Is the Dollar Breaking Out?

The key issue as the market heads into the weekend is whether the US dollar is breaking out of its trading range to the downside. Has the disappointing US economic data and the somewhat better European data finally taken its toll and forcing the dollar bulls to rein their enthusiasm? 

Helped by the sixth consecutive advance in oil, the Canadian dollar extended its advance out of the three month trading range.  A less dovish central bank had provided the earlier fuel.  

Australia's jobs data was sufficiently strong as to encourage market participants to downgrade the odds of a May rate cut.  The market still leans that way, but the OIS implies about a 60% chance, rather than near 80% chance earlier in the week.  The Aussie has largely been confined to a $0.7600-$0.7950 range since the start of February.  It is moving above $0.7800 for the first time in a couple of weeks. 

Sterling is trying to establish a foothold above the $1.50 level for the first time since March 18, when in response to the "dovish FOMC" sterling reached $1.5165.   The employment data was the catalyst, but it was not particularly strong, which means it may be a better indication of the more generalized pressure on the US dollar longs.  After all, the UK election is in three weeks, and how a majority government will be cobbled together remains elusive.  The claimant count fell by 20.7k.  The market had been looking for a decline of nearly 30k and the February figure was revised to -29.1k from -31.0k.  Average weekly earnings, reported with an extra month lag, rose 1.7%  (three months year-over-year), down from a revised 1.9% pace in January.  Excluding bonuses, however, the pace increased to 1.8% from 1.6%. 

The euro is advancing for its fourth day, though remains well below last week's $1.1035 high.  After trading nearing $1.0820 yesterday, the euro slid back to a little below $1.0740 in late Asia, but was quick bought back in early Europe to make a new high for the week just above $1.0830. 

Core European bonds are continuing to rally, with the German 10-year yield slipping to 7 bp.  German yields out through nine years are negative.  A little more than half of German bonds yields are negative, or more than $800 bln.  In the US, the average coupon yield is a near 125 bp.  Some $2 trillion of European debt have negative yields. 

There has been a shift this week in US interest rate expectations as measured by the Fed funds and Eurodollar futures.  The December Fed funds contract implies a 32.5 average Fed funds rate, a five bp decline on the week.  It is within half a basis point from the contract high (low yield) that was set in the flash crash in the middle of last October.   The yield on the December Eurodollar futures contract has fallen 8 bp this week to 56 bp.  It is setting the contract high (yield low) today. 

That said, investors ought to keep in mind yesterday's comments from Fed Vice Chairman.  He acknowledged Q1 was poor, but that a recovery was already underway, and that the central bank wants to raise interest rates and is looking for the economic data to provide the opportunity.   Some economists are claiming, and the market has begun positioning as if this data will not be forthcoming this year.   Without much key economic data next week (durable goods orders), there will be nothing to challenge this view, leaving market still vulnerable given its positioning.  

US CPI for March is expected to remain unchanged at 0.2% m/m, but core is seen as slipping from 0.2 m/m to 0.1%. Recall that February CPI was the first positive month-on-month print since October. The increase was partially due to 2.4% rise in gasoline prices, after plummeting 18.7% in January. After that, US markets get Univ. of Michigan consumer sentiment data for April, which is expected to increase from 93.0 to 95.0. In Canada, headline CPI for March is expected to slow from 0.9% m/m to 0.5%, with core falling to 0.3% m/m from 0.6%. Separately, retail sales is expected to bounce back to 0.5% m/m in February, after declining -1.7% in March.  Strong downside momentum for the US dollar has developed, but it is now stretched, below its lower Bollinger Band (~CAD1.2225).  Oil prices appear to be snapping a six day advance.  Oil prices are up around 30% from the mid-March lows.   Anticipation of a slowdown in US output and  the insurgents control of a oil export terminal in Yemen, helped lift oil prices to the highs for the years.  A consolidative tone is evident today.