Currency Positioning and Technical Outlook: Look to Fade the Correction
The technical tone of the major foreign currencies changed in the second half of last week. Better Australian jobs data, more dovish Reserve Bank of New Zealand and Norges Bank, unexpectedly optimistic comments from Bank of England Governor King and reports Qatar was looking to invest GBP10 bln in the UK, saw dramatic counter-trend moves. While recognizing that market positioning gives scope for some extension of these corrective moves, we advise taking advantage of the price action as a better opportunity to participate in the underlying trends or, alternatively, adjust hedges accordingly.
The one major exception to this general view is the Japanese yen. We remain concerned that the yen's dramatic depreciation is nearly over. The market's react more to surprises than known developments. Abenomics is largely a known quantity. There is still one more window of opportunity to shock and awe the markets. That is when Kuroda announces the new asset purchases, which may happen as early as later next week, or the following week, but likely before the regularly scheduled meeting in early April.
We note that Japanese investors have generally been selling foreign bonds here in 2013, with MOF data showing only two weeks this year in which Japanese investors were net buyers. Ahead of the fiscal year end, it would not be surprising to see more repatriation, which may be yen positive.
Our work shows that the US-Japan 10-year interest rate spread has done a fair job tracking the dollar-yen exchange rate. Expectations of new and more aggressive BOJ purchases of long-dated JGBs have helped keep the 10-yield near the lowest level in almost a decade. However, it is the US Treasury leg that appears to be more influential on the spread. Despite a series of strong economic data, which is beginning to convince some naysayers that the US economy may indeed be resilient in the face of spending cuts and tax increases, the US 10-year yield remains near 2%.
The dollar recorded its low for the week just above JPY95 pre-weekend dealings. This band, that extends to JPY94.80 needs to be taken out to provide greater technical evidence that a top is being carved out. Alternatively, a move back above JPY96.30-50 would suggest a new leg up.
The euro's recent losses have met the minimum objective of the large head and shoulders topping pattern we identified (the right shoulder was carved out in the second half of Dec '12, the head was created by the brief move above $1.3700, and the right shoulder was formed in mid-Feb). This, coupled with retracement targets, suggested a test on the $1.2880-$1.2900. The euro neared $1.2900 (~$1.2911 on March 14) before bouncing almost two cents to briefly trade through the 20-day moving average for the first time in a month.
More often than not this year, the euro moves in the opposite direction on Monday from what it moved on the previous Friday. This suggests a lower close is likely in North America on March 18. We peg resistance in the $1.3130-60 area. A convincing break of this area warns of a deeper correction that could carry the euro in the $1.3200-$1.3400 area. This is not the most likely scenario to us. The 2-year interest rate differential between the US and Germany continues to gently push higher and new highs since early January were recorded and this should be dollar supportive.
Sterling bounced smartly off 3-year lows recorded early last week near $1.4830. This met our technical objective ($1.4800-$1.5000). The bounce appears to have stalled ahead of the band of resistance in the $1.5200-20 area. If this area is convincingly surmounted, the next target is near $1.5340.
Technical indicators, like the RSI and MACDs warn that both the euro and sterling have scope for a more significant recovery. We are not as convinced that this will be realized. We think the risk is that the euro and sterling make another leg down before a more sustained correction unfolds.
The Canadian and Australian dollars had impressive corrections. However, both seem to have run its course, The Canadian dollar tested a retracement objective of the four week decline that saw the greenback go from CAD1.0000 to almost CAD1.0350. A break of CAD1.0170 now would suggest one more leg down toward CAD1.0130 before another low risk opportunity to buy the US dollar again.
The Australian dollar's recovery that began on March 4 off the multi-month low near $1.1015 is more mature. At the pre-weekend high just above $1.0400 represents a 61.8% retracement. We are not convinced that the jobs data were as strong as many observers seem to believe. Nor does it change our view that the RBA will likely resume its easing cycle later in Q2. If there is follow through Aussie buying, we look for another opportunity to sell it near $1.0470.
Lastly, the Mexican peso has rallied strongly even after the central bank's surprise 50 bp rate cut on March 3. Over the past week, the peso has been one of the strongest of the actively traded currencies, second only to the Australian dollar, which rose sharply following news of a headline gain of 71k jobs (though the bulk were part time positions and even an RBA member recognized a statistical quirk. We anticipate near-term consolidation before the peso strengthens further, and are inclined to sell into dollar bounces that could extend toward MXN12.53-MXN12.60.
We share the following observations about speculative positioning in the futures market.
1. The CFTC Commitment of Traders report is usually released with a 3 day lag. Most of the time the data is sufficiently timely. However, given the large price swings in the Wed-Fri last week, the positioning data may be less relevant. We will try to minimize this by focusing on the big picture.
2. In the period ending March 3, in the currency futures we track, all the gross longs fell and all the gross shorts rose. In the most recent reporting week, ending March 10, the long euro, sterling, Swiss franc and Canadian dollar positions continued to be pared. The yen bottom pickers barely grew, but it was a small positive. Speculators continued to build long Australian dollar and Mexican peso futures positions.
3. There were some minor signs of profit taking in the reporting period with a small paring of short euro and sterling positions. Some short peso positions capitulated.
4. There were only three gross futures positions that changed by more than 10k contracts. Two of which were the Australian dollar and Mexican peso as longs piled in. The third was the Japanese yen were shorts jumped by almost 21k contracts.
5. With no net switching from short to long (or the other way around) took place, positioning in the Canadian dollar maybe the most interesting. The net short positions edged higher as longs were cut and shorts grew. The gross short position of 90.4k is approaching the record short seen in Jan 07 near 106k contracts. Many of these new short positions are in weak hands. By weak hands we mean vulnerable to a correction. We deduce that by the pace at which they have grown. Recall that in early February, there were 12.5k gross short contracts. A similar but less powerful case an be made for sterling. The gross short position has more than doubled since early Jan. This most recent reporting period was the first since late Dec that the gross short position did not grow. We suspect the many yen shorts are in weak hands for the same reason.