Thoughts about the Price Action

The US dollar has begun the week with a strong advance against sterling and the euro. Sterling's drop, the most in several years, is not a function of macroeconomic policy.  It is a function of Brexit and its endorsement by London Mayor Johnson.  Recent polls and identified Johnson, who term as Mayor ends in early May, as the second most influential person on the issue after the Prime Minister himself. 

Sterling fell to about $1.4050 by early North American trading and has subsequently moved broadly sideways.  Since the low was recorded, sterling has managed to recoup a cent and is finishing the North American session near its post-low highs.   We suspect the market has over-reacted, a near-term bounce can carry it back toward $1.4230-$1.4250.   

Although Cameron appeared to have called the referendum to unite the party, with Johnson taking the other side, the battle for the Tory Party becomes a battle over EU membership, which the Conservatives sponsored in the first place.    The eurosceptics have enjoyed free rein, as other camp has been stymied by the negotiations.  However, look for those wanting to stay in the EU to begin making their presence felt in a way that was impossible until this past weekend.  

The euro's slide lost momentum in front of $1.10.  It will finish the day below the 20-day moving average for the first time since January 29.   The five-day moving average is set to slip below the 20-day average as early as tomorrow.  The euro spent most of December and January in a $1.08 to $1.10 trading range.  There is some chart support near $1.0950 and $1.0850, but a break of $1.10 would likely signal a move back to $1.08.  

Under a "turn-around Tuesday" scenario, initial resistance is pegged near $1.1070, and then near $1.1120.  We suspect euro gains will be limited by the re-widening of the two-year interest rate differential, which is back to levels seen in late-January (~130 bp), and anticipation of further easing by the ECB (with the fall in prices, new orders and output in the flash PMI fanning expectations).  

While sterling and the euro's weakness is understandable, the drivers of the yen would seem to be suggesting the yen ought to be weaker.  We see two drivers that account for the yen's use as a funding currency and export of Japanese savings.  For the first function, we can use the S&P 500 as a proxy.  With today's gains, it is about 7.7% above the February 11 low.  It has approached a key technical area near 1950.  

For the yen's second driver, we use the 10-year interest rate differential between the US and Japan.  It has also moved back into the US favor.  Recall that the US premium peaked at the end of last year near 203 bp.  It fell to 163 bp on February 1.  It is now at 177 bp.  The 38.2% Fibonacci retracement is near 179 bp.  

We often have found that the dollar-yen exchange rate is often a range-bound pair, and when it looks like it is trending, it is moving from one range to another.  The dramatic move earlier this month has unhinged many participants.  A new range is still be shaped.  It looks like JPY110 to JPY115.00, with initial support in the middle of that range.  

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