Currency Positioning and Technical Outlook: Heavy Dollar Looks Likely
There are several incremental additions to our information set from developments over the past week. The US manufacturing sector is stalling, with the ISM at new four month lows, and the sector failed to add jobs in April, for the first time since last September. The euro area economy remains weak and the German engine also appears to be flat lining.
Industrial output in Japan is stabilizing, albeit at weak levels, while domestic consumption remains restrained and wage growth is poor. This suggests that only the weak yen component of Abenomics seems to be working. Ironically, it is the UK's economy that provided the upside surprises in recent days and sterling was rewarded by being bid to new 11 week highs and finally reaching our $1.56 objective first cited here in late March.
In terms of policy, there were no surprises by the FOMC, but by including into the statement what Bernanke and others have already said about its flexibility, to quicken or slow the pace of its purchases in response to economic developments, drives home the point about the symmetry of its stance. Although the recent FOMC minutes showed there was a discussion about tapering off purchases, it is still possible that the Fed may have to accelerate its purchases, especially if growth slows sharper than anticipated and if disinflation continues.
The ECB delivered a 25 bp cut, but effectively kept the door open to more action, which could include another 25 bp rate cut in the refi rate and possibly measures to support the ABS market for non-financials. Although Draghi seemed to suggest greater willingness to consider a negative deposit rate, our sense was that this was not a signal of intent or even desire. We suspect that a negative deposit rate would be disruptive and another headwind for the financial sector and savers. Draghi's rhetoric may have been aimed at demonstrating that the ECB had not exhausted its options.
The US dollar fell against the major currencies, except the yen, last week and appears poised, from a technical perspective, to continue to trade heavily in the days ahead, though the week will begin slowly with both Tokyo and London markets closed on Monday.
The Dollar-Index did rally in the second half of last week, but ran into a wall of offers near 82.50 a key retracement objective of the previous week's drop. Provided this area holds, we are more inclined to see it fall toward 81.20 and maybe 80.70.
The decline in the euro in the second half of last week largely held a trend line drawn off the April 4 and April 24 lows. The trend line comes in near $1.3070 on Monday and $1.3125 by the end of next week. Initial resistance is see near $1.3160 and then $1.3240. The euro has not managed to finish the North American session above $1.32 since Feb 20. Good demand for euros around $1.30 has spurred talk of central bank interest.
After the conclusion of the Golden Week holidays, Japanese institutional investors are thought likely to begin implementing the investment plans for the new fiscal year. We remain skeptical of the magnitude of the outflows. Many core European bonds, like France, Belgium and Austria offer record low yields. Yield in the large peripherals, like Spain and Italy are at multi-year lows. Meanwhile, anecdotal reports suggest the foreign appetite for Japanese shares, which in the year through mid-April, has been nearly $65 bln (more than twice the pace of the year ago period) may be slowing.
Short-term speculative sentiment remains wholly yen negative and technically the market looks poised to try again at the JPY100 level. A break of it could see a quick move toward JPY101.40. Now only a break of JPY97 would dampen the constructive technical tone.
It has taken a bit longer than we anticipated, but sterling has reached our $1.56 objective, but it does not look as if the move is over. The next target is near $1.58, while a break of $1.54 would suggest a top is in place.
The dollar-bloc finished last week on firm footing. Although poor data have increased the risk that the Reserve Bank of Australia cuts interest rate as early as next week, the Australian dollar finished the week at three day highs. A move now above $1.0325 would target $1.04. Some Aussie bulls may also take heart from the recover in copper prices, which finished the week at its best level since mid-April. Gold prices traded broadly sideways last week, but also managed to record a marginal new high since the dramatic sell-off in mid-April.
The Canadian dollar recovered from the knee-jerk sell-off on news that the new central bank governor sounded a bearish note when talking about the need to boost exports to reinvigorate the economy. The US dollar slipped as we anticipated last week into the CAD1.0070-CAD1.0100 area. Our next target is near CAD1.0020.
We turn more cautious the Mexican peso as the dollar approaches the MXN12.00 area. The dollar bounced smartly off this area in mid-April. Technical indicators suggest that with a running start the greenback can be pushed through there now. However, our cautious stance is based on two considerations. The government seems to be turning less receptive to further peso gains and the trade is very crowded. The Mexican peso has been the strongest currency we monitor here, up about 6.5% year-to-date and strongest in the emerging markets as well.
Observations on the speculative positioning in CME currency futures:
1. The net short position of the euro, yen, sterling and Canadian dollars were reduced, while the net long Australian dollar and Mexican peso were pared.
2. The net Swiss franc position swung from long back to short. The net long position was a function of reduction of gross longs and shorts, while the shift back to a net short position was function of the establishment of new shorts and paring of longs.
3. The net short yen position was reduced for the second consecutive week, but participation was reduced as gross longs and shorts fell.
4. There was no gross position adjustment of more than 10k contracts. In fact, all but three positions (gross long euros, gross short yen and Canadian dollar positions) changed by no more than 6k contracts.
5. There was almost a doubling of gross short peso positions to 7.4k contracts. The increase snapped a five week streak in which the gross shorts were reduced. However, peso gains after the end of the reporting period may have forced out these late shorts.