Dollar Correction may Continue, but S&P 500 Post Key Upside Reversal

In the wake of the May 5 tweets that signaled the end of the tariff truce, the dollar was mixed, with a heavier bias.  The strongest currencies were the Japanese yen (~1.0%) and Swiss franc (~0.45%).  The Dollar Index fell about 0.2%.  The major currencies that failed to gain against the dollar had idiosyncratic factors, like the seeming failure of the cross-party talks in the UK (sterling fell ~1.3%) or the rate cut in New Zealand (~-0.75%), and a series of weak economic data from Sweden (krona ~-0.70%) in contrast to Norway where the central bank indicated another hike as early as next month.  

Within a medium-term bullish outlook, we anticipated and continue to track what appears to be a consolidative/corrective phase for the dollar.  On balance, we expect this phase to continue in the week ahead.  The escalation of trade tensions between the US and China has offset the impact of the surge in Q1 US GDP and the strong April jobs data on expectations for Fed policy.  The dollar bulls need more time, as it were, to adjust to the narrowing of interest rate differentials, and consider the impact on US corporate earnings from formal or informal retaliatory action by China that may follow.  

Dollar Index:  A 0.2% loss for the week follows the 0.5% loss the previous week and is the first back-to-back decline since late January-early February. The high for the move was set on April 26, in the initial reaction to the stronger Q1 GDP report (~98.33).   Before the weekend, the dollar traded a little below 97.15, its lowest level since April 18.    Reflecting the dollar's soggy tone, the five-day moving average slipped below the 20-day average at the end of the week for the first time since late March.  The technical indicators are consistent with additional near-term losses.  The 97.00 may offer some support, but better support may be seen near 96.70, which is a (61.8%) retracement of the leg up that began on the last day of winter.  It also coincides with the 100-day average.  

Euro: At the end of April, the euro appeared to break out of its trading range.  That range was roughly $1.3-$1.15 but had been extended to $1.12.  Immediately after the surprisingly strong Q1 US GDP, the euro fell to about $1.1110, a new low since mid-2017. It rebounded to closer high on the day and has preceded to trend gradually higher since.  It began a run higher that has now extended to eight of the past 11 sessions. The euro edged to a seven-day high before the weekend but continues to find offers in the $1.1250-$1.1260 area, which also houses the 50-day moving average (~$1.1255)  The technical indicators are constructive, and the upside risk extends into the band from $1.1285-$1.1340.  The five-day moving average is poised to move above the 20-day in the coming days. Initial support now is $1.1180-$1.1200.   

Yen:   The dollar gapped lower against the yen at the start of last week.  That gap is of technical importance and is found between about JPY110.95 and JPY111.05.  Japanese markets re-opened from their extended holiday the following day but did not protest the yen's strength.  Instead, the dollar fell.  It fell in the first four sessions before bouncing a bit (~0.2%) ahead of the weekend to close a touch below JPY110.00, and just inside lower Bollinger Band (~JPY109.85).  The RSI turned up and the MACDs look poised to cross higher, while the Slow Stochastic demurs.  The gap may attract prices.  Support is seen in the JPY109.50 area.  We are inclined to see it hold and dollar test the gap. 

Sterling:  Short-term market participants have little to anchor their views for sterling.  Last week, sterling tumbled 1.3% after gaining nearly 2% the week before. Despite those swings, implied three-month vol drifted toward 7% from 7.5% the week before.  Sterling closed below $1.30 ahead of the weekend for the first time in nearly two weeks.  There is nothing particularly special about last week's low a little below $1.2970. The low from late April near $1.2850 and the $1.2800 area is more important. 

Canadian Dollar:  The US dollar has been mostly confined to a CAD1.34-CAD1.35 trading range for the past couple of weeks.  Although the option-skew (risk-reversal) favors US dollar calls, we are concerned that the narrowing of the two-year interest rate premium the US offers exposes the greenback's downside.    The two-year differential finished last week at 63 bp.  It had peaked in early March at 85 bp.  It is not just the prospects of a Fed cut if the trade war intensifies, but the recent data are seen reinforcing the Bank of Canada's neutral setting.  The implied yield of the December Banker Acceptance (BA) futures fell five basis points in response to the strong April jobs data that also showed a 2.6% year-over-year increase the average hourly wage rate for permanent workers. Perhaps it if equities and oil stabilize, as we expected, investors can focus on the rate differential. 

Australian Dollar:   The Australian dollar fell for the fourth consecutive week.  The momentum appears to have stalled, though a break below $0.6960 could re-start it.  The MACDs and Slow Stochastics seem set to turn up.  The RSI (nine-day) has already done so, and more: there is a bullish divergence as the indicator bottomed in late April and did not confirm these May lows.  Between the central bank's downgraded economic forecasts, the unexpected decline in quantity (price adjusted) retail sales in Q1, trade tensions, and risk-off environment, there were plenty of macro reasons to sell the Aussie.  The limited nature of the decline is illustrated by the weekly close a couple hundredths of a cent above $0.7000.  On the upside, initial resistance near $0.7025 needs to be overcome to challenge a stronger cap almost half a cent higher.  

Mexican Peso:  The trade tensions and risk-off mood saw the dollar rise in the first four sessions of last week, reaching a high of almost MXN19.32, the highest since late March and the 200-day moving average.  The dollar surrendered about of third of those gains ahead of the weekend to close a little above MXN19.10.  We envision Mexico to be one of the potential beneficiaries of the US-China trade tensions and especially as the higher tariffs begin being levied on more consumer goods.  The central bank will likely keep rates on hold this week (8.25%).  The high-interest rates (nominal and real), and there is reason to expect lower interest rates at some juncture, as the economy is already feeling the pinch, continue to draw investor interest.  The (61.8%) retracement of the dollar's advance since the start of the month is near MXN18.99, but there might not be strong support ahead of the lower end of the range around MXN18.75.  

Oil: The price of June light sweet crude oil fell for the third consecutive week, the longest losing streak of the year.  It had closed near $61.50 before dropping to almost $60 (200-day moving average is about $60.70) in response to Trump's tweets.  It spent the rest of the week within the range established Monday (~$60-$63). The pattern is often understood as a continuation formation.  It would project toward $58 a barrel, which approximates the (38.2%) retracement objective of the rally since the end of last year.   The 100-day moving average is found near $57.25. The technical indicators are more constructive, and the MACDs and Slow Stochastics appear poised to turn up.

US Yields:   The US 10-year yield has fallen by 10 basis points over the past four weeks and a little more than half were recorded last week.  The yield decline was recorded before the slightly softer than expected April CPI reported ahead of the weekend when the 10-year yield rose by 2.5 basis points.  The three-month to 10-year curve briefly turned inverted, and shortly after the blogosphere was full of accounts of what it meant, it reverted to what it really is: flat.  We note that the effective fed funds rate has drifted lower since the May 1 FOMC decision to cut the interest on reserves by five basis points.  The effective average rate had firmed to 2.45%, through the 2.40% interest on reserves at the time.  The effective average eased to 2.38% on May 9.  The June note futures gapped higher on Monday, and that gap remains unfilled (123-15 to 123-18). Strong upside momentum could not be established.  The high for the week was 124-08.  It was unable to close above 124-02 where the (61.8%) retracement of the decline from the late March high is found. 

S&P 500:  The S&P 500 staged a dramatic reversal ahead of the weekend, likely signaling an end to the downdraft that took it 4.4% from the record high on May 1 when it posted a downside reversal.  First, the S&P 500 was sold below May 9 low. Then it turned on a dime and rallied through the May 9 high.  It proceeded to close above it as well. The MACD and Slow Stochastics lag and do not recognize the significance of the reversal as a reflection of market psychology. In one fell swoop, it recouped half of that it had lost since the start of the month.  The next (61.8%) retracement objective is near 2905. The Dow Jones Industrials also posted a key reversal, but the NASDAQ did not.    

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