Currency Positioning and Technical Outlook: Dollar Weakness is Really Euro and Sterling Strength

The holiday-thinned activity may have distorted the price action, but the general theme that has emerged in recent weeks remains very much intact. The US dollar's weakness, which many observers and the media emphasize, is very narrow and largely confined to the euro and sterling (and a few currencies that move in their orbits).

Even in recent days, as the euro and sterling climbed to two-year high, the yen slumped to five-year lows, and Australian and Canadian dollars remain pinned near multi-year lows.  Eastern and central European currencies have been lifted against the dollar by the rising euro, but many of the larger accessible emerging market currencies, like the South African rand, the crisis-stricken Turkish lira, and Mexican peso have not performed well.   And over the past week, the Thai baht has lost almost as much as the Japanese yen.

It seems that the combination of the large current account surplus, aided by the re-balancing of the periphery, including Spain, portfolio capital inflows, and the ongoing de-leveraging of the financial sector is giving the euro greater legs than anticipated.  At the same time, despite the divergence in the trajectory of monetary policy, Dec Eurodollar-Euribor spread stands at an unimpressive 8 bp. Three-month Euribor was fixed higher than three-month Eurodollar (0.2735% vs 0.2466%).

The thin market conditions appear to have exacerbated the move that was already underway.  The move to almost $1.39 at the end of last week was exaggerated and some near-term backing and filling is likely.  Initial support is seen in the $1.3680-$1.3700 area and then $1.3600.   On the upside, there is increased focus on the trend line drawn off the record high in 2008 (~ $1.6040) and the May 2011 high (~$1.4940).   In early January near $1.4050.

Sterling has convincingly violated a similar trend line.  It is drawn off the August 2009 high (~$1.7045) and the April 2011 high (~$1.6750).  It was approached several times since, including in January, July and October 2013.  Before the weekend, it recorded its highest close in 2 1/2 years.  Any backing and filling should be limited to the $1.6300-area.  Assuming that sterling pushed through the $1.66, the next important technical target is near $1.6750.

The losses in the Dollar Index have been mitigated by the dollar's strength against the yen and Canadian dollar.  It rebounded quickly from the drop below the month's previous lows, leaving it stuck between the uptrend drawn off the October 25 low (~79.00) and the December 18 low (~79.80) and the downtrend line drawn off the November 12 and 21 highs (~81.45 and 81.30) and the December 20 high (a little above 0.8080).  These converging trend lines are found near 80.00 and 80.65 at on January 3.

If the euro and sterling's strength are a theme so is the yen's weakness, making it difficult, as we have noted in talking about the dollar in general.    The dollar pushed through the JPY105 level after breaking JPY104 in the immediate response to the Fed's tapering decision on December 18. The next important technical target comes near JPY110.

The euro has not looked back since breaking above JPY140 on December 6.  The next target is JPY150. Sterling surpassed JPY170 on the Fed's tapering and this area was tested as support before bouncing higher in recent days.  There is potential, from a technical point of view toward JPY180 and possibly JPY184.

The broadly sideways price action in the Australian dollar failed to improve the technical picture.  Its bounce in the early part of the last week stalled just ahead of the lower end technical resistance we noted in the $0.8970 area.  It can be expected to test the $0.8800 in the days ahead. The next major objective is near $0.8550.

After the yen and Australian dollar, the Canadian dollar has been the third worst performer against the dollar over here in Q4.  Over the past week, the Canadian dollar was weaker than the Aussie. We look for the greenback to convincingly rise through the CAD1.07 level.  The next immediate technical target is around CAD1.08 and we look for a move toward CAD1.12-CAD1.14 in the coming months.

For seven consecutive sessions through the end of last week, the dollar recorded a higher low against the Mexican peso.  Nevertheless, the broad trading range of MXN12.80-MXN13.10, identified last week, has remained largely intact.  Technical indicators are not generating strong signals presently, but if this analysis is accurate and there is some backing and filling technical action in the near-term, we suspect the dollar is more likely to ease toward the lower end of this narrow range.

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