The European Central Bank meeting is on June 5. It is among the most important events of the first half and possibly the entire year. After much preparation and jawboning, the ECB is widely expected to take unconventional measures counter the low inflation and risk of deflation. It may also announce fresh initiatives to help facilitate financing for small and medium sized businesses.
In anticipation of this, the euro has been sold. It declined by about 1.8% on the month. The net speculative position in the futures market swung to favor shorts. We suspect the market is particularly vulnerable to "sell the rumor and buy the fact" activity. This is what has happened when the Fed has announced its quantitative easing programs: the dollar would sell off in anticipation and then rally on the announcement.
The euro's four cent decline pushed it below $1.3600 briefly. The 38.2% retracement objective of the rally off last July's lows is found near $1.3520. However, the decline has stretched the technical indicators. The RSI has already turned up, and the MACDs are about to cross higher.
This dovetails with our suspicion of "sell the rumor buy the fact" behavior in response to the ECB. This may be counter-intuitive, but this is essentially what happened in the past. When the Fed announced QE, it was often well anticipated, and the dollar sold off until it was announced and then rallied. We suspect that the challenges the ECB faces are not something that 10-15 bp of rate cuts, and even a negative deposit rate, will convincingly address. Once the event risk passes, investors may return to form and chase yield.
If this analysis is correct, what kind of bounce can the euro have? The first objective is the $1.3720-40 area, The next target would be in the $1.3780-$1.3820 area. If the ECB does genuinely surprise, the $1.3520 is the initial target on a break of $1.3580.
Sterling declined 3 cents against the dollar in May. This was among its worst monthly performances in the past year. The technical outlook is somewhat similar, though sterling's 200-day moving average (just below $1.6400) was not tested. The RSI has turned up, but the MACDs do not appear as close to turning as the euro's. The initial upside objective is the $1.6810-40 band. On the downside, a break of the $1.6700 area risks a move toward $1.6625.
There are two forces underpinning the yen. First, the US 10-year premium over Japan has fallen to its lowest level since last August. Second, market expectations of new stimulus by the BOJ are being reconsidered. Previously the overwhelming majority expected new measures by the end of July. We have long argued this was jumping the gun and, if there is to be more monetary stimulus, it would likely be later.
The technical indicators for the yen are broadly neutral. The two yen range that confined the dollar in May looks set to continue. A trend line off the April high near JPY104.10 and the May high near 103 caught the past week's high near JPY102.15. On the downside, the dollar, the market appear cautious about pushing the dollar much below the 200-day moving average found near JPY101.40.
Over the past two week, the euro has carved out a shelf near JPY138. Technical signals here seem clearer than against dollar-yen. Provided the shelf holds, the euro can rise toward JPY139.65 and possibly JPY140. This fits in well with a sell the rumor buy the fact activity around the ECB meeting.
The Canadian dollar was the strongest major currency in the month of May, appreciating 1% against the US dollar. However, the US dollar recorded a low near CAD1.0815 on May 8-9 and the retest at the end of last week was aborted after the weaker than expected Q1 GDP figures (1.2% rather than 1.8% consensus) and industrial product prices actually declined (-0.2% whereas the consensus anticipated a 0.4% rise).
The Bank of Canada, which meets on June 4, is particularly sensitive to the downside risks of inflation. It follows soft retail sales and jobs report. No rate cut can be reasonably expected, but a dovish statement could see the US dollar move back toward CAD1.0950.
The Australian dollar was the best performing major currency last week, rising about 0.8% against the greenback. This was roughly four times the advance of the yen, which was the strongest currency. The decline in global interest rates helped solidify the $0.9200 base, which was tested half a dozen times in May. The downtrend line drawn off the April and May high comes near $0.9375 at the end of next week. However, more immediate resistance near $0.9335 held Aussie upticks in check ahead of the weekend. Support is pegged near $0.92870-85.
The Mexican peso was flat in the past week, though the dollar saw its recent losses extended toward MXN12.825, which represents the new 2104 low. The RSI and MACDs look neutral, but fresh downticks have been difficult to sustain. There has been a large build-up of speculative peso longs in the futures market. A dollar advance through the MXN12.90 would encourage a test on the down trendline drawn off the late-January high, the March high and the late April high. It comes in near MXN12.95.
Observations from the speculative positioning in the CME futures market:
1. With a couple week lag behind the euro, the net speculative position swung to the short side for the Swiss franc in the latest Commitment of Traders report that covers the week through May 27. It is the first net short franc position in three months.
2. The net speculative position is short four of the seven currency futures we track here: euro, yen, Swiss franc and Canadian dollar.
3. There were no major (10k contract shift of more) gross position adjustment over the past week. The largest position adjustment was the gross long peso positions, which grew 9.1k contracts to 101.8k. This is the largest gross long position since last June. The net position of 83.3k contracts is also the largest since last June.
4. The general pattern in the latest reporting period was for the gross short currency futures positions to have increased. The only exception was for sterling. Gross shorts were pared by 3.8k contracts to 43.1. The gross long positions were cut for the euro (-4.3k contracts to 70.8k), the yen (-1.7k contracts to 17.0k), sterling (-1.6k contracts to 78.4k) and the Swiss franc (-5,8k contracts to 11.6k).
5. The other three currencies saw an increase in the gross long positions: Canadian dollar (+6.1k to 32.6k contracts), the Australian dollar (+1.9 to 52.k contracts), and the Mexican peso, that we already discussed as the largest gross position adjustment.
6. The month of May saw the net speculative position for both the euro and franc shift to the short side. During the month, the net short yen and Canadian dollar positions were reduced, while the net long sterling position was also cut. The net position in the Australian dollar was little changed. The net long peso position grew.
7. Given the focus on the US bond market rally, we looked at the Commitment of Traders for the 10-year Treasury note futures. There was a large adjustment to positions. Both long and shorts were cut. The latter more than the former and this led to sharp reduced in the next short position to 19.1k contracts from 97.9k. The gross short position was slashed by 131k contracts to 398.4k. This is the largest short covering since December 2012. The gross short position returned to late April levels. The gross long position was cut by 52.1k contracts to 379.3k. Up until now there was no evidence from the futures market that the bond rally was a product of short-covering. The reporting week ending May 20 saw the net short position rise to it highest level since before the financial crisis.