Breakout Continues to be Elusive for the Greenback

The US dollar has failed to break higher, and this seems to boost the chances that it experiences a near-term setback.  Elsewhere we suggest that two dominant themes--US-China trade talks and Brexit--will likely be delayed.   The combination of the technical condition and the macro backdrop may deter players from looking for a break out in the week ahead.  A delay in Brexit is understood to be good for sterling because it ostensibly reduces the risk of a no-deal exit. An extension of the US-China tariff freeze is understood to mean a trade agreement is likely, but consequences for the dollar are not obvious.  The significant currency agreement that was announced without a lick of specifics before the weekend does not mean China will accept a re-valuation of the yuan.   Driving the yuan higher now would undermine efforts to stimulate the economy.  

Dollar Index:   The Dollar Index eight-day rally ended on February 11. In the eight sessions since, it has risen twice.  Initial support is seen in the 96.25-96.35 area, where last week's low, the halfway mark of this month's rally, and the 20-day moving average are found.  It has not closed below this moving average since February 4.  It may take a break of 96.00 to be convincing.  The MACDs and Slow Stochastics favor the downside.   

Euro:  There have been a few exceptions, but $1.13-$1.15 range has contained most of the euro's movement for the past four months.  The euro has been unable to rise through the mid-point of the range since February 6.  Unless it does so in the coming days, it will post its second consecutive monthly decline.  It finished January a touch below $1.1450.  The technical indicators favor the upside after last week's 0.35% gain snapped a two-week slump.  Three-month implied volatility is near 6.2%, the lowest in a couple of years.  The 100-day moving average is near 7.2%.  The low volatility may make options more attractive than forwards for some hedging or other strategies. 

Yen:   The dollar spent last week on a JPY110-handle.  Three-month implied volatility slumped to about 6.1%, which is a five-year low.  The dollar has come a long way since the flash crash low early last month below JPY105 but is struggling to push above JPY111.00.  A band of resistance is seen between JPY111.15 and JPY111.40    The dollar has risen against the yen for the past three consecutive weeks by a total of about 1.1%.  Each week, the pattern has been the same.  The dollar appreciates Monday through Wednesday, and then the market pares the gains in the last two days of the week.  We do not put much stock in the pattern and would file it under, "fooled by randomness" to borrow a phrase.  However, technically, we see the risk of a near-term dollar setback.  Not only has the upside momentum stalled, but the Slow Stochastics continues to show a bearish divergence and MACDs look poised to turn south.  The dollar finished last month a little below JPY109.  February could be the first monthly gain for the dollar against the yen since last November.  

Sterling:  Sterling rallied 1.35% in the first two days last week and closed the week with a 1.25% advance.  This made it the strongest of the major currencies last week.  Many have concluded through the drama and defections that a delay will avoid a no-deal exit.  Before the weekend, sterling recovered from a slide to about $1.2960, a four-day low, to new session highs, near $1.3080, putting it in a good position to recover further in the coming days.  The MACDs and Slow Stochastics are in agreement.  The initial goal is near $1.32. The implied vol curve peaks at the three-month tenor, but even that has fallen.  It began the week near 12% and finished near 11%.  For perspective, it has averaged about 11.7% for the past 100 days.  Last month's low was near 10%.  

Canadian Dollar:  The US dollar posted an outside down day against the Canadian dollar before the weekend.  We see the exchange rate frequently shaped by three considerations, oil prices, risk appetites, and interest rate differentials.  Oil prices have rallied by more than a quarter already this year.  Stocks are have rallied.  The Toronto Stock Exchange Composite is up 11.8% through the end of last week, edging out the US S&P 500 as the leading major index among the G7 (NASDAQ is up nearly 13.5% year-to-date).  Interest rate differentials have not moved in the Canadian dollar's favor.  Indeed, the two-year spread between the US and Canada has widened by around a dozen basis points this year.  The Canadian dollar was practically flat going into pre-weekend session and despite a central bank that is in no hurry to hike rates again and poor retail sales (second consecutive monthly drop at the headline level and the fourth month in a row that sales excluding autos fell), the Canadian dollar rallied.  The US dollar finished a little more than 0.8% lower on the week and its lowest level since February 6 (~CAD1.3135).   We had been leaning the other way and expected the poor retail sales to weigh on the Canadian dollar,  though we recognized that a loss of CAD1.3180 would likely send the greenback toward the lows seen earlier this month near CAD1.3070. 

Australian Dollar:   The Australian dollar has confined to a $0.7000-$0.7400-range for the past five months, except for the quirky flash crash (for the lack of a better term now) in early January that saw it spike to around $0.6740.  The Aussie had been recovering from a push toward the lower end of its range when news of a potential disruption in Australia's coal exports to China sent sharply lower (from $0.7200 to $0.7070).   The Aussie traded higher alongside risk assets ahead of the weekend, and the technical indicators are consistent with additional gains, perhaps even back to $0.7200.  

Mexican Peso:  The peso's 0.75% rally before the weekend reversed the small loss it had suffered last week until then and allow it to post a 0.5% week and increase the year-to-date gain to 2.6%.  Heightened risk appetites, helped by optimism on US-China trade, may have spurred the peso at the end of last week.  The peso rose for nine consecutive weeks through the end of January.  Here in February, it has alternated between advancing and declining weeks.  The dollar closed below its 20-day moving average for the first time in a couple of weeks, and the momentum could carry it back to MXN19.00.  It did spend a little time below there last month.  When the dollar is south of MXN19.00, the attractiveness of short-dated Cetes seems to diminish.  

Oil:  Light sweet crude oil for April delivery finished 2018 at about $46 a barrel.  It finished last week near $57.25, new highs since the middle of last November.  There are two technical forces we are monitoring.  First is a potential head and shoulders bottom with a neckline at $55 and a measuring objective near $67 a barrel.  The second corrective retracement targets to the drop since last October.  The 38.2% retracement came in just above the neckline, while the 50% retracement is found near $59.50.  The 61.8% retracement is about $63.40.  The daily technical indicators are stretched, but the weeklies show greater promise.  A retest on the neckline is not uncommon for the pattern, but a close much below it would weaken the case.  

US Rates: Bond market volatility measured by MOVE is near the lowest since at least 1988 when the Bloomberg time series began.  It runs contrary to conventional wisdom that explained the low volatility in terms of the expansion of the Fed's balance sheet.  Volatility has continued to decline despite the Fed's balance sheet shrinking and net expansion of the major central banks coming to an end.   It is related to why interest rates are low.  We argue that it is a function of supply and demand and it supports our surplus capital hypothesis.  We also recognize that low-interest rates reflect slow growth and low inflation.  It is also notable that the correlation between US 10-year yields and oil prices has broken down.  In fact, over the past 60 days, on a purely directional basis, the correlation as inverted, and over the past 30-days, the inverted correlation is the most extreme since last August.  The 10-year yield looks content between 2.60%-2.70% and the two-year yield 2.45%-2.55%. 

S&P 500:   The S&P 500 has fallen in only one week since December 21.  It gained 0.6% last week solely due to the pre-weekend advance, said to have been helped by the extension of the trade talks over the weekend.  Many market observers are trying to get their heads around the apparent reversal of the Fed's stance, but it may be the old mote and beam problem.  Investors sent the S&P 500 down 16.4% in a few weeks in December from 2800 and subsequently brought it entirely back.  The pre-weekend close of almost 2793 was the highest since November 8.  The 2800 area held the benchmark back in the second half of last October, November, and early December.  The Slow Stochastics and MACDs readings are stretched, and the former appears to be rolling over.  There is a gap from the higher opening on February 15 that is found between roughly 2757.9 and 2760.2 and may be the first target of a pullback.  The price action around it may offer insight into sentiment.  

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