Is this the Price Signal We have been Waiting For ?

The dollar is finding firmer footing today. It does not appear that it is in response to any fresh fundamental development.  That the Slovakian Prime Minister sees a 50/50 chance of EMU collapsing is hardly significant and matches up well with what some predictive markets see by the end of next year.   

The dollar rally began at the tail end of the European session after it had been under some mild pressure earlier. This strikes us as important.  The most compelling explanation is that it is position squaring, and in the current context, that means covering short dollar positions, ahead of Bernanke's much awaited Jackson Hole speech tomorrow.

In recent days, many participants appear to have come over to our thinking that Bernanke is not (and cannot) tip his hand at Jackson Hole as he did in 2010.  A broad array of economic and financial sector data were in considerably poorer shape then.  The economic and financial conditions are not nearly as  poor now.  The economy is limping along and, if any thing, the composition of the revised Q2 growth suggests a more positive base for Q3 growth and the 0.4% rise in July personal consumption expenditures is more than in cumulative monthly rise in Q2.  

The key is the next national jobs report due a week from tomorrow.  We note that the Bloomberg consensus has risen over the past few days to now stand at about 128k gain for private sector payrolls, up from 91k at the end of last week.  The four-week moving average of the weekly initial jobless claims has shown minor improvement (-6k) from the July survey week, the longer reporting period, and general firmer tone to the August economic data gives us no reason to revise down our expectation that roughly the same number of net private sector jobs were created in August as were in July (172k).

That said, there is little doubt that key Fed officials want to do provide more support for the economy.  However, more support for the economy and asset purchases are not necessarily the same thing.   On balance we expect the Fed to tweak its economic assessment and shift its guidance for how long rates may remain low for into 2015.  This coupled with the ongoing Operation Twist and, from he Fed's point of view, the existing stock of it holdings, should continue to provide support for the economy.  

Yet, we would not read too much into the euro's decline here today, though it could be the beginning of  the signal we are looking for.   Contacts report light activity, dominated by stops, rather than new positioning.  The euro looks likely to hold above the low for the week seen on Tuesday near $1.2465.   The euro, shied away from last week's high near $1.2590, now is likely to see new offers in front of the $1.2520-40 area.  

However, more generally the price action is consistent with what we are looking for, namely that the Australian dollar and British pound to provide lead signals.   The Aussie has fallen to just above $1.03, for its lowest level since July 26.  While recognizing that the Aussie had turned, we thought that perhaps on the back of a potential reversal in the Shanghai Composite, but alas the Shanghai Composite has made new multi-year lows today, before recovering a bit to close just above Wednesday's lows.  The steady flow of "resource peak prices" and the continued fall in iron ore prices appears to be forcing position adjusting.  Note that latest Commitment of Traders report (new one tomorrow) showed a record gross long Aussie position at the IMM (127.5k contracts).  

We had also looked for sterling to recover from the $1.5755 low seen on Tuesday to re-challenge the $1.5910 high seen last week.  We had anticipated a failure there.  Today's run to $1.5875 and the subsequent sell-off seems to fit our scenario.   A break now of the $1.5755 area would confirm the break of the month-long uptrend in sterling and lend credence to out view that the position adjustment move that has largely characterized the month of August is over or nearly so.  

The Canadian dollar, which has been particularly frustrating for us, appears to be breaking down as well.  The US dollar has recorded what appears to be a double bottom at CAD0.9843 on both August 21 and August 28.  A move now above CAD0.9950 would confirm it and suggest a minimum measuring objective of near CAD$1.0050.  

The dollar is in a 25 tick range against the yen today and less than a 40 tick range for the week.  It remains uninspiring against the dollar, but by implication stronger on the crosses.  

Our conclusion is that:

1.  The price action is consistent with out broad views, believing advance in the foreign currencies seen over the past month is over or nearly so.  

2.  The Australian dollar and sterling had appeared to be among the strongest the early stages of the move are reversing and the may again prove to a leading indicator of the general dollar direction.  

3.  The Canadian dollar is also showing some signs of fatigue.  

4.  The technical condition of the euro has weakened and we would be inclined to sell the next bounce, which we suspect could be back into the $1.2520-40 area.  

5.  We do not expect Bernanke to reveal what particular policy option the FOMC is likely to adopt next month.  We expected an appraisal of different options and some recognition of the limits of monetary policy.