Reassessing Fundamentals is Not Conducive for High Conviction FX Trades
The US dollar has entered a corrective/consolidative phase, and its performance over the past week was mixed. The greenback lost ground against the dollar-bloc and Scandis. The Norwegian krone, lifted by a rise in the CPI and retail sales, gained almost 1.6% against the dollar to lead the majors. The dollar rose against the euro, sterling and the Japanese yen.
The yen was the weakest of the majors, losing almost 0.6% against the dollar. The yen's weakness was a bit surprising given its sensitivity to US yields (the 10-year yield fell to its lowest level since mid-2013, slipping below 2.35%). The 10-year German bund yield moved below 1%, to record lows. The 10-year JGB yield slipped below 50 bp, for its lowest level in 16-months.
Investors are reassessing the growth outlook for the high-income countries, with knock-on effects on the expected trajectory of policy. Although the data are mixed, it does appear that the US economy is struggling to sustain the momentum seen in Q2. According to the Atlanta Fed model, the US economy is tracking a little below 3% here in Q3.
The unexpected contraction in the German economy has spurred more calls for the ECB to engage in an asset purchase program, even though the full impact of its June rate cuts have not been felt, and the TLTRO facility has not yet been launched. Meanwhile, the impact of the April 1 sales tax hike appears to be having a larger and longer-lasting impact than Japanese policy makers had expected. Even the UK economy, the best performer in the G7, appears to have lost some momentum recently.
The euro has established a clear trading range here in the first half of August. It is a little over a cent wide: $1.3335-$1.3445. The modest bullish divergence in the RSI, we noted last week, remains intact, and the RSI has moved higher. The MACDs are about to cross. The euro has not traded above its 20-day moving average since July 15. It tested it (~$1.3412) before the weekend. A move through there could spur a move to the downtrend line drawn off the May and July highs. It comes in near $1.3440 at the end of next week.
The technical indicators are not generating strong signals for the yen at the moment. The dollar remains well within the two yen range (JPY101-JPY103) that has confined the price action since mid-April. There is no compelling sign that the US bond yield has bottomed, and the upside correction, we had anticipated in the stock market, appears to have run its course. Both of these considerations would seem to favor a recovery of the yen.
Sterling has shed about 5.5 cents since peaking in mid-July near $1.72. Although technical indicators warn that it is stretched, there is nothing that rules out a marginal new low. The 200-day moving average just below $1.6670 has been tested, the reactionary bounce has not been very convincing. This suggests the risk is still on the downside. Initial support is pegged near $1.6630 and then $1.6600 itself. A move above $1.6750-70 would stabilize the technical tone.
Technical considerations are not generating high conviction ideas about the Australian dollar. We are not convinced that its modest strength in recent days is a sign that carry trades are back in vogue, though many observers and media reports make this claim. We think that the lower highs the Aussie is recording supports are less than constructive outlook. Support is seen in the $0.9240-50 area, but the key area remains around $0.9200.
The price action in the Canadian dollar is not very inspiring. It had set two-week highs before the weekend but was unable to sustain the moment and reversed lower. The restated July employment report was better than the original faulty report, but Canada still lost 18k full-jobs. After squeezing out some stale US dollar longs, we suspect the greenback is now in a position to re-challenge the CAD1.10 level.
We had anticipated that dollar's high on August 6 a little above MXN13.33 was important. However, the pullback to MXN13.06 overshot our expectation (MXN13.10-15). The technical indicators suggest further dollar losses are likely, but we are less sanguine. The 100-day average has been important in recent weeks, and it comes in now a little above MXN13.01. The market has absorbed favorable developments (energy reform in Mexico, relatively high interest rates, strong US auto sales), with the peso rallying. The peso is down marginally (0.33%) year-to-date.
After recognizing the technical significance of the gap lower opening in the S&P 500 the day after the record high was made, we anticipated this week's bounce. The bounce, arguably encouraged by the rally in bonds, has reached an important area around 1960. Additional gains next week would suggest that the losses were corrective in nature and that new record highs should be anticipated. On the other hand, a break below the 1930 area would suggest that only the first leg of the correction was seen, and a retest on the 1900 is likely.
Lastly, we highlighted the technical weakness of the CRB Index. After the small bounce on August 11, the commodity prices recorded new lows every day last week. The losses were sufficient to fulfill a couple of technical objectives, and a bounce is now likely. The initial target is 292 after recording a pre-weekend low near 288.50. A secondary target is found near 297.
Observations based on the speculative positioning in the futures market:
1. There were two significant gross position adjustments (10k contracts or more) in the reporting period ending August 12. The gross short yen position was cut by 11.7k contracts to 93.6k. The gross long peso position was slashed by a third to just less than 52k contacts.
2. The overreaching characteristic of the position adjustment was the reduction market exposure. Of the 14 gross positions we track, only two increased. The gross long yen position increased by 2.6k contracts to 12.5k and the gross short peso position increased by almost 7k contracts to 52k.
3. The general reduction of speculative exposures resulted in some notable changes in net positions. The net short euro position slipped 3k contracts to 126k, snapping a five week steak in which the net short position had increased. The net long sterling position increased for the first time in six weeks (18.8k contracts from 12.1k). The net short Swiss franc position fell for the first time in four weeks (17.4k contracts from 18.9k).
4. The net short 10-year Treasury increased to 50.2k contracts from 45.1k contracts. Both longs and shorts increased. The gross long position rose by 9.5k contracts to 462,5k. The gross shorts, undeterred by the persistent rally rose by 14.6k contracts to 512.6k.
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