Our analysis of the foreign exchange market has emphasized that what many see as the US dollar's decline has largely limited to the euro and sterling. On a broader basis, the dollar has been appreciating. The Bank of England trade weighted measure of the US dollar, which is updated daily, had appreciated almost 4% since testing the year's low almost three months ago. In fact, on this metric, it was trading at 6-month highs on the eve of the US jobs report.
The shockingly weak employment report has dealt an important blow to market psychology, even if the immediate price action was a bit exaggerated. The disappointment over the jobs data was acute because many investors had been moving in the opposite direction. The 4-handle on Q3 GDP, the upward revisions to Q4 GDP estimates, had convinced many investors that the US growth was accelerating. With less of fiscal drag, 2014 was going to be a breakout year.
We have argued that the Fed's forward guidance delivered by Bernanke who will not be there to implement it, and seemingly refusal to provide the new chairman with the opportunity to display her leadership skills, undermines the Fed's credibility. Yellen appears to have been Obama's first choice, which appears to have been Summers. Now Obama is nominating Stanley Fischer, the rock star of central bankers who was the dissertation adviser for both Bernanke and Draghi's doctorate degrees in economics, as Vice Chairman of the Federal Reserve. Under such circumstances how can the former #2 get the respect (earn the gravitas) of a #1 ?
On top of that it was the Bernanke Fed that laid out the road map for the exit from QE3+. The weaker Fed credibility translates into the lack of conviction by investors. The first significant piece of disappointing data and many questioned whether the Fed's tapering will continue. In response to the poor jobs report, the US 10-year yields dropped about 10 bp, the most since the mid-September reaction to the Fed's decision not to taper. The 2-year yield had been edging toward the September high near 50 bp, dropped back below 40 bp--levels not seen in a month--and approaching trend line support near 33 bp.
Given this context, we suspect that the dollar will be particularly sensitive to the next string of economic data. Not all data, but real sector, output and consumption data. The US reports PPI and CPI figures are the end of next week, but as we have seen the Fed did not let the lower core inflation readings deter the December tapering decision, much to our chagrin.
Next week sees two important real sector reports: retail sales and industrial output. The unexpected weakness in US December auto sales will likely translate into a soft retail sales report and the poor weather in December that depressed the employment report may have dampened shopping. Industrial output may have also been depressed by weather factors, though the frigid temperatures may have boosted utility output.
The bottom line is that investors should be prepared for some less inspiring US data and this may weigh on the dollar. The euro and sterling appear poised to re-challenge the recent highs around $1.3800 and $1.6600 respectively, even if there is some consolidation at the start of the new week. This is a key area for the euro as the market has tried on three separate occasions to sustain a break of it (the second half of October and mid-and late-December) On the downside, it probably requires a convincing break of the $1.3550 area to spur ideas that a top is in place. This area corresponds to the 100-day moving average, a level that the euro has closed below once in the past six months. The Relative Strength Index has turned up and the MACDs are about to cross higher.
The technical indicators are not as clear for sterling and the UK reported its own disappointing data (industrial and construction output and BRC retail sales), but the weaker US dollar was the dominant theme. It is also in the middle of what appears to a largely $1.64-$1.66 near-term trading range. This implies that the euro should out perform sterling in the period ahead. After hitting a one year low against sterling on the eve of the US jobs report (~GBP0.8230), the euro looks poised to recover toward GBP0.8320-50.
The sharp decline in US yields in response to the jobs report sent the greenback sharply lower against the yen. It was the biggest dollar decline in about ten weeks. It finished below the 20-day moving average for the first time in two months. The risk is that the yen's strength weighs on the Nikkei, which lost 2.3% last week to be the weakest of the major bourses. Still, investor psychology is such that a short yen position is among the most favorite trades for 2014. This means that yen bears are not going to rush for cover and are inclined to sell into yen bounces. Initial support is seen in front of JPY103.50. A break of it could spur a move toward JPY102.50. However, given sentiment, the risk is that yen bounces are less than what technical indicators would suggest.
The dollar-bloc currencies have generally under-performed, but the Canadian dollar has taken the leadership from the Australian dollar. Given the large short speculative Canadian dollar position, second only to the Japanese yen in the futures market, we suspect the first sign of flagging momentum could spur a bout of short covering. The first indication may be if the US dollar falls below its previous day's low, which has not taken place for the last six consecutive sessions.
Short covering seems to be already taking place in the Australian dollar, where the technical indicators, like RSI, MACD and the crossing of the 5-day average above the 20-day average. The Ausssie gained a little more than 0.5% against the US dollar last week, for the second consecutive weekly advance, which has not been done in three months. A move now above the $0.9000-$0.9030 area could spur a further short squeeze toward $0.9100 before the bears make another stand.
The US dollar ran out of steam near MXN13.20, the upper end of the trading range. One might have thought that the weakness in the US and Canadian jobs data may have had a negative knock-on effect on the Mexican peso. Instead, the peso rallied alongside most of emerging market currencies, helped by the drop in US Treasury yields. The lower end of the dollar's range comes in near MXN12.80. Look for this area to be approach in the days ahead, but at this juncture, a break of it does not seem particularly likely.
Observations from the speculative positioning in the CME currency futures:
1. The main feature of the Commitment of Traders report in the week through January 7 was a reduction of exposures. We track the gross positions (long and short) of seven currency futures, making for 14 in all. In the latest reporting period, 10 of the 14 fell. The Canadian dollar account for half of the remainder as both longs and shorts grew fractionally (2.3k and 4.9k contracts respectively). The other two were short euros (+2.3k contracts) and long pesos (+0.6k contracts).
2. Position adjustment were general minor. Ten of the 15 gross positions changed by less than 5k contracts. There was only one change, long euros, that was more than 10k contracts (-13.8k).
3. The net long euro position was halved in the last reporting period, falling from 30.6k contracts to 14.5k. There has been a slow, but significant, adjustment to the speculative euro positioning. In late October, the gross long euro position was near 140k contracts. Now it stands at 88.1k contacts. Shorts have grown, but more slowly. In late October, there were around 60k short euro contracts. Now there are almost 74k. This translates into a drop in the net long position from over 70k contracts to 14.5k now. Still the gross euro longs are the largest among the currency futures. The gross euro shorts are the third largest, behind the Japanese yen and Canadian dollar and just ahead of the Australian dollar.
4. The net short yen position of 129k contracts is the smallest since late November. Given the yen's rally following the poor US jobs data, the bout of profit-taking was inspired. The price action probably saw more the 140k gross short contracts cover.
5. Speculators have been aggressively building a short Canadian dollar position. At 91k contracts, it is more than 2.5 times larger that it was in late November. The slide in recent days, encouraged by poor data and new speculation of a rate cut, has carried the Canadian dollar to new multi-year lows.