Big Week Ahead for FX
Technical and fundamentals appear aligned against the dollar versus most of the major currencies in the week ahead. Last week, we cautioned against playing for a break out, pending key data. The the higher than expected preliminary CPI figure from the euro zone before the weekend, lifted the euro and Swiss franc to new highs. Sterling is poised to push through its multi-year high set in mid-February near $1.6825.
It is almost like the first law of thermodynamics: an object remains at rest or in motion unless acted upon by another force. No other force has emerged sufficiently strong to counter the recent trends. The market accepts that, even though the chair of the Fed suggests that it is difficult to determine how much of the recent economic weakness is due to weather, the measured tapering will continue. Yet, investors also recognize that tapering is not tightening and that the first rate hike is still well over a year away (H2 15).
Even with the German Constitutional Court raising questions about the legitimacy of the ECB's OMT, a new government in Italy, the political uncertainty in Cyprus, and the fissures in the Ukraine, the euro has remained well supported. The preliminary CPI report reduces the perception of the pressure on the ECB to take bold action, such as QE or a negative deposit rate at the meeting on March 6 to address the threat of deflation.
A small cut in the repo rate (25 bp) would have next to no impact on inflation or inflation expectations. Nor would it help the ECB address its other two challenges: elevated and volatile EONIA, and the continued reduction in lending to businesses and households. A cut in the lending rate, would address the former, while the latter may require a new program (which Draghi has hinted involving buying bank bonds that are backed by loans, as in asset-backed securities).
Euro: Technical indicators are constructive, but the two-day rally at the end of last week has brought the euro near the top of its Bollinger band. Consolidation or even a small pullback toward $1.3770 early in the week may be seen as a new buying opportunity ahead of the ECB meeting and US jobs data, where the early call is for an increase of about 155k. The next immediate target for the euro is the $1.3900 area that was approached just after Xmas, but it is the $1.40 area that poses the next key hurdle. The move to new highs for the year did not see the benchmark 3-month implied euro volatility increase. It remains a low vol environment.
Sterling: Barring a significant downside surprise in the UK's three PMIs due out in the first week in March, the market will continue to see the BOE as the first of the major central banks to lift rates. Most expectations are for the first hike in Q1 2015, but strong data will keep the risk asymmetrically biased toward earlier rather than later. The Dec 14 and March 15 short-sterling futures ended last week little changed, but are poised move lower (implying higher rates). This is consistent with sterling challenging and surpassing the mid-February high (~$1.6825). Over the slightly longer term, a test on $1.70 still seems reasonable.
Yen: The technical outlook for the yen is decidedly less clear than for the euro and sterling. The uptrend off the early February lows was violated in the second half of last week. The dollar recorded lower highs and lower lows every day last week, yet there is not much momentum. Three-month implied volatility looks set to test last year's lows set in October near 8.5%. after starting the February above 10%. The RSI is flat and MACDs may cross lower, but from well below zero. The 100-day moving average, which the dollar has closed below once since mid-Nov 2013 comes in near JPY101.85 now, and is still rising about 20 ticks a week. The JPY102.45 marks nearby resistance, but the JPY102.70-80 capped efforts to rally in February remains the key hurdle to stronger dollar recovery.
Canadian dollar: The Bank of Canada is likely to retain a dovish tone at the March policy meeting, but barring some significant economic deterioration, a rate cut is not envisioned. Although technical indicators are not generating a strong signal, we are inclined to look for the US dollar to correct lower. This could bring the dollar toward CAD1.10. A break then would could spur a move to CAD1.0920. Resistance is see near CAD1.1150.
Australian dollar: The technical outlook is poor. It is the only major currency to finish lower against the dollar last week, managing to hold just above the 50-day moving average near $0.8910. The 5-day moving average will likely move below the 20-day at the start of the week for the first time in nearly a month. MACDs are rolling over and the RSI is weakening after moving sideways in recent weeks. The initial target is in the $0.8840-80 band. In the bigger picture, though the month-long rally is likely over and the longer term down trend may be resuming. Fundamentally, the market has taken on board the neutral RBA, but weak data and slowing of its largest trading partner may spur expectations of another cut in late Q2 or Q3. A move back above $0.9000 would help improve the technical tone.
Mexican peso: The dollar spent last week within the previous week's range against the Mexican peso, but posted the lowest weekly closes since the first full week of the year. It is near the lower end of the trading range seen since mid-January. A break of the MXN13.19-MXN13.20 area could spur a move toward MXN13.00, though technical indicators are not generating particularly strong signals. The upper end of the range is seen near MXN13.40.
Observations from the CFTC Commitment of Traders for the CME currency futures:
1. Position adjustments in the reporting week ending February 25 were mostly minor. There were not gross position adjustments of more than 10k contracts. Indeed, only 2 of the 14 gross positions we track were in excess of 6k contracts. Short sterling positions were reduced by 8.2k contracts to 45.8k. The short Canadian dollar positions were cut by 9.3k contracts to 83.5k, which is the second largest gross short position after the yen's 99.8k contracts.
2. The 5.2k contract increase in the gross long Swiss franc position was sufficiently larger than the 2k increase in the gross short positions to swing the net franc position back to the long side, albeit barely with a 400 contracts.
3. The increase in the net long sterling position was not a function of new longs being established, as the gross longs were actually reduced by 1.7k contracts to 74.6k. Rather it reflected an 8.2k gross short contracts were covered.
4. The net short Australian dollar position of 39k contracts is the smallest since late November. The decline has been fueled by short-covering. The gross short position most recently peaked in late-Jan/early Feb near 80k contracts. During the latest reporting period, it fell 4.5k contracts to slip below 50k. Despite the fact that the Aussie rallied 4 cents from the multi-year low in late-Jan through mid-Feb, the gross long positions are a lowly 10.3k, having risen by nearly 1k in the period. This is the smallest of the gross positions we track. There are even more gross long yen contracts (14.7k) than Australian dollars.
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