Beware of Corrective Forces

The US dollar rose against most of the major currencies over the past week. The main exception was the Japanese yen. The combination of the decline in US yields to new 12-month lows, the drop in equities (S&P 500 reached 3-month lows, and the heightened geopolitical anxiety appears to have prompted a further reduction of short yen positions.

That said, the JPY101-JPY103 range that has confined the dollar for the better part of the past four months remains intact. We see little from the technical or fundamental vantage point that suggests a break of this range in the coming week. However, view is partly predicated on ideas that US 10-year premium over Japan will not dip below the low for the year set in late May near 185 bp.

Over the medium term we remain bearish the euro, we are cautious about pressing the case now. There are bullish divergences that have emerged in the RSI. Essentially, the RSI did not confirm the new muli-month low set at mid-week near $1.3333. A similar divergence is seen in the Stochastics, which have turned up. The MACDs are poised to turn higher as well.

The euro's decline from the early July test on $1.37 to the recent low looks to have likely completed a move. The first target is $1.3450-75 and then $1.3500-20. This is not a recommendation to buy the euro. Rather, it is a message of caution against building short exposure at these levels. We are identifying better opportunities to sell it.

The technical signals are similar for the Swiss franc, and we see it as confirming our more constructive outlook of the euro. The dollar-bearish divergence between prices and the technical indicators can be found in both the RSI and MACDs while the Stochastics have turned down (for the dollar). Since the July 1 low (~CHF0.8850) it appears the greenback appears to have carved out a five-leg advance (euro has a five-leg decline) which appears to have been completed. The first target is CHF0.9015-30 and then CHF0.8955-85.

Sterling continues to trade heavily. Stale longs (against the dollar, euro and yen) are under pressure. Its poor close before the weekend and the state of the technical indicators, warn of the risk of additional losses. We look for one more leg down before a bottom can be carved out. Potential extends to $1.6700-30. On the upside, a move above $1.6900 would suggest the down move has been exhausted.

The Canadian dollar was the weakest of the major currencies last week, slipping 0.5% against the greenback. The disappointing jobs data reinforced the CAD1.09 support area for the US dollar. The technical indicators are consistent with additional near-term weakness in the Canadian dollar. The initial target is in the CAD1.1030-50 area, which corresponds a retracement objective and the US dollar highs set in early April.

The technical and fundamental backdrop for the Australian dollar have deteriorated. The Australian dollar fell to a two-month low in response to the central bank cutting it growth and inflation forecasts. It approached the lower end of its four-month trading range near $0.9200. It recovered smartly and closed firmly, leaving a modest bullish divergence in the RSI in its wake. The MACDs have not turned, though the Stochastics are turning higher. Initial potential extends toward $0.9325, and then the $0.9360 area.

The US dollar rose to five-month highs against the Mexican peso, reaching almost MXN13.3360 at midweek. This seems to have exhausted the profit-taking and hedging operations, leaving the dollar vulnerable for a setback. We initially target MXN13.15 and then MXN13.10.

We have been negative the S&P 500 since the gap lower opening on July 25 (after the record high was posted the preceding day). Now we warn of the risk of a near-term bounce. The outside down day (traded on both sides of the prior day's range and closed below the prior day's low) on Thursday did not spur follow through selling before the weekend. This loss of the downside momentum warns of the risk of a near-term bounce. A move above 1935 signals potential toward 1945.

A bounce in US shares may help push US 10-year yields back into the old range that it appeared to break out of before the weekend, when it fell to 2.35%. The September 10-year bond futures spent nearly the entire session before the weekend above the upper Bollinger Band. That band is set at 2 standard deviations above (and below) the 20-day moving average. For what appears to be the first time in years, the note futures actually traded move than 3 standard deviations above its 20-day moving average. Even though the other technical indicators do not suggest a top is necessarily in place, we suggest caution is in order.

Lastly, we note that the CRB index slipped to new (marginal) six-month lows, after nesting for several sessions. It brings the decline from the late June high to almost 7%. Technical indicators suggest new lows likely in the days ahead. The immediate target is an old gap from mid-February that has not been filled. It is found between 290.24 and 290.60.

Observations based on the speculative positioning in the futures market:

1. There were four significant position adjustments (more than 10k contracts) in the reporting week ending August 5. Speculators continued to amass a large gross short euro position. It jumped 19.3k contracts to 183.9k. This follows a 17.7k rise the previous week. The record that was set two years ago was near 250k contracts short. Speculators also continued to build a short yen position. It rose 24.4k contracts to 105.3k. The gross short yen position has risen by 50% over the past three weeks, and is the largest since the end of April. The other two significant gross position adjustments were in the Mexican peso. The gross long speculative peso was cut by 23k to 77.5k contracts. The gross short position nearly doubled to 45.1k contracts by growing 21.7k contracts.

2. There has been a marked increased in activity in recent weeks. The net short euro positions of 129k contracts has doubled since early July and has grown four-fold since early June. The net short yen position of 95.4k contracts has nearly doubled since the end of July. The net long sterling position was halved in the most recent reporting period to 12.1k contracts. It stood near 56k in late July. The gross long Australian dollar position of 33.3k contracts is the smallest since late June. The net long peso position was more than halved to 32.4k contracts.

3. The net short 10-year Treasury position jumped to 45.1k contracts from 5.8k the prior week. This was a function of a 20.4k contract liquidation of gross long positions and a nearly 19k contract increase in the gross short position.

week ending August 5		Commitment of Traders

	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-129.0	-108.0	55.2	-1.4	183.9	19.3
Yen	-95.4	-73.1	9.9	2.1	105.3	24.4
Sterling	12.1	24.9	66.4	-8.9	54.3	3.9
Swiss Franc	-18.9	-11.8	9.2	0.6	28.1	7.7
C$	21.5	22.7	48.9	-7.5	27.5	-6.3
A$	33.3	39.6	60.9	-8.5	27.6	-2.2
Mexican Peso	32.4	77.1	77.5	-23.0	45.1	21.7