Breather in Dollar Rally has Begun

The US dollar has been on such a strong advance that some investors and journalists may suspect that there is a shortage of dollars.  The Dollar Index rise has been relentless, appreciating in all but one week in each of the past three months. The US dollar is now higher on the year against most of the major currencies but the yen (3.0%), Norwegian krone (2.5%) and sterling (0.20%).  

However, the dollar's advance continues to seem largely a function of short-covering rather than outright new longs.  Although there may be more negative yielding bonds in Europe and Japan than at the end of last year, the foreign demand for US Treasuries does not appear especially robust. Domestic institutions continue to be the featured buyers.  In the futures market, in the week ending May 8, which saw the euro drop two cents in the spot market, speculators added to their gross long futures position (5.6k contracts) bringing it 226.6k contracts. Sterling was the victim of long liquidation.  They cut the gross long sterling position by a 22.4k contracts (to contracts 62.2 contracts).

We are not convinced the third large dollar rally since the end of Bretton Woods is over despite the 2017 losses.  We think the main driver, the divergence of policy mixes, remain intact.  Technically, the Dollar Index did hold the 61.8% retracement(~88.40) of the rally from the 2014 lows.  The euro held a similar retracement and a monthly downtrend line from the 2008 record highs that converged near $1.26.  

However, appreciating that the dollar's recovery has left technical indicators stretched, we have been anticipating the emergence of signs that a correction is at hand.  The recent price action is generating those signals.  In this phase, at least initially, we look for the Dollar Index to return to the 91.30-91.80 in the coming days.  

The euro reached a low in the middle of last week near $1.1825.  It is the lowest since the end of last year.  However, the following day, perhaps encouraged by a slightly softer than expected US CPI report, the euro closed above the five-day moving average for the first time since April 17.  The gains were not sufficient to avoid extending the losing streak the for a fourth consecutive week.   The technical indicators have not turned, but they are poised to do so in the coming days.  We suggest an initial target near the 200-day moving average, which is found near $1.2020 and the 38.2% retracement of the single currency's losses since the April 19 high.that is found near $1.2045. 

The dollar may have recorded a double top against the yen with its brief and shallow forays above JPY110 on May 2 and May 10.  In between, the greenback slipped to JPY108.65, which would be the neckline of the pattern, and a break would suggest potential toward JPY107.30.  That target corresponds with a 50% retracement objective of the dollar's recovery from the JPY104.55 low at the end of Japan's fiscal year.  The MACDs are turning lower, and the Slow Stochastics have already done so.  

With a few intra-day exceptions, sterling was in a $1.35-$136 range last week.  One of those exceptions was after the BOE meeting when sterling slumped to test the low for the year near $1.3460.  The RSI and the Slow Stochastic have turned higher, the MACDs will shortly.  While a move above $1.36 would be constructive, a more formidable technical resistance is seen near $1.3665 and $1.3730.  

The Australian dollar staged an impressive recovery after to almost $0.7400 in the middle of last week.  It had not been that low since last June.  It traced out a hammer candlestick pattern and saw follow-through buying in the second half of the week.  It was testing the $0.7560 area ahead of the weekend.  The technical indicators are constructive.  Initial resistance may be encountered in the  $0.7600-$0.7615 area, we suspect there is potential toward $0.7660.  

Against the Canadian dollar, the greenback recorded a big outside down week to snap a three-week rally.    It traded on both sides of the previous week's range and finished last week lower than the previous week's range.  The negativity is tempered by the firmer tone ahead of the weekend following some mixed jobs data.  The trendline drawn off the end of January low (~CAD1.2250) and the mid-April low (~CAD1.2530) is found near CAD1.2640 at the end of next week.  A band of resistance is seen in the CAD.12800-CAD1.2830 band that may offer a lower risk US dollar selling opportunity.   

The unexpected decline in US oil inventories, other supply disruptions, and the resumption of US sanctions against Iran helped lift oil prices to new four year highs.  Many observers are concerned that the US decision may escalate Israel's confrontation with Iran.  Israeli reports suggest it conducted the biggest raid in at least 30 years at Iranian military facilities in Syria.  Brent has appreciated for five consecutive weeks.  WTI has risen four of the past five weeks.  July Brent reached $78 a barrel, and June WTI reached almost $72.  The technical indicators do not suggest a top is in place.  The next targets are near $80 and $75 for Bent and WTI respectively. 

The slightly disappointing US CPI stopped turned the 10-year Treasury yield back from probe above 3.0%.  It is first this month the 3% handle was seen after being rebuffed here in late April.  The consolidation between 2.90% and 3.0% may continue, and the 20-day moving average is in the middle of the range.  That translates into a 119-201 range for the June note futures.

The Federal Reserve's custody holdings for foreign central banks fell for the fourth week through May 9.  Over this period, the holdings have fallen around $52 bln.  We suspect this is a reflection of some central banks intervening to support their currencies.  Custodial holdings are still about $34 bln higher than at the end of last year.  Bulls and bears added to positions in the 10-year note futures market.  The bulls added 66.7k contracts to bring the gross long position to almost 698k contracts.  The bears added nearly 30k contracts.  The gross short position stands at 1.106 mln contracts.  The position data ended the day before the slightly softer than expected CPI

The S&P 500 rose 2.4% last week, its largest weekly advance in two months.  The technical tone improved in recent days as the index moved above last month's high, breaking the pattern of lower highs and the diminishing bounces off the 200-day moving average.  It also took out the downtrend line drawn off the January and March highs.  The S&P 500 gapped on May 10 and jumped above the previous unfilled gap from April 19, leaving a bullish island bottom, a potential "W" pattern in its wake.  The next target is near 2743 and then 2800.  Initial support should be the gap that is found between the May 9 high (~2701.25) and the May 10 low (~2704.55).  The Dow Industrials will begin next week with a seven-day advance in tow.  During this run, it has risen about 3.8%.   

The Russell 1000 Growth index has advanced for six consecutive sessions and nearly 4%.  It has advanced in four of the past five weeks.  The Russell 1000 Value Index rose in five of the past six sessions and gained about 3.5%.  The Value Index is still off year-to-date (~-1.5%), while the Growth Index is up (5.6%).  Year-to-date, the S&P 500 is up 2%, and the NASDAQ is up nearly 7.25%.  

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