Dollar Thrashed into Year End

In the last week of the year, the US dollar succumbed to broad selling pressure.  Nearly all the major currencies appreciated by at least one percent against the dollar, save the Japanese yen, which gained about 0.6%.  There did not seem to be a macro spark for the sell-off.   

Ironically, the consensus appears to be a mirror image of a year ago.  At the end of 2016, with the prospect of populist winning European elections, and the promise of strong fiscal stimulus in the US, investors and speculators were bullish on the dollar.  Now it seems that nearly everyone is bearish the dollar.  

Evidence that the synchronized global expansion is strengthening has failed to help the dollar.   This macro fact is not seen as changing the trajectory of Fed policy but is thought to increase the chances of policy responses elsewhere.  The Fed says it will reduce its balance sheet by $420 bln in 2018 and raise rates three times.  Initially, the market has ignored the small paring of the balance sheet ($30 by in Q4 17) and is quite skeptical that the Fed will deliver three rate hikes as the median dot plot anticipate.  

At the same time, many investors see the substantial current account surplus in Japan and the eurozone as an indication that barring a systemic crisis, the euro and yen have a tailwind.   In contrasts, the US has current account deficit, which despite the dramatic improvement in energy imbalance, is seeing overall deterioration.  

The Dollar Index fell just shy of 10% in 2017, snapping a four year advance.  It finished at three-month lows, falling for nine of the past ten sessions.  The descent extended to almost 92.00.  The year's low was set in early September near 91.00.  A break of that low targets 88.40, the 61.8% retracement of the rally from mid-2014 through the end of 2016.  On the upside, 92.50 may offer initial resistance and a move above 93.00-93.20 would help begin repairing the technical damage.

The euro posted one of its highest closes of the year to finish 2017.  The gains between Christmas and New Years was sufficient to turn the month positive.  The euro rose 1% in December after 2.2% gain in November.  It was the strongest major of the year, appreciating 14.3%.  The next obvious target is the high for the year set in early September near $1.2090, and above there is $1.2165, the 50% retracement objective of the two and a half year slide that began in mid-2014.  That said, we suspect the market has moved too far too far, and anticipate consolidation or a near-term correction.  The euro closed above the upper Bollinger Band, which is found near $1.1970.  

With stocks and core bond yields mostly lower, including a six basis point decline in the US 10-year yield, it may be surprising that yen was the weakest of the major currencies over the past week, gaining about 0.6% against the greenback.  The dollar has fallen six of the past seven sessions against the yen and has given back the gains scored earlier in the month.  Support is seen around JPY112.00, and then nothing very meaty, until toward JPY111.00.  

Technically, the British pound looks sterling.  The immediate note of caution is that the five-day rally left it above the upper Bollinger Band (~$1.3505).  Although speculators have among the largest net long sterling position in 3 1/2 years, they still seem to be inclined to buy dips.  A pullback toward $1.3400 may provide such an opportunity.   The daily and weekly technical indicators are constructive.  The next immediate target is $1.3550, the high from the end of November, and then $1.3660, the high since the referendum, recorded in early September.   

The Canadian dollar was the second strongest of the majors in the last trading week of 2017 with a 1.5% gain, trailing the Swedish krona's nearly 1.6% advance.  The Canadian dollar ended the year with an eight-day advancing streak.  It rose nine of the last ten sessions.  The gains have in part been fueled by speculation that the central bank could be among the first to hike rates in the new year.  The Bank of Canada meets on January 17.  The OIS suggests 45% of a hike.  We suspect the risk is lower due to the economic stagnation in recent months, and uncertainties stemming from the domestic housing market and the US (including NAFTA).  

The US dollar broke out of the consolidative range that persisted since late October.     The sell-off saw it approach the 50% retracement objective (~CAD1.2490) of the rally that began in early September.  There is additional support near CAD1.2450.  The US dollar closed below the lower Bollinger Band (CAD1.2565) for the past two sessions.  A push to new lows may come before the consolidative or corrective phase is likely.    

The Australian dollar ended a four-month slide with a 3.2% rally in December.  It not only advanced every day last week, but it rose in 13 of the past 15 sessions.   The rally in copper and iron ore and the restoration of a positive carry with the US fueled the Aussie's climb.  Establishing a foothold above $0.7815 signals a move toward $0.7885-$0.7900.  The weekly MACD and Slow Stochastics are favorable, but the near-term readings are over-stretched.  Initial support is seen near $0.7760 and then $0.7720. 

Oil prices were boosted by supply disruptions in the UK and Libya, and the lack of new supply in the US (rigs flat output down).  The front-month futures contract for February delivery of light sweet crude oil finished the year near its best level in 2 1/2 years above $60.00.  Prices rose in three of last week's four sessions and in seven of the past eight.  The February contract rose nearly 3% last week after a 2% advance the week before.  It was nearly flat in the first half of December.  Its two-week performance extended the advancing streak to a fourth consecutive month.  The technical condition is stretched, but not sufficiently to stand in the way of additional near-term gains.  Still, the $60 a barrel level needs to be confirmed and some consolidation may be in order.  Initial support is seen near $59. 

  

The US 10-year yield was toying with 2.50% in the days before Christmas but was back at 2.40% by the end of the year.  The technical indicators for the March 10-year note futures contract are constructive, with the MACDs and Slow Stochastics poised to turn higher.  A move above 124-04 could signal a test on the downtrend line of the mid-October and early and late November highs.  It is near 124-20 at the end of the week ahead that will likely feature another robust (even if not spectacular) labor market report.   

Tax changes and the higher incomes will likely boost growth and inflation in the year ahead.  We pencil in a range for the 10-yield of 2.25%-2.80%.  The tax changes will also lead to higher earnings--the statutory rate was cut, capital investment fully deductible, many other deductions (loopholes) remain.  The past experience with tax holidays on repatriated earnings favor shareholders via share buybacks and dividends.   

The funds that are not used to pay the tax man may also help fund mergers and acquisitions.  The concentration and consolidation seen in numerous industries may be an important factor explaining the increase in the share of GDP that has gone to profits rather than wages.   Profits have not simply diverged from wages but from the behavior of real interest rates.  

The S&P 500 finished the year less than 0.5% below the record high set on December 18 near 2694.2.  Two days later it had fallen to 2676.10.  It traded between the two until an hour before the market closed for the year when it dropped 0.5%.  It was the best performing G10 stock market in 2017 with a 19.4%, edging out Japan's Nikkei's 19.1% gain. The major European bourses were up 7.5% to 14.5%.  With the benefit of hindsight, dollar-based investors would have done as well with the 28.7% gain in the NASDAQ as they did in a buying the DAX (28.4% unhedged).  After such a strong year, investors may start the year cautiously.  The MACDs and Slow Stochastics have turned down, suggesting a technical justification for the caution.  

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