Pause in US Dollar Rally

The US dollar had looked like it was finally finding traction. The euro was at its lowest level since last November. Sterling, which had been a market darling, was pushed through its 100-day moving average for the first time since last August, falling about 2.25% since mid-July. The dollar pushed through JPY103 to trade at its best level since April. The Australian and Canadian dollars retreated to their lows from early June.

A critical consideration behind the dollar's advance was that the Fed's mandate of full employment and price stability were being approached more rapidly than many, including Fed officials had anticipated. The recent data prompted spurred speculation of a more hawkish Yellen at the Jackson Hole confab late this month and increased risk that that the first rate hike is delivered earlier (~Q1 15) rather than H2 15.

However, the July employment data did not confirm an acceleration of the economy. While overall job growth was in excess of 200k for the sixth month, it was flattered by government jobs. The private sector added the least amount of jobs since January. More telling for the Federal Reserve than the tick up in the unemployment rate was the fact that hourly earnings were flat. In the FOMC statement, the Fed recognized the downside risks to inflation had been reduced, but still highlighted the "significant" slack in the labor market. There seemed little in July employment report to change their minds.

The July jobs data stopped the dollar's rally in its tracks. It now appears poised to consolidate its recent gains, and that consolidation phase will translate into a somewhat weaker greenback. The Dollar Index rallied from 79.74 to 81.57 in July. The RSI and Stochastics have turned down, though the MACDs haven't. The downside target is 80.60-80.95.

The speculative market has amassed a large short euro position. The euro fell from $1.37 at the start of July to just below $1.3370 on July 30. The RSI has turned up, and the MACDs look poised to cross over the next couple of sessions. The slow Stochastics are also about to turn higher. Although the initial retracement objective comes in near $1.3470, we suspect the bottom of the old $1.35-$1.37 range is more significant. A break of the $1.3365 area would signal a new leg down, with the initial target near $1.3230.

In the second half of last week, the dollar traded a little above JPY103, which is the upper end of the greenback's three-month trading range. It failed to close above that threshold and appears likely to consolidate, with initial support near JPY102.35 and then JPY102.00. The yen did not appear to respond much to the equity market swoon, but does still seem to be responsive to US yields.

The jump in the 10-year yield from 2.45% to above 2.60% supported the US dollar, but the dramatic loss on July 31, followed by the disappointing employment report saw US yields pullback to 2.50%. The dollar-yen exchange rate followed suit. Yields are likely to consolidate in the week ahead.

Whereas the euro's decline was characterized by the accumulation of shorts, sterling's fall has been driven by long liquidation. Short-covering of the euro against sterling prevented cable from finding much traction in the otherwise softer US dollar environment post-jobs and pre-weekend. While the technical indicators show risk of additional losses, the sterling finished the week below the lower Bollinger Band (~$1.6860, which corresponds to the 100-day moving average), warning the short-term market may be over-extended. The $1.6910-30 area may cap upticks. Given that the economic data appears to be moderating, and the approaching Scottish referendum, new buyers may be deterred. A break of $1.68 could spur another cent decline initially.

The dollar-bloc currencies stabilized before the weekend, but both the Australian and Canadian dollars were the poorest performers of the week, losing almost 1% against the US dollar. The Reserve Bank of Australia meets in the week ahead, and while no change in policy is widely anticipated, given the weakness in building approvals and terms of trade (import/export prices), the risk is the RBA tries talking down the currency, which even is about the 100-day moving average on a trade-weighted basis.

The RBA will have two such opportunities next week: The central bank meeting (Aug 5) and the monetary policy statement (Aug 7). That said, it is an important week for Australian economic data. The calendar includes retail sales, trade and employment. Initial resistance is seen near $0.9350. The bottom of the four-month trading range is $0.9200, which is just above the 200-day moving average (~$0.9185).

There is no compelling technical sign that the US dollar has topped out against the Canadian dollar, though by trading through the upper Bollinger Band, it appears stretched. The greenback approach the June highs near CAD1.0960. A break of its signals CAD1.1030-50. Initial support is pegged near CAD1.0870.

The Mexican peso was the weakest currency last week, losing 2% against the US dollar. The dollar though MXN12.26 briefly, which is the highest it has been since March. Many had expected that the peso would have been more resilient given the number and depth of economic linkages. The catalyst may have been market positioning.

The dollar appears stretched against the peso as it traded roughly 3-standard deviations above the 20-day moving average (Bollinger Band is +/- 2 standard deviations). Although this takes place more than normal distribution would imply, it is still a fairly rare event. It is the second or third time this year. Consolidation usually follows. Initial dollar support is seen near MXN13.15 and then MXN13.10.

Last week we noted that after making record highs on July 23 (almost 1985), the S&P 500 gapped lower on July 24. We identified this as an important gap. The attempt to fill it at mid-week failed, sending the index down 2.3% in the final two days of the week. This is the biggest two-day decline since April. It too traded beyond 3-standard deviations from its 20-day moving average. The short-term market is over-sold, but the technical condition has deteriorated and the five-day moving average crossing below the 20-day for the first time since May. Resistance is seen in the 1942-1950 area.

Observations from the speculative positioning in the futures market:

1. As the currencies moved out of familiar ranges, speculative activity in the futures market picked-up. There were two significant gross position (more than 10k contracts) adjustments in the Commitment of Traders report ending July 29. The first is that the gross short euro position rose 17.7k contracts to 164.6k. It grew by around 50% over the course of July to stand at a two-year high. The second significant position adjustment was the 15k contract increase in the gross short yen position to almost 81k. The gross short yen position had been trending lower, and before this reporting period, it had fallen to the lowest level since before Abe was elected Prime Minister of Japan.

2. The speculative participants generally added to the short foreign currency futures positions in the most recent week. There were two exceptions: the Australian and Canadian dollars. However, what was really happening there was that participants, both longs and shorts, moved to the sidelines. Many observers who simply focus on the net figures will see that the net long position in both increased. They will wrongly conclude the market got longer, but the increase in the net long position was a function of shorts being covered more than longs were liquidated.

3. In a somewhat similar fashion, the net long sterling position fell (to 24.9k contracts from 27.5k), but the gross long position grew by 3.6k contract to 75.4k. It is still larger than the gross long euro, yen and Swiss franc positions combined.

4. The net short speculative position in the 10-year US Treasury note futures fell to 5.8k contracts from 38.2k. This was largely a function of short covering. The gross short position fell 26.5k contracts to a little more than 479k contracts. The gross longs edged 5.8k higher to 473.3k contracts.

week ending July 29		Commitment of Traders

	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-108.0	-88.8	56.6	-1.6	164.6	17.7
Yen	-73.1	-53.9	7.8	-4.2	80.9	15.0
Sterling	24.9	27.5	75.4	3.6	50.5	6.2
Swiss Franc	-11.8	-7.4	8.7	-1.0	20.4	3.4
C$	22.7	20.6	56.5	-5.6	33.8	-7.7
A$	39.6	38.8	69.3	-2.8	29.7	-3.6
Mexican Peso	77.1	79.1	100.6	1.7	23.4	3.7