Currency Positioning and Technical Outlook: Dollar Heaviness may Continue

The US dollar was broadly mixed last week.  Its gains were strongest against the New Zealand dollar and Australian dollars (~3.6% and 1.70% respectively).  The Norwegian krone and Canadian dollar lost almost as much ground as the Aussie. 

On the other hand, Swedish krona and Swiss franc were the strongest currencies (~0.5%), owing in part to a pre-weekend recovery, helped in part by unexpectedly poor July US new home sales (fell 13.4% compared with expectations of a 2% decline and the June pace was more than halved to 3.6% from 8.3%).  The subsequent US Treasury rally, that saw 10-year yields fall 6 bp, helped knock the wind out of the dollar sales against the yen too; against which it had traded above JPY99 for the first time since the beginning of the month.  

Although the UK recovery was confirmed as Q2 GDP was revised up and evidence suggest the pace of expansion has not slackened, sterling drew little succor.  Sterling peaked mid-week above $1.57 and slipped lower in the second half of the week, giving back every thing it gained in the first part plus some and finished the week off by about 0.4%. 

Broadly speaking,  we still see some near-term downside risks for the US dollar.  We note that the US-German 2-year interest rate differential finished last week near 9 bp, the lowest in two months. More importantly, with Fed tapering so widely expected, and arguably overly discounted,   the dollar is particularly vulnerable to disappointing data, or anything that encourages the market to scale back its expectations. 

Technically, the Dollar Index looks soft.  It flirted with the 20-day moving average on an intraday basis a few times, but has failed to close above it.  A move back below 81.00 would likely confirm a near-term top is place.  There is a short-term trend line, drawn off the August 2, 15 and 22-23 highs which needs to be convincingly violated to lift the tone.  

Most of the euro's activity is likely to take place in a $1.3315-$1.3420 range, within the broader $1.33-$1.35 range.  The euro looks poised to recover against sterling in the days ahead, having carved out a bottom over the past couple of weeks. This dovetails with the modest deterioration of sterling's technical tone.  Cable fell to seven-day lows before the weekend.  However, having approached a retracement objective near $1.5540, and the bank holiday in the UK on Monday, a quiet start to the week may be conducive to some consolidation.  

The key technical consideration for the dollar-yen pair is a downtrend line drawn off the late May and early July highs.  Depending on precisely how one draws the trend line, it is found near JPY99.60 (our preferred view) or JPY99.15. The dollar did rise to a 15-day high before the weekend and technical indicators we look at remain constructive for the dollar.  However, as the housing data showed, the  yen draws support from soft or disappointing US data.  

Although we think the market had gone too far it taking back another RBA rate this year, we had been looking for a technical bounce in the Australian dollar and have suggested cross positions against the yen and Canadian dollar.  From Friday's close to Friday's close the Aussie was little changed against the Canadian dollar and about 0.5% softer against the yen.  In the period, ahead a long Australian dollar position against the US dollar looks to be a better risk-reward proposition.  

After a series of weak data that weighed on the Canadian dollar, pushing it to its lowest level since early July, it staged an impressive recovery before the weekend, suggesting that a near-term low was recorded. In candlestick terms, a shooting star looks to have been formed.  That suggests the US dollar can ease back toward CAD1.04.   

The Mexican peso staged a strong recovery in the second half of last week.  The US dollar peaked near MXN 13.31 on Thursday and finished the week near MXN12.96.  Poor GDP and retail sales data took a toll and boosted speculation that the central bank could cut rates in the coming months.  However, the peso suffered amid the rout of emerging markets more generally.  The fragile stability seen in many, if not most, emerging market currencies late last week helped fuel the peso's recovery.  The test of the peso bull is if they can push the US dollar back below MXN12.80-MXN12.83.  

More strategically, in contrast with the tactical outlook discussed here, the recent price action has created an opportunity to participate in what we have identified as the "trade of the year" (since December 2012) and that is long the peso against the Australian dollar.  This month, the Australian dollar has risen from MXN11.21 to almost MXN11.93-95, where it put in a double top.  The measuring objective of the double top pattern is near MXN11.45.   Over the longer term, we expect a move through MXN11.00.  

Observations on the speculative positioning in the CME currency futures:

1.  It was another reporting week of mostly minor position adjustments.  The notable exception was the 23.1k jump in gross long euro positions.  All the other currency futures, save the Mexican peso, saw an increase in gross longs.  The increase in the euro gross longs was bigger than all the others combined.  Ten of the 14 gross positions we track changed by less than 5k contracts.  The net Canadian and Australian dollar positions and the Mexican peso changed by less than 1k contracts.

2.  The net long euro positioned more than doubled in the latest reporting period.  At 36.7k contracts, it is approaching the largest this year, which was set in February with almost 38k contracts.  The gross long position is the largest in nearly two years.  It has more than doubled from 52.2k contracts in early July.

3.  That is perhaps the most remarkable aspect of the euro positioning.  The euro's advance has been more a function of new longs being established than shorts being cut.  Since early July, the gross longs have grown by more than 60k contracts, while about 17k short contracts have been covered.

4.  In contrast, consider that gross short speculative sterling positions have been almost halved since peaking in late May near 111k contracts, while the gross long position bottomed in late July and has risen by less than 10 contracts since then.

5.  The net short speculative yen position has been trimmed for four consecutive weeks.  Still, the short yen position, both gross and net, is the largest among the currency futures we track.  

  

week ending Aug 20		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	36.7	16.1	113.1	23.1	76.3	2.4
Yen	-71.7	-74.5	19.7	2.3	91.4	-0.4
Sterling	-39.5	-46.5	26.9	4.7	66.5	-2.3
Swiss Franc	0.3	2.1	12.1	1.4	11.8	3.3
C$	-9.5	-9.1	26.6	4.8	36.1	5.3
A$	-63.2	-62.7	13.7	1.1	76.9	1.5
Mexican Peso	36.1	36.3	61.2	-5.7	25.1	-5.5