Is the Dollar Breaking Out?

The US dollar appreciated against most of the major currencies over the past week.  The Canadian dollar was the strongest of the majors, benefiting from a better than expected May GDP  (0.5%) and a June merchandise trade shortfall a quarter of what was expected (-$630 mln vs. C$2.3 bln median forecast in the Bloomberg survey). 

The Canadian dollar traded at its best level in nearly two months ahead of the weekend.  The greenback finished a little below CAD1.30.  The trendline drawn from the year's low in January through the April low comes in near CAD1.2935 at the start of the new week.  A couple of retracement objectives are found just above there in the CAD1.2950-$1.2960 area.  If the downside momentum cannot be maintained, the upper end of the recent range is around CAD1.3100, and the 20-day moving average is CAD1.3110.  We note that the US 2-year premium over Canada has narrowed by 21 bp since the end of June to a 2 1/2 month low below 55 bp.  

More broadly, the Dollar Index advanced half a percentage point last week and finished above its old nemesis at 95.00.  The top end of the range is in the 95.50-95.60 area.  The technical indicators appear supportive.  Ahead of the weekend, the Dollar Index stopped near the upper Bollinger Band (~95.35).

In a near-mirror image of the Dollar Index, the euro fell 0.7% last week.  The single currency fell to its lowest level since the end of June near $1.1560.  Most importantly from a technical perspective is that it violated and closed twice below the trendline connecting the June 21, June 28, and July 19 lows.    It is found near $1.1600 at the start of the new week.  While the $1.15 is psychologically significant, $1.1450 corresponds to a 50% retracement of last year's rally. The caveat against selling the euro out of the gate is that it closed below the lower Bollinger Band ~$1.1585).  Yet traders are increasingly incentivized to be long dollars. The two-year interest rate differential has widened by an average of a little more than 30 basis points a quarter for the last four quarters.  

The dollar recovered against the yen on the BOJ moves to tweak its extraordinary policy to extend it indefinitely. It peaked at JPY112.15 and slid into the weekend nearly a big figure lower.  A shelf of untested durability was carved in the JPY110.60-JPY110.75 area.  So far, here in Q3, the dollar has not traded below JPY110.25.  The volatility of JGBs and the steeper yield curve may entice more savings to stay at home, and there is still talk of unwinding some short yen funding positions that were used to purchase Turkey.   

July was the third consecutive month that sterling recorded lower highs and lows.  Perceived risks of an exit from the EU without an agreement and BOE Governor Carney's signal of the appropriateness of one hike a year capped sterling near $1.3200 at the beginning of the week and pinned near the 10-month lows seen on July 19 near $1.2960.   The next target is seen near $1.2800, where the 61.8% retracement of sterling's gains since the flash crash low in October 2016.   While the US-Germany two-year spread has widened by an average of 30 bp a quarter, the US-UK premium has widened by an average of 20 bp a quarter for the last four. 

The Australian dollar's recovery before the weekend was not so much sparked by the slightly stronger than expected retail sales but by the Chinese decision to signal it had stepped up its efforts to arrest the yuan's slide.  The Aussie finished the week back in the middle of its $0.7300-$0.7500 trading range.  The RBA meeting is a non-event, though official comments pose bigger headline risks than the meeting itself.  A trading range is established by alternating tests.  Since the test was on the lower end before the weekend, the rule of alternation indicates a push into the upper end.  The high from the second half of July was near $0.7465.  

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September light sweet crude oil slipped marginally last week (~0.2%) in choppy trading.  The outside up-day on August 2 failed to spur follow-through buying ahead of the weekend.  A break of last week's range, roughly $67 to $70 may point to the direction of the near-term move.  Preliminary data shows Russia and Saudi Arabia lifted their output and the US reported an unexpected increase in oil inventories.  China apparently indicated that it would not, in deference to the US,  stop buying Iranian oil.  However, it signaled it would not increase its purchases either. On the other hand, China's Unipec suspended US oil imports.  Reports indicated that there will not be new US orders for at least two months. It was to take 300k barrels this year.  

The US 10-year yield closed above 3% in the middle of last week for the first time since late May.  The increase in US supply, strong economic data in the form of a 4-handle on the preliminary estimate for Q2 GDP, talk of making the middle-class tax cuts permanent, and volatility emanating from Japan seemed to point to a continued rise in US rates.  However, the trade tensions and the decline in the non-manufacturing ISM composite (to its lowest level since last August) saw yields ease ahead of the weekend.  In the end, the 10-year yield slipped half a basis point to end a three-week period of rising yields.   The September note futures contract tested the lower end of the range (~119-00) before bouncing back to the upper end of a two-week range (~119-22).  The technical indicators suggest there is scope for a further recovery in prices and 120-00 to 120-16 cannot be ruled out.  

The bears are pressing hard.  In the futures market, the speculators added 26.2k contracts to the gross short position. It is the third consecutive weekly build of the speculative short position, over which time nearly 140k contracts were added.  The gross short position of 1.062 mln contracts is just shy of the record 1.111 mln seen earlier this year.  The bulls cut 54.5k contracts from their net long position, leaving them 471.7k contracts, which is the second smallest since early last year.  Late shorts seem vulnerable to a squeeze, though the fundamental case for higher yields seems compelling.  

The S&P 500 closed higher for the fifth consecutive week, the longest advancing streak of the year. It finished just off the week's high set into the close.  An outside up day was recorded on August 2, and the follow-through buying illustrates the market's strength. The next immediate target is last month's high near 2850, a little beyond the upper Bollinger Band (~2845), and then the record high seen at the start of the year near 2873.   On the downside, a close below 2800 would be disappointing.  

The NASDAQ gained nearly 1% last week.  It had fallen about 4.2% between July 25 and July 30.  It retraced 61.8% of those losses (~7807.6) and closed near 7812. The record high set on July 25 was near 7933.3.  That sell-off itself was a 61.8% retracement of the last leg up beginning in late June.  The seemingly technical nature of the market looks constructive.  

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