Dollar's Downside Correction Set to Continue

The US dollar's downside correction, which we anticipated, has more room to run.  On the margins, the fundamental drivers have softened.  The tame US wage data, the flattening of the yield curve, and the angst over the trade tensions all argue against an acceleration of Fed tightening.  

At the same time, the improved June EMU composite PMI and surge in German factory orders, and industrial output suggests the winter/spring soft patch is over. Following the guidance by ECB's Chief Economist Praet and unnamed hawks who took their case to press, the market has pushed the first rate hike to September from the end of the year, where it had drifted in recent weeks.  

US 10-year Treasury yields are consolidating around 30 bp off the high recorded on May 18 near 3.12%.  The lower yields remove some of the enthusiasm for dollar-yen. Equities have been soggy, which also tends to support the yen as funding positions are unwound.  The MSCI World Equity Index rose about 0.75% last week.  It is only the third weekly advance since the end of April.

The Dollar Index put in a double top just above 95.50 on June 21 and June 28.  The neckline near 94.20 was taken out before the weekend.  The pattern projects toward 92.80-92.90.  The 38.2% retracement of the Dollar Index's rally from the February low is near 92.75.  The May low was set near 93.20.    The 50% retracement and the 100-day moving average are found a little 92.00.  The technical indicators also favor additional losses, as the bearish divergence with the RSI and MACDs were have been monitoring anticipated the price decline.  

The euro appears to have carved out a bottom.  The $1.1510 area had been approached three times.  The more common head and shoulders bottom is a similar type of reversal pattern.   Depending on how one identifies the neckline it could project toward $1.20-$1.21.  The euro's gains did take out the downtrend line drawn off the $1.24 high on April 19 and the $1.1850 high on June 14.  The trendline held several tests in recent days until giving way in the second half of last week.  The $1.1850 are is the next immediate target.  It is not only last month's high, but it also corresponds to a 38.2% retracement of the losses since April 19.  Before the weekend the euro closed a tick above  50-day moving average (~$1.1745) for the first time since then.  The technical indicators are constructive, and the five-day moving average has crossed above the 20-day reflecting the upside momentum  

The market appears to have rejected the JPY111 handle for the dollar after an initial probe to start last week.  That is the upper end of the two-month range.  Initial support is seen near JPY110.20, and a trendline connecting the late May spike to almost JPY108.10 and the late June low near JPY109.35 comes in at the start of next week by JPY109.90 and rising a little more than 5 ticks a day.  The broad sideways activity has neutered the technical indicators.  

Sterling gained almost 0.5% last week to snap a three-week 1.5% decline.  The generally soft dollar tone and Carney's confident tone that the weak start of the year was past, and favorable service PMI helped neutralize the concerns that the UK and the EU are still far apart on the terms of the Brexit.  Sterling closed near two-week highs, a little below $1.3300, which is the 61.8% retracement mark of the losses seen from June 14.  The high from the second half of June was set near $1.3315.  A move above there, which the technical indicators seem to favor, would target the $1.3450 area.  

The Canadian dollar edged higher against the US dollar last week.  It had been flat going to the US and Canadian jobs and trade data ahead of the weekend.  Although Canada reported a larger trade deficit than expected and less net new full-time jobs and smaller pay increase, investors are still expecting the Bank of Canada to hike rates on July 11.  The US dollar has recorded seven consecutive sessions of lower highs, but it wasn't until greenback's slide ahead of the weekend that the CAD1.31 level was finally penetrated.  A trendline drawn off the April and May lows comes in CAD1.2980 at the start of the new week and rises toward CAD1.3010 by the end of the week.  The CAD1.2950 area corresponds to 38.2% retracement of the greenback's advance off that April low.  The five-day moving average has slipped below the 20-day for the first time since late May.  

The Australian dollar also ended a three-week decline with a modest 0.3% advance last week.  It too appears to have carved out a bottom.  The technical indicators also support additional near-term gains.  A head and shoulders bottom may have been traced out.  The neckline is roughly $0.7445 and the measuring objective a little below $0.7590.  The $0.7450 area corresponds to a 38.2% retracement of last month's decline, and $0.7535 is the 61.8% retracement.  Iron ore prices fell 3% last week, and copper prices continued to plunge.  Copper has risen only in three sessions in the past month (since June 8) and has slid over 16% in the four-week tumble.  

Neither the unexpected rise in US oil stocks nor the Saudi price cut was sufficient to deliver the lower prices that the US President has called for in tweets.  US retail gasoline prices reached a four-year high.  US recessions have often been proceeded by a sharp rise in oil prices.  The pre-weekend rally of nearly 1.2% allowed WTI for August delivery to recoup the lion's share of the earlier pullback.  The technical indicators allow for another run at the $75 level, but it could be last push higher before a more serious correction.   A break of $72 would sap the momentum, and a move below $0.70.75 would confirm a near-term high is in place.  

The US 10-year yield slipped to its lowest level since late May near 2.80% ahead of the weekend.  That May low itself was a six-week extreme about 2.76%.  The yield has fallen for four consecutive weeks and six of the past seven.  There are two conventional explanations for the decline in the yields.  The first sees it as a typical pattern of Fed tightening and is similar to the what had been dubbed the Greenspan Conundrum in the early 2000s.  The negative yields in Europe and Japan may also increase the attractiveness of the US long-term yields.  The second is more sinister and emphasizes a pessimistic outlook for the US economy.  The flattening of the yield curve and the higher oil prices, as well as other late-cycle behavior (e.g., peak in the 12-month moving average of non-farm payrolls and auto in sales, and rising delinquency rates on credit cards.  We do not see the two explanations as mutually exclusive.  That said, we suspect the 10-year yield is near a low, and the anticipated rise in the June CPI next week toward 3% may help provide a floor.  

The September 10-year note futures reached 120-20 ahead of the weekend.  We suspect the 121-00/121-05 seen in late May will go unmolested.  The technical indicators suggest the upside momentum is exhausted or nearly so.  A break of 119-28 would lend credence to our view that a top is in place.  The 20-day moving average is found there as well. 

The S&P 500 rose 1.5% during the holiday-shortened week and ended the two-week slippage that saw it pullback from around 2800 to 2700.  The rally before the weekend closed the gap on the daily and weekly bar charts from the lower opening on June 25.  It finished the week with its highest close since June 20, above its 20-day moving average (~2750.3) for the first time since then, and above the 61.8% retracement of its decline since the June 13 high near 2800.  The technical indicators are supportive.  A move above 2800, which is the high since the February meltdown, is needed to lift the technical tone.  

The Russell 1000 Growth Index rose 1.9% last week, recouping about half of what it lost over preceding two weeks.  It is up nearly 8.5% for the year.  The Russell 1000 Value index rose 1.3% after losing almost 2.4% over the previous three weeks.  It is off 1.6% this year. 

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