Greenback's Recovery is Intact

The prospect of tax reform and a Fed hike in December, with expectations of more next year, helped lift the dollar broadly last week. Although the Japanese election and ECB meeting lie ahead, the fundamental backdrop for dollar looks constructive.  The technical condition is also favorable, especially on the weekly charts.  

The Dollar Index continues to appear to be carving out a bottom after trending lower through early September.  There are two key levels to monitor.  On the downside, it the Dollar Index falls through the 92.55-92.75 area, the favorable chart pattern will be challenged.  On the upside, the move above 94.25 would suggest a more significant recovery is in work, signaling potential toward 96.50-97.00. 

Technically, the euro may be forming a large topping pattern.  A break of the mid-August and early October lows near $1.1660 is needed to confirm the pattern, and a break of $1.1600 would likely signal a move toward $1.1250 in the coming weeks.  The weekly MACD and Slow Stochastics favor the eventual downside break.  On the other hand, a move above the $1.1880-$1.1910 area would undermine the credibility of the pattern.  

The 10-year interest rate differential between the US and German widened from the year's low near 1.70% to 1.95% in recent days, the most in four months.  The US two-year premium has continued to rise, reaching almost 2.30% before the weekend.  It is the most since 1999.  There is not a one-to-one correspondence between the level of the euro and the rate differential.  However, we find that direction is more important.  The correlation of the percent change in the euro and the two-year interest rate differential is still about 0.4 over the past 60 sessions, which is still robust from a historical perspective, even if off the peak near 0.6.  The correlation at the longer-end is also near 0.4, which is robust for this time series. 

The dollar-yen rate is highly correlated with the US 10-year yield.  That correlation over the past 60 sessions is a little above 0.82, which appears to be the highest on record.   In fact, that correlation is higher the correlation with the US-Japanese 10-year premium (0.75).  The dollar recorded higher highs and higher lows against the yen every day last week and reached JPY113.50 before the weekend.  It was its best level since July.   The daily and weekly technical indicators suggest scope for additional dollar gains,   A trendline connecting the March and July highs is found near in the JPY113.60-JPY113.75 area and it represents the nearby hurdle.  We would peg initial support in the JPY112.50-JPY112.75.  

Sterling fell to new lows for the week a little below $1.3090 before snapping back as both Germany's Merkel and EU's Tusk played down the deadlocked Brexit talks, suggested progress was taking place, and hinted that an agreement was likely in December to move the talks to the second stage (future relationship).   Although a couple of MPC members raised questions about the timing of the BOE's rate hike, short-sterling interest rate futures and the OIS continue to price in a strong 80% chance of a move next month.  

Sterling fell about 0.7% last week, paring almost half of the previous week's gains.  Sterling's recovery ahead of the weekend was impressive and it closed on its highs.  However, a close above $1.3220 would have been more convincing,with more offers expected in the $1.3240-$1.3260 area. The daily technical readings are mixed, while the weekly technicals warn of the risk of coming weakness.  A seven-month trendline comes in just above $1.30 at the end of next week, and the 100-day moving average is near $1.3050.  

The combination of elevated Fed rate hike expectations and a growing appreciation that after taking its two 2015 rate cuts back, Bank of Canada is on hold for some time has seen the two-year interest rate differential rose about 15 bp over the past week and is the first weekly close with a premium in over a month.  The correlation on the level of the USD-CAD and the two-year interest rate differential is more than 0.90 over the past 60 days.  On the back of disappointing Canadian retail sales, the US dollar pushed above CAD1.26 before the weekend for the first time since the end of August.   The next immediate target is near CAD1.2660 and the 100-day moving average, found by CAD1.2680.  The CAD1.2730 area corresponds to the 38.2% retracement of the loss since early May (when the US dollar peaked just shy of CAD1.38).  Support is seen near CAD1.25 now.  

The Australian dollar closed well last week near $0.7900, but it could not overcome this cap this week.  It finished near week's lows and looked poised to return to the lows since earlier this month near $0.7735.  We continue to think the Australian dollar is tracing out a large topping pattern, and over the medium-term see potential toward $0.7500.  The weekly technical indicators are pointing lower.   A move above the 50-day moving average (a little above $0.7900) would call this bearish view into question. 

The price action of the light sweet crude oil for December delivery was not particularly inspiring.  The high for the week (~$52.65) was set at the start of the week, while the low was set ahead of the weekend near $50.85.  The daily technical studies warn of range trading, and in the current context, with prices at the upper end of their month-long range, the risk is to the downside.  Support is seen between $49.50 and $50.00.  The weekly technical studies are somewhat more constructive.  The recovery ahead of the weekend lifted the contract to new highs into the close.  A move above the $52.60 area is needed to signify anything important.  

The US 10-year yield settled at two-week lows on October 13 (~2.27%) and rose to 2.38% before the weekend.  It appeared driven by economic data, speculation about the next Fed chair, and some optimism that after the Senate approved a budget, tax reforms are more likely.  Still, to be significant, the yield must rise above the 2.40%-2.42% area, which has capped yields since mid-March.  The December note futures posted its lowest close in three months and is near the six-month shelf (~124-16 to 124-20).  The low for the year, on a continuation contract, was set in March near 123-10.  The low print from December 2016  was 123.  On the upside, a move back above 125-16 would suggest that once again the broad trading range is holding.  

The S&P 500 opened outside of the previous day's range in each of the past three sessions. The higher opening on October 18 was closed the same day.  The market gapped lower on October 19 and recovered to fill the gap by the close.  On October 20, the S&P 500 gapped higher again, but this time the gap was not closed.    The S&P 500 closed higher for the sixth consecutive session before the weekend.   In the first three weeks of October, the S&P 500 has fallen in only three sessions, and the average loss was about 0.15%.  The key benchmark rose for the sixth consecutive week, and since August 18, the S&P 500 has fallen in only one week.  The technical indicators remain stretched, as has been the case for some time.  Separately, we note that Japanese shares also have a strong run.  The Nikkei has rallied for 14 consecutive sessions.  Foreign interest in the three weeks through October 13 appears to the strong foreign buying spree since at least 2001.  

The Russell 1000 Value Index rose nearly 0.9% last week recouping the previous week's decline in full (-0.30%).  It reached a record high before the weekend and is up almost 7.7% for the year.  The Russell 1000 Growth Index also rose nearly 0.8% last week.  It is the fourth weekly advance and brings the year-to-date gain to 22.7%.   

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