Dollar Bulls in the Driver Seat, but Consolidation Looms

You go to a casino and meander over to  the roulette table.  It shows eight reds in a row.  What do you do, knowing full well that each spin is an independent event, but also cognizant that probability argues against very long streaks too?   Do you bet "red" that the streak continues to an even less probable nine, or do you bet on "black"? 

The euro has completed its eighth consecutive week depreciating against the dollar.  This is the longest such streak in its relatively short history.  

The short-term speculative market has amassed a significant short euro position.  Although the ECB may have surprised many with the rate cut and the clear commitment to ABS/covered bond purchases, the market has anticipated an increasing divergence between the US and euro area in terms of economic performance and monetary policy.  

However, the supportive news stream may have peaked until the FOMC meeting and launch of the TLTRO.   The German factory orders and industrial output data were significantly stronger than expected.  This suggests the euro area's largest economy is not about to slip into a recession despite the contraction in Q2 GDP.  It also points to a favorable euro area aggregate figure on September 12 (upside risk to the consensus forecast of 0.6% after -0.3% in June).   At the same time, the weakest net job creation in the US this year may temper enthusiasm that had been building for an earlier start to the US rate cycle.    A truce in Ukraine would also be consistent with a modest shift in the news stream.  

 Given the medium and longer term fundamentally driven euro bearishness, how much of a bounce can be reasonable expected.   Technically, the $1.3000-50 area needs to be overcome to signal a correction, we suspect, instead of a consolidation phase.   On the downside, the next big target is just below $1.28. 

The less extreme positioning in sterling and the looming Scottish referendum may mean that sterling lags behind the euro during the days ahead.  In fact, while the euro was collapsing against the dollar in response to the ECB's announcement, it did not make a new low against sterling.  Its two-year low was set in late July.   The euro could test the upper end of its recent range near GBP0.8000.  Against the dollar,  the $1.6400-20 area may cap initial upticks. 

The dollar's advance against the yen accelerated since the JPY103 cap was broken on August 20.  It recorded a new five-year high near JPY105.70 before the weekend.   It too appears to be exhausted on a short-term view and the the RSI did not confirm the new dollar high.  Support is seen in the JPY104.35-65 area.  

The Australian dollar was the strongest major currency in the past week, gaining about 0.6% against the US dollar and a little more than 2% against sterling, which was the weakest of the majors.  However, with the pre-weekend gains, it is approached the downtrend line drawn off the early and late July highs.  It comes in near $0.9400 at the end of next week.   This also corresponds with the 61.8% retracement off that July 1 high just above $0.9500.   At the same time, the it closed just above the upper Bollinger Band, which also seems to warn against chasing it.  

The Canadian dollar's flat showing was sufficient for it to be the second best performing major currency last week.  Disappointing jobs data and IVEY survey offsets the larger than expected trade surplus reported earlier in the week.  The US dollar looks comfortably in a CAD1.08-CAD1.10 range.  If the larger consolidation that we anticipate pans out, the Canadian dollar may under-perform on the crosses, especially the euro and currencies that move in its orbit.  

For almost a month, the US dollar has been confined to a MXN13.04-MXN13.17 trading range.  The technical indicators are not generating strong signals.   The upper end of the range was tested three times last week, and the dollar finished the week near the lower end of the range.  We are more inclined to see some further dollar weakness in the days ahead.  An uptrend line drawn off the June and July lows comes in near MXN13.02 next week.  A convincing break of it, which means a break of MXN13.00 would be needed to ease the disappointment of the peso bulls.    The peso is flat against the dollar this year.  Many, including ourselves had expected a stronger showing. 

We suspect the US 10-year yield has bottomed.   The actual yield low was set on August 15, the 43rd anniversary of the end of Bretton Woods near 2.30%.   Technical indicators are constructive,  and the five-day moving average crossed above the 20-day average at the end of the week.  The down trend line drawn off the July and August highs comes in near 2.49% at the end of next week. 

The technical tone of the S&P 500 has softened, and additional losses appear likely in the days ahead, which dovetails with our consoldiative theme. The record high set on September 4 was not confirmed by the RSI.  Immediate downside potential extends toward 1978 and then 1970.   Lastly, oil prices and commodity prices, more generally continue to struggle to sustain upticks.

Observations based on the speculative positioning in the futures market: 

1.  There were two significant position adjustments (10k contracts or more) in the CFTC reporting week ending Sept 2.  The first, gross short euro position increased by 16.2k contracts to 220.1k.  The record gross short position was set in June 2012 near 251k contracts.  The second, the gross short yen position increased by 10.4k contracts to 132.8k.  At the end of last year, they stood at 158k contracts.  The record was set in June 2007 near 237k contracts.

2.  Nine of the 14 gross positions we track changed by less than 5k contracts.  Market interest is highly concentrated short euro and yen positions.  However, we note that the largest gross long positions are in the Australian dollar, with 77.1k long contracts in speculator hands, closely followed by the Mexican peso's 75.2k contracts.

3.  With the exception of the Canadian and Australian dollar, speculators added to gross short positions. There was less of a clear pattern in the gross long positions.  The euro, Swiss franc, Australian dollar and Mexican peso saw gross longs increase.

4.  After flipping to the long side for the first time in a year, the net speculative position in the 10-year futures contact swung back to the short side.  A combination of longs being cut by 35.6k contracts (to 382.4k) and 55k new short contracts (to 465.1k) saw the net position shift to almost 83k short contracts from just less than 8k long contracts the previous reporting period.

week ending Sept 2		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-161.0	151.0	59.4	5.4	220.1	16.2
Yen	-117.0	-103.0	15.5	-4.0	132.8	10.4
Sterling	9.4	15.7	67.5	-3.5	58.1	2.6
Swiss Franc	-13.2	-13.0	9.2	1.7	22.3	1.8
C$	9.2	5.7	35.3	-3.2	26.1	-6.7
A$	49.0	41.9	77.1	5.4	28.0	-1.7
Mexican Peso	39.2	36.7	75.4	3.8	36.3	1.3