The dramatic moves in the money market were investors discounting the acceleration of the tightening cycle among the major
economies. Japan is the outlier as the central bank clings to the idea that the rise in price pressures will not be sustained. Other central bankers can talk about being data dependent, but some
data are more important than others. Price data and inflation expectation
measures are more important than real sector reports. Even after news of the
unexpected contraction in May manufacturing output, the first since January,
expectations for a 75 bp hike next month edged a little higher.
The dollar spent the first part of June recovering after pulling back
in the second half of May. The retracement was deeper than we
expected, and the dollar made new highs against sterling and the yen. However, against the other major currencies, last month's highs held. Our
reading of the price action and the technical condition warns that the dollar's
recovery is over. It is vulnerable to a setback. It dovetails well with a
narrative that suggests the market has reached an extreme based on
the current information set of a peak in Fed funds around 4.5% next year. It was hovering around 3% at the end of May. Recall that the Fed's
median dot suggests a peak funds rate of about 4%. It has been such a rapid
adjustment (~150 bp in a couple of weeks) that some consolidation now seems likely.
Another notable development last week was the ECB's emergency meeting
that pushed along the process toward crafting a new instrument to resist
fragmentation (divergence) within the eurozone bonds markets. The
ECB argues that fragmentation interferes with achieving its price stability
objective. However, we have argued that 1) such a tool already exists, and 2) a
critical hurdle still seems to be strings (conditionality) attached. The earlier
tool under was the Outright Market Transactions, aimed at the short end of the coupon
curve (1-3 years), and the purchases were to be sterilized to minimize the
impact on the balance sheet. However, the innovation now is that the ECB
seems to be suggesting that it rather than the country will determine when to
trigger it. There seems to be a greater sense (hubris?) that officials can
identify what President Lagarde referred to as "irrational"
moves.
Dollar Index: The "buy the rumor, sell the fact"
after the Fed's 75 bp hike saw the Dollar Index retrace half of this month's
rally. It found new bids around 103.50 after setting new highs slightly
below 105.80. The MACD is in the middle of its range, but the Slow
Stochastic is over-extended and poised to turn lower early next
week. The upper Bollinger Band was violated on a closing basis early last
week, but the pullback brought into the band again. The upper band begins
the near week near 105.50. The Dollar Index looks poised to make a new high,
but we will be looking for a reversal pattern or another sign that the bulls
are getting tired. That said, the next important technical area is not
until 1.08-1.09.
Euro: On June 9, partly in reaction to the ECB meeting, the euro
posted a bearish outside day, trading on both sides of the previous session's
range and closing below its low. The single currency was stymied around
$1.0775. The sell-off extended to about $1.0360, with the low recorded
shortly after the FOMC's announcement. Recall that the five-year low set
last month was closer to $1.0350. The ECB signaled its commitment to resist
significant divergence in the EMU bond market. The combination of this
and the US 2-year premium over Germany slipping below 200 bp for the first time in nearly four months helped spur a short-squeeze that lifted the euro, which briefly
poked through $1.06. While core-periphery spreads narrowed further ahead
of the weekend, the euro lost its mojo and returned to around $1.0440. The MACD
is moving lower, and the Slow Stochastic is over-extended. Although it
looks like it could turn higher next week, recall that it remained in oversold
territory from early April through the middle of May.
Japanese Yen: Japanese officials succeeded in stabilizing the
dollar-yen exchange rates despite the stark divergence of monetary
policy. Within about 24 hours of the FOMC meeting, the dollar had fallen
from a new 22-year high near JPY135.60 to JPY131.50, a nine-day low. The
work was undone by the BOJ, which at its meeting gave no sign that it would
alter its monetary stance even though the core inflation measure has met its
target. While acknowledging that a dramatic fall in the yen is destabilizing,
Governor Kuroda did nothing to shake the perception that he favors the
direction. The BOJ statement said that it will watch the foreign exchange
market and capital markets closely. Does
it really tell us anything that we did not know? Continuing to ease
policy via the balance sheet and keeping the 10-year yield capped at 0.25% is disrupting
the function of the markets, and last week the futures/cash link broke down. The chances of intervention seem even more remote on this side of the BOJ
meeting, not that we thought they were particularly high in the first
place. The Slow Stochastic has turned down, while the MACD is turning
higher from a shallow dip. Still, the dollar looks poised for possibly strong
gains next week. There will be more talk of a move toward JPY140.
British Pound: Sterling was squeezed higher after falling to a
new two-year low near $1.1935 on June 14. The broad setback in the dollar
after the FOMC meeting and the hawkish forward guidance by the Bank of England
lifted sterling almost a nickel off the low, a little above $1.24. It met the
(61.8%) retracement objective of the decline from the late May high (~$1.2665)
that came slightly lower. Support near $1.2170 was tested before the
weekend. A break below $1.2100 warns of a return to the lows. Last week, the 3% gain on Wednesday and Thursday was sufficient to turn the Slow
Stochastic tentatively higher, but the MACD looks to be rolling back
down. June 24 marks the sixth anniversary of the Brexit
referendum. It poked a little above $1.50 that day but subsequently fell
to $1.3230 and settled around $1.3680.
Canadian Dollar: Ahead of the weekend, the Canadian dollar fell
to a new low since November 2020. The risk-off mood, encouraged by many central banks' more aggressive efforts to tighten financial conditions,
seems to offset Canada's good macro story. One weight in addition to the
S&P 500's (proxy for risk) 5.8% decline last week was the continued
reduction in Canada's two-year premium over the US. It had reached a new high
for the year of almost 35 bp on June 8 and by the end of last week had fallen
to less than five. The momentum indicators give the greenback room to
extend what could prove to be an upside break out. The CAD1.3025 area
corresponds to the (38.2%) retracement of the greenback's decline from the March
2020 high (~CAD1.4670). The US dollar took it out last month, but it
proved a false break. The next retracement (50%) is near CAD1.3340. However, the sharp run-up (from CAD1.2520 on June 8) has pushed the US dollar
above the upper Bollinger Band ~CAD1.3035). Canada reports April retail sales
next Wednesday and, arguably more important in the current context, May CPI
on Thursday. The swaps market is only about halfway toward pricing a 75
bp more instead of 50 at the July 13 Bank of Canada meeting. A strong
inflation report could boost the market's confidence.
Australian Dollar: The Australian dollar approached last
month's low (~$0.6830) and found a bid near $0.6850. It squeezed to
almost $0.7070 after the strong jobs data and hawkish comments from RBA
Governor Lowe. However, it appears to be a proverbial dead cat bounce, and
before the weekend, it has returned to $0.6900 and the lower Bollinger
Band. The two days of gains failed to turn the MACD higher. The
Slow Stochastic looked as if it were poised to turn lower, but the poor price
action before the weekend means it may not. The futures market now sees the
year-end rate near 3.85%, up slightly more than 150 bp over the past two
weeks. The rate premium over the US has also jumped, but the Australian
dollar depreciated by nearly 4% over those two weeks. A break of $0.6830
could signal a move toward $0.6760, the (50%) retracement of the Aussies' gain
since the March 2020 low (~$0.5510). The Australian dollar's correlation
with iron ore on a 30-day rolling basis is at a two-year high (0.52), and new
Covid restrictions saw iron ore prices fall 14% last week, the biggest weekly
decline since last September.
Mexican Peso: The dollar rose by about 2% against the
Mexican peso for the second consecutive week, which snapped a five-week slide. Tuesday through Thursday, the greenback stalled in the MXN20.69-MXN20.70
range. That is the highest level since mid-March. The momentum indicators
are getting stretched. A break below MXN20.20 may be enough to turn them
down. Shortly before Banxico meets on June 23, Mexico will report the
mid-June CPI figure. The biweekly measure has been stabilizing between
7.5% and 7.75% for nearly three months. April retail sales will also be
reported before the central bank decision. A small decline would not be
surprising. There is almost universal agreement that Banxico hikes by 75
bp after moving in 50 bp increments at the last four meetings. The
trendline drawn from last November's high (~MXN22.1550) and the March high (~MXN214675)
comes near MXN20.76 at the beginning of next week. A break could spur a move toward
MXN21.00 initially.
Chinese Yuan: The greenback edged lower against the Chinese yuan last week. In the 15 weeks since the end of February, the dollar has risen against the yuan in all but three weeks. However, the strong uptrend ended a month ago after the dollar peaked around CNY6.8125. Since then, it has been in a range, mostly CNY6.65-CNY6.75. Maybe the CNY6.60-CNY6.80 is acceptable. Chinese stocks bucked the regional and global push lower. The CSI 300 rose 1.65%, its third consecutive weekly gain and the fifth in the past six weeks. It is still off about 12.8% for the year. On the other hand, the Chinese 10-year yield discount to the US widened to 42 bp last week. A small premium had been restored in the second half of May.
Disclaimer
Reviewed by Marc Chandler
on
June 19, 2022
Rating:
