bollinger Band for the fourth consecutive session is cautionary even though the Slow Stochastic and MACD are still reflecting the upside momentum.  Initial support may be seen in the $1620-$1630 area.  

Oil:  We are tracking a potential double bottom in April WTI that we identified last week, with a measuring objective near $55.50. It peaked on February 20, around $54.65, and retraced a little more than a third of its rally and fell to about $52.65.  However, it recovered by nearly a dollar by the end of the session.   This leaves it in a fine position to continue the recovery in the coming days.  The five-day moving average has crossed above the 20-day for the first time since the second week of January.  

US Rates:  Investors bid up US debt securities pushing yields to incredibly low levels.  The 30-year offers a record low yield a little more than 1.90%.  The 10-year yield dropped below 1.45%, seen last September.  The lion's share of the 11-12 decline in these yields can be accounted for the shift in the outlook for Fed policy.  Specifically, the implied yield of the December 2020 fed funds futures contract fell nine basis points.  It now discounts 44 bp of easing this year.  Nary a Fed official has shown any indication of recognizing the wisdom of crowds on this. Still, if the flash PMI is any indication and Apple's earnings warning is any indication, they will come around. 

S&P 500:  The S&P 500 gapped higher at mid-week and set new record highs before selling off the following day and then again ahead of the weekend.  That mid-week gap may have been exhaustion.  The MACD did not confirm the record high and is leaving a potential bearish divergence, while the Slow Stochastic has flatlined in overextended territory.   The S&P has spent around half a dozen sessions below its 20-day moving average in the past four months.  Perhaps that is one way to quantify buying on a pullback.  That moving average is found near 3323 to start the new week, and there is an old gap roughly 3306 and 3317 whose vacuum may attract.   If this area does not hold, consider that the benchmark finished last month near 3225.50.  

Disclaimer