New Phase in FX has Begun
In general, the price action in recent weeks has been characterized by weaker equities, firmer core bonds, heavy emerging markets and a firmer yen and US dollar. Our technical analysis suggests that that phase has ended and a new one has begun.
Many investors had been looking for a correction as new opportunity to increase exposures. They were chopping at the bit, so to speak, to jump back in. It appears they began to do so in the second half of last week.
The euro's recovery was impressive, not so much because of the magnitude of the move, but rather that it gained at all given the events. The ECB did change policy, which many had expected, but clearly the door is open to action in a few weeks and expectations remain in a heightened state. The German Constitutional Court ruling, which raised more doubts about the legality of the Outright Market Transaction (OMT) backstop, could have provided a handy excuse to pummel the euro, which the market did not. In addition, despite the somewhat disappointing US jobs data, the Fed's tapering is widely expected to continue apace.
The euro recorded a large outside up day on Thursday and saw follow through buying on Friday. The RSI is moving higher and the MACDs have crossed. The euro finished the week above its 100-day moving average (~$1.3608). Provided support in the $1.3540-50 area holds, the euro can work higher.
There are a few levels on the upside to bear in mind. First, $1.3640 area corresponds to a 61.8% retracement of the move down from the January 24 high near $1.3740 and to a 38.2% retracement of the move from last year's high set on December 27 just below $1.39. The trend line connecting both those highs comes in near $1.3655 on Monday and falls to $1.3625 at the end of the week. Above there the $1.3740 high beckons.
Sterling too looks poised to trade higher in the days ahead. However, with the Bank of England's Quarterly Inflation Report likely to push back against ideas that with the 7.0% unemployment threshold near that the risk of an early rate hike have increased, sterling may under-perform the euro. Technically, the euro looks to test the GBP0;8350 area, and maybe as high as GBP0.8400 over the slightly longer-term.
Against the dollar, sterling's technical tone is constructive, with the RSI turning up and the MACDs set to cross early in the week ahead. The immediate target is the $1.6430-60 area, where a number of technical levels converge. Initial support is pegged near $1.6350.
The dollar finished last week by posting three consecutive sessions of higher highs and higher lows against the Japanese yen. A shelf has been built around JPY100.70-80. The RSI has begun to rise and the MACDs are poised to cross in the coming days. Although the JPY102.55 area represents immediate resistance, we see potential on this leg up for the dollar to test the JPY103.00-50 area. Such a move would likely coincide with additional gains in the S&P 500 and, perhaps to a lesser extent, a further recovery in US interest rate premium over Japan.
The technical outlook for the dollar-bloc is less clear. The New Zealand and Australian dollars were the best performers against the dollar last week among the major currencies, gaining 2.6% and 2.3% respectively. The RBNZ is still on track to hike rates next month. Although this is fully discounted, it will likely lend the Kiwi support.
The adoption of a neutral bias by the RBA helped trigger a short squeeze in the Aussie. The gains stalled in front of the $0.9000 level. Arguably there is potential toward the mid-January high near $0.9085. However, with risk of soft Chinese data and Australia's employment report midweek and our understanding of market sentiment, we suspect participants want to sell into additional Aussie gains. While some sectors of the Australian economy are responding to the drop in interest rates, the labor market has been lagging. One way to express this is through the Aussie-Kiwi cross. It finished last week at a four-day low near NZD1.08. There is scope in the coming days to test the NZD1.0670 area.
Strong Canadian employment data at the end of last week saw the US dollar trade briefly below CAD1.10 for the first time since January 22. The Canadian dollar could not sustain the upside momentum and retreated again. The large short Canadian dollar position, coupled with the downtrend in the USD RSI and MACDs warn of the risk of additional short-covering. If this is to happen, it is best that the US dollar holds below CAD1.0060-80 and it could fall toward CAD1.0850
A rebound in emerging markets and Moody's upgrade of Mexico's credit rating helped the peso recover, but its 0.5% gain on the week against the greenback leaves something to be desired. Even after the upgrade, the US dollar managed to test the MXN13.40 level before coming off before the weekend. The RSI is flat and the MACDs are moving lower, A convincing break of the MXN13.17 area is needed to signal a deeper dollar pullback. If this happens, the initial target is MXN13.00, but potentially MXN12.80 on what could be a double top at MXN13.55-MXN13.60.
Observations from the speculative positioning in the CME currency futures:
1. The net speculative position in the euro has chopped back and forth and for the reporting period ending Feb 4 swung back to the short side. This likely misrepresents the current positioning as it does not capture the euro's rally in the second half of the last week. On the other hand, the net Swiss franc position shifted back long.
2. There were three substantial (more than 10k contract) gross position adjustments during the reporting period. Long euros and long sterling positions were slashed (19.3k and 11.3k contracts respectively). The gross short Australian dollar position was reduced by 12.5k contracts.
3. The overhang of long gross euro positions has been pared, arguable leaving it in a better position to move higher. After peaking in late October near 137k contracts, the gross long position of 67.6k contracts is smallest since July.
4. The net short yen position of 76.8k contracts, is the smallest since the first half of November. It has been largely driven by short covering. The 9.4k reduction in short yen positions in the most recent reporting period just missed our 10k threshold and brings the gross position to 92.7k contracts. It peaked three months ago near 158k contracts.
5. The net long sterling position was halved to 11k in the most recent reporting period. It is the smallest since the end of November. The 11.3k contract decline in gross long positions was the largest since July. The 52.1k gross long contracts compares with a peak in early December near 74k contracts.
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