Currency Positioning and Technical Outlook: Dollar Rides High

Fundamental and technical considerations are aligned in favor of the US dollar.  The latest string of economic data, including the June employment report, is strengthening the market's conviction that the Federal Reserve will begin tapering its long-term asset purchases later this year and raise the Fed funds target by the end of next year.  

At the same time, the other major central banks are moving in the opposite direction.  The Bank of England issued a mild protest to the rise in UK rates.  The ECB more explicitly pre-committed to low rates for an extended period.  The Bank of Japan is only a few months into its QE, and while deflation is indeed being arrested, the 2% inflation target is remains a long distance off.  

The incentives for unwinding the structural short-dollar trade remains intact.  Emerging markets were among the major beneficiaries of the trade and remain vulnerable to the reversal.   Thinner currencies, even among the majors, like the Swedish krona and Norwegian krone, are also typically vulnerable to such position adjusting as well.  

The Dollar Index made new three year highs before the weekend and after the employment data.  Although it is flirting with the top of its Bollinger Band, there is no compelling sign that the move is exhausted.  It has rallied over 5% off the low on June 19, when it recorded a key upside reversal.  Our next target is the downtrend line drawn off 2009 and 2010 highs and comes in near 86.00.   

The euro has taken out the trend line objective we have been highlighting that came in near $1.2850. That area, and perhaps extending toward $1.2900 may offer fresh selling opportunities on corrective upticks.   Our next target is the $1.2680-$1.2750 area.  The euro-dollar exchange rate continues to track the US-German 2-year rate differential.  That spread has widened sharply from about 8 bp on June 20 to nearly 29 bp before the weekend, a new high for the year.  

The dollar looks poised to advance further against the yen in the near-term.  We look for JPY102.50 on its way to retest the recent high near JPY103.75.  We envision buyers on dips to emerge near par.  For this pair we find the 10-year interest rate differential more useful.   The US offered 105 bp more than Japan in late May and this increased by roughly 50 bp in response Bernanke's comments in late June and another 30 bp since; finishing last week at 186 bp, a two-year high.  

Sterling shed about 4.5 cents in the last two sessions on a combination 1-2 punch from the BOE's Carney and the better US jobs data.   The year's low, set in mid-March near $1.4830, may not offer much support.  We expect sterling to continue to work its way lower and there seems to be little in the way of substantive technical support until closer to $1.45, which will bring the post-Lehman $1.4230 low into view.  

The Swiss franc's correlation with the euro has lessened and its correlation with the yen has increased (60-day percent change basis).  This may be an important and early insight in the evolution of funding currencies. The franc and yen may replace the dollar for some participants in some market segments.  Technically, our next objective is near CHF0.9800-CHF0.9840 for the dollar.  Support is likely found ahead of CHF0.9530.

This environment is not good for the dollar-bloc, which had been the market's darlings for much of the post-Lehman period.  Both the Canadian and Australian dollar recorded new lows for the year last week and the adjustment is not over.  The next technical target for the Australian dollar is in the $0.8980-$0.9000 area.  The next target for the US dollar is in the CAD1.0660-80 area that corresponds to the highs from 2011 and H2 2010.  For the Aussie, corrective upticks will likely be limited now to the $0.9180-$0.9200 band, while US dollar slippage to CAD1.05 will likely be bought.  

The dollar did fall toward our secondary target near MXN12.80 before the US employment report.  The sharp sell-off in US Treasuries proved too much for the peso and Mexican bonds and equities.  Here the market positioning and technical story overwhelm the constructive fundamental picture.   The near-term risk extends toward MXN13.15 and MXN13.22.  The price action reinforces the significance of the MXN12.80 support area for the US dollar.    

We note that on occasion some observers will try to spin the peso as a petro-currency, and with the rise in oil prices (14-month high before the weekend), it may be cited.  Our work shows that the correlation between the peso and front month crude oil futures contract on both a 30- and 60-day rolling basis, among the lowest of thus far this year (0.20 and 0.26 respectively).   

Due to the holiday, the CFTC Commitment of Traders report of speculative positioning in the futures market has been delayed.