Next Leg Up for the Dollar

The US dollar had a good week to close out October.  It was bolstered to new highs against the euro and yen.  It is driven by both positive developments in the US and negative developments in Europe and Japan.  

There were two highlights from the US.  First, the FOMC statement was read with a hawkish tilt. The decline in inflation expectations seemed to have been played down while the improvement in the labor market was recognized.   The two hawks that dissented last time, joined the majority, while there was new dovish dissent.  Q3 US GDP surprised on the upside.  

Second, the preliminary estimate of 3.5%, was above the 3.0% consensus, and the 4.2% rise in final sales was the strongest since 2010.  The April-September period is the best six-month economic performance in the US since the second half of 2003.  

Underpinning the dollar has been a shift in the pendulum of market expectations of Fed policy. During the panic in the middle of October, the effective Fed funds rate at the end of 2015 fell to 32 bp, according to the December 2015 Fed funds futures contract.  It finished last week at 53 bp, which is almost half way back to where the contract finished September (77 bp). 

Developments on the US are positive for the dollar, but developments in Europe and Japan have been negative for their respective currencies.  The lowest inflation in nearly a year, and apparent confirmation that the large government pension fund (GPIF, which acts as a path setter for other pension funds) will reduce its JGB purchases, spurred the BOJ’s unexpected decision to increase its asset purchases from JPY60-JPY70 trillion to JPY80 trillion.  This sent the yen reeling.  The dollar soared to near JPY112.50, the highest level since late-2007. 

The dollar's 3.8% advance against the yen was the largest in seven years and pushed the greenback well above its upper Bollinger Band, which is set two standard deviations above the 20-day moving average.  In fact, dollar finished the week near 3.5 standard deviations away from the 20-day moving average.  This should make one cautious even though the RSI and MACDs look constructive.   

Since the high was recorded, the dollar has not been below JPY111.80.  A break of this area could spur a move toward JPY111.00.  The dollar's pullbacks may be limited because many weak longs had already been squeezed out on the pullback to almost JPY105.25 in the middle of October. In addition, the  bulls are not just talking about JPY115.00, but JPY120.  

Euro area data, especially until the end of the week, was generally better than expected.  These reports included the Asset Quality Review and stress tests, PMI, M3 money supply and the bank lending survey.  The euro's rally fizzled mid-week near $1.2770, from which it staged a reversal and an outside down day.  Data in the second half of the week, including German and French retail sales and soft German inflation figures pushed a soft market even lower.  

The euro was pushed to almost $1.2485 before the weekend.  The technical tone is poor.  The RSI continues to head lower, (but is not over-extended), and the MACDs have turned down.  The only note of caution comes from the weekly close below the lower Bollinger Band (~$1.2550).  There is little chart support until $1.20.   Initial resistance is pegged near $1.2560 and then $1.2600-20.  

The inverse head and shoulders pattern sterling appeared to have carved out failed.  Sterling has found bids below $1.60, but the upside may be limited.  Initial resistance is seen in the $1.6060-70 area, more formidable resistance near $1.6200 seems miles away.   

The Australian dollar was the only of the major currencies to have held its own against the US dollar last week. The RSI is neutral, and the MACDs are set to cross.  A rally into the $0.8880-$0.8900 will likely be sold while initial support is seen in the $0.8770 area.  

The Canadian dollar was pushed lower ahead of the weekend by a poor August GDP figure.  The 0.1% contraction is the first such contractions this year.  The US dollar appears to be comfortable in a CAD1.12-CAD1.13.  A close beyond that range may point to the direction of the next big figure move,  

The strong dollar environment is too much for the peso.  At the start of last week, the dollar pushed above MXN13.60, before reversing.  In the second half of the week, the greenback tested MXN13.40 and found bids there.    Look for a test on the dollar cap again in the week ahead.  

Observations based on speculative positioning in the futures market:  

1.  There were no significant (more than 10k contracts) adjustment in the gross currency futures positions in the CFTC reporting week ending October 28.  Of the 14 gross positions we track, only four changed by more than 5k contracts.  

2.  The bearish currency view is highlighted by the increase gross short position, except for the yen (-7.1k contracts to 91.3k) and Canadian dollar (-2.9k contracts to 47.5k).  Gross long positions mostly fell, except for sterling (+4.2k contracts to 40.7k) and the Australian dollar (+3.5k contracts to 17.4k)

3.  The net short yen futures position has been nearly halved to 67.4k contracts early September.  It is the smallest since July.  This has been mostly a function of short covering.  The gross short position has fallen by 60k contracts over the past four reporting periods.  The gross long position has fallen by about 6k contracts over the same period.   The yen's sell-off in the second half of last week occurred as the gross short yen position was the smallest in two months.

4.  The gross short 10-year US Treasury futures position was cut to 35.8k contracts from 90.0k.  The longs were trimmed by 25.5k contracts to 431.2k.  The gross short position fell 79.7k to 467.1k contracts.  

week ending Oct 28		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-166.0	-159.0	59.1	-1.1	224.8	5.2
Yen	-67.4	-71.7	23.9	-2.8	91.3	-7.1
Sterling	-6.2	-4.5	40.7	4.2	47.0	5.9
Swiss Franc	-20.3	-17.9	6.9	-0.8	27.2	1.7
C$	-21.4	-21.5	26.1	-2.7	47.5	-2.9
A$	-33.9	-31.5	17.4	3.5	51.3	5.8
Mexican Peso	-26.8	-21.1	26.8	-3.3	53.7	2.5