Sticky Prices in FX
The major currencies continue to trade in fairly narrow ranges. The persistence of lackluster activity renders our trend identification, momentum, and positioning tools less useful.
The ECB meeting in the week ahead may be a window of opportunity for more activity. Yet, neither the threat of asset purchases and/or a negative deposit rate nor heightened tensions over Ukraine, or a re-acceleration of the US economy have seemingly provided new trading incentives.
Most participants expect the ECB to move in June, but standing pat this week may not be a non-event. Getting past the residual event risk may be important. The event risk includes comments from Draghi, who despite the critics who claim action is necessary, continues to do a fairly good job staying true to the spirit of the G20 "best practices" regarding the foreign exchange market, and checking the euro's advance. He has not succeeded in pushing it down as remove, or at least greatly reduce, the upside momentum.
Over the last three weeks, the euro has been confined to a $1.3775-$1.3890 range. With a couple minor and brief exceptions the dollar has traded on the JPY102-handle for seven weeks. For the last three week, the Dollar Index has traded between 79.55 and 80.00. The narrow price ranges are both the cause and effect of the lack of participation, which is reflected in the minor position adjustments in the currency futures and what appears to be lower volumes in the spot market.
More light will be shed when several central banks report their estimate of foreign exchange turnover covering this period, later in the year.
Given the narrow ranges and recognition that our technical tools are less effective in such market conditions, we offer this week, only a brief overview of how we see the price action.
Euro: We are more inclined to see an upside than a downside break. There seems to be a reasonable risk of the euro moving above $1.3900, but whether it can break $1.40 now is a different matter. The importance of the $1.37775 area support appears to be growing.
Yen: Buying the dollar against the yen now seems to be a bet, if you will on two things. First, that the downside reversal in US equities seen before the weekend is not the start of a significant pullback. Second, that the US Treasury yields and the premium over Japan are near a bottoming. The US premium dipped below 200 bp last week for the first time since early February, when it was a bit of a one-day fluke. Last week premium stayed below that threshold for two consecutive days, the first time since last October. Japanese markets are closed early in the new week.
Sterling: New four year highs were recorded last week, but the move does not appear to be complete. The strength of the UK economy, and this quarter it will likely surpass its pre-crisis peak is helping to widen interest rate differentials in sterling's favor. We look for bulls to continue to absorb the offers ahead of $1.70 and eventually drive sterling through there. The referendum in Scotland poses some political risk (that can have serious economic repercussions) but that is not a near-term consideration. The May 25 EU parliamentary elections may be more important, especially if the UKIP turns in a strong performance, perhaps aided by the European Court of Justice decision not to stop the plans for some members to implement a financial transaction tax. The $1.6780-$1.6800 area is forming an important area. It probably requires a break of $1.6760 to suggest a break out.
Dollar-Bloc: The US dollar is supported around CAD1.0940. The upper end of the range, which we favor a test on, is seen in the CAD1.1050-70 area. On a more medium term perspective, we still look for weakness in the Canadian dollar. The Australian dollar staged an impressive recovery before the weekend after testing the $0.9200 area support. A move now above $0.9315-25 would suggest that 1) the pullback from $0.9460 in early April was a correction and 2) that another run toward $0.9500, the measuring objective of an old head and shoulders bottom pattern.
Mexican Peso: The dollar closed lower against the peso every day last week, slipping to its lowest level in almost a month. However, the price action did not persuade us that the a breakout is at hand. The dollar's resilience and ability to hold the low from early April near MXN12.94 and resurface above MXN13.00 suggests some additional upside in the days ahead.
Observations on speculative positioning in the CME currency futures:
1. For the second consecutive reporting period, the week to April 29, saw minor position adjustments. The largest gross position adjustment was short Australian dollar position that rose 6.1k contracts to 39.3k. Second place went to the 3.8k contract decline in gross long sterling positions, bringing them down to 85.9k contracts. That is the second largest gross long currency futures position, behind the euro's 102.3k contracts.
2. It was the fourth reporting period that the net euro position has been largely flat. The net position in the Swiss franc has been essentially flat for six weeks.
3. The net short yen position increase to 70.4k contracts from 67.2k. It is the first increase in four weeks. It was more a function of gross longs being reduced (2.7k contracts to 13.8k) than new shorts (400 contracts to 84.2k).
4. The decline in the next long Australian dollar position from 16.4k to 10.7k contracts in the latest reporting period break a seven week streak in which the net shorts were cut or net longs grew. The gross long Aussie positions were not cut. Instead they rose by a slight 500 contracts to 50.0k.
5. The net short Canadian dollar position slipped to 30.3k from 35.4k contracts. This is the smallest net short position since last November.
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