Trump's Tariffs Did What Fed Couldn't: Start a Dollar Correction

We look for patterns in macroeconomic data and prices.  We have a sense of deja vu.  A period of trade calm, the US uses tariffs to force China to do something.  Stocks go down.  Interest rates fall as does the dollar.  A truce is declared, leaving tariffs at higher levels and equities recover, the dollar firms and interest rates stabilize.  We have seen this play out now for the third time.

The dollar was accelerating higher in response to Powell's spinning the rate hike as a midcourse adjustment while investors wanted a clear signal of an extended easing cycle.  Equities were getting over their shock, and interest rates stabilized, and the greenback's momentum slowed before Trump unexpectedly broke the tariff truce.  This saw equities, interest rates, and the dollar fall.  Our reading of the technical condition warns that the moves are not over. 

Dollar Index:  Shortly before the tariff truce ended on August 1, the Dollar Index approached 99.00, the highest level since May 2017 and also the objective of a possible head and shoulders pattern. It reversed lower with a potential bearish shooting star candlestick and follow-through selling ahead of the weekend.  It held technical support ahead of 98.00, and there is additional support a little lower in the 97.75-97.80 area.  The technical indicators give little indication that nearby support will hold and a break of the 97.50 area will likely be convincing that the upside breakout was repelled.

Euro:   The less dovish Fed spin on its first rate cut in over a decade send the euro skidding through $1.1100 to new lows for more than two years.  Follow-through selling it saw it reach almost $1.1025.  The $1.10 area was the technical objective.  The euro reversed higher with the adjustment to US rate expectations in response to the tariff tweet, and a bullish hammer candlestick may have been laid.  It closed the week a little above $1.1100.  The Slow Stochastics and RSI are turning higher, but MACDs are lagging a little.  A move above the $1.1165 area is needed to be of anything important.  On the downside, a break of $1.10 would target $1.08.  In the options market, benchmark three-month implied volatility has risen, and calls are trading the largest discount to puts in three months, apparently reflecting put buying. 

Yen:    The dollar essentially covered the range of the past two months in the last two trading sessions.  The dollar punched through JPY109, which had capped it since the end of May. It saw JPY109.30 before the end of the trade truce was declared.  The tweets set off a sharp reversal, and the dollar recorded a large outside down day, holding a little above JPY107.00.  Continued selling the next day saw the dollar trade to JPY106.50 and closed just above there.  The move is extended as the greenback begins the new week below its lower Bollinger Band (JPY107).  The technical indicators reflect the strong downside momentum.  The next important chart area is near JPY105.

Sterling:  Sterling's sell-off continued unabated.  It fell to around $1.2080, its lowest level since January 2017. Ir fell for the 13th consecutive week against the euro.  The technical indicators suggest a consolidative phase may be near.  A bounce toward $1.2250-$1.2300 may be the first line of defense for the bears.  The euro has already entered a consolidative phase in the GBP0.9100-GBP0.9200 range. Three-month implied volatility is near the year's highs seen in February near 12%.  It had fallen to around 6.3% in early July. 

Canadian Dollar:  The US dollar's performance against the Canadian dollar also seems to be a possible tell of a broader greenback correction.  It overshot out CAD1.3220 target and reached CAD1.3265 before the weekend and reversing lower, and apparently leaving bearish hammer candlestick pattern behind.   A break now of the CAD1.3165 area would confirm a top is in place.  The technical indicators suggest turn is coming.   We target the CAD1.30-CAD1.31 range initially.  A healthy jobs report at the end of next week will remind participants why the Bank of Canada is one of the few central banks that is not considering easier monetary policy. 

Australian Dollar:   Bloomberg tells us that the 10-day sell-off was snapped ahead of the weekend by the smallest of gains.  It fell to six-month lows a little below $0.6765. The technical indicators reflect the downside momentum but are near turning.  A move back above the $0.6830-$0.6850 would help improve the technical tone.  The turn lower of iron ore prices and the decline in copper prices coupled with the escalation in US-China trade conflict makes for a poor backdrop for the Australian dollar. 

Mexican Peso:  The US dollar will take a six-session rally against the Mexican peso into the start of next week.  It matches the long advance over the past five years.  The greenback briefly traded above the spike high seen in response to the unexpected resignation of the finance minister a month ago.  It reached the highest level since the US tariff threat was lifted in the first part of June.  Risk-off sentiment and concerns about world growth weighed on nearly all the emerging market currencies last week.  The dollar stopped at its 200-day moving average (~MXN19.3765).  News that Mexico avoided, albeit barely, a second consecutive quarterly contraction, failed to turn the peso's fortunes around as the year-over-year decline (0.7%) was more than twice what was expected.  We suspect the strength of the Japanese yen may have sparked unwinding of carry trades that fund long peso positions with short yen.  After Ukraine, it appears Mexico now has the highest real rates and among the highest nominal rates, which will continue to make it an attractive carry candidate.  The dollar closed above its upper Bollinger Band (~MXN19.2655), but the other technical indicators we use are not stretched.  Still, with the dollar below its lower Bollinger Band against the yen and above its upper band against the peso, new peso-yen trades may look appealing.  The cross is approaching a three-year uptrend line ahead of the early June lows (~JPY5.4350).  

Chinese Yuan: The US government may grit its teeth on news that the dollar rose to new highs for the year against the Chinese yuan and that the US bilateral trade deficit rose to a five-month high in June. Pundits may talk about the PBOC offsetting the tariffs with a weaker yuan, but the fuel of the move is to be found in Washington.  Between the Federal Reserve delivering what many saw as a hawkish cut and the new tariffs that Trump tweet was the main impetus behind the yuan's slide.  Until those events, the dollar-yuan rate was as stable as imaginable, especially given the greenback's gains elsewhere.  We argue that if the yuan were a truly free-floating currency, it would likely have depreciated more given the macroeconomic developments and the dollar's performance more broadly.  The onshore yuan (CNY) rose a little through CNY6.95, and the offshore yuan (CNH) rose to CNY6.98.  It raises the question of the importance of CNY7.0 and how seriously China will defend it.  It remains an inflection point that could spur more volatility so officials will be monitoring it closely.  The heavier dollar tone seen in North America despite the employment report being in line with expectations (though weakness in hours worked will keep Q3 GDP forecast subdued with the NY Fed and Atlanta Fed trackers at 1.6% and 1.9% respectively), may spill over and reduce the urgency to challenge CNY7.0. The forward rate (spot+interest rate differential) is not above CNY7.0 until about nine-month tenor at indicative levels at the end of last week.  

Oil:  When everything was said and done, WTI for September delivery fell by a little less than one percent last week.  But this is not a dog-bites-man story.  Trump's new tariffs stopped cold a five-day roughly 5% rally that had been partly encouraged by the continued drawdown of US oil stocks.  The draw comes despite near-record US production as imports, especially from Saudi Arabia, have declined.  September crude tanked by almost 8% on August 1, one of the largest declines in a single day.  It seemed an exaggerated response and prices recovered above half the following day, ahead of the weekend.  The 200-day moving average is $58, and this area seems to need to be overcome to lift the technical tone.  

US Rates:  The US 10-year yield fell to 1.83% last week, the lowest level since the 2016 election, despite the rising deficit and debt levels.  Yields have fallen by 22 bp over the six-day drop.  Powell said a midcourse adjustment, but the market did not fully buy it.  The new tariffs emboldened investors. Over half the decline in yields took place in the immediate response to the tweets.  The September note futures contract closed the past two sessions above its upper Bollinger Band, which may spur some consolidation in the coming days.  The 10-year yield bottomed in 2012 (~1.38%) and 2016 (~1.38%).  The market is totally convinced the Fed will cut rates again next month and sees a slightly greater chance of a 50 bp move than it standing pat.  The January 2020 fed funds futures contract implies a 1.62% average effective rate, a decline of a dozen basis points on the week.  It is the lowest closing weekly rate since September 2017.   This means the market has discounted two cuts in the three FOMC meetings and a little bit more.  

S&P 500:  The benchmark began the week at record highs, but the momentum was lost.  It was signaled by the gap lower opening on Tuesday that was quickly closed, and the gap lower opening on Friday that was also quickly closed before new lows were recorded.  The 3.1% loss is the largest weekly slump of this year.  The decline fulfilled the (38.2%) retracement objective of the rally that began in early June.  The MACDs and Slow Stochastics did not confirm the record highs, and this may leave the underlying technical tone suspect.  The five-day moving average has crossed below the 20-day moving average for the first time in nearly two months. If a deeper pullback, as we suspect, is unfolding, the 2960-2970 cap a bounce and our target is the gap from the middle of June (~2897.3-2909.5).  That gap currently houses the 100-day moving average (~2900.50).  The next retracement of the two-month leg up (50%) is found a bit lower around 2878.50.

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