Currency Positioning and Technical Outlook: Weak Signals, Lots of Noise

The holiday week saw the
dollar consolidate against most of the major currencies.  The yen was the
main exception as its losses were extended under the aggressive signals coming
from the new Japanese government.   

At the end of the week,
the other key consideration, the US fiscal cliff made its presence felt.
 The recent pattern remained intact.  News that gives the
participants a sense that the cliff may be averted encourages risk taking,
which means in the foreign exchange market, the sale of dollars and yen.  

News that makes
participants more fearful that the political dysfunction failed to avert the
cliff and send the world's largest economy into recession, generally see the
dollar and yen recover.  This is what happened in very thin markets just
ahead of the weekend as Obama's ling last ditch negotiating stance seemed to
reflect a retreat from his earlier compromises.

While negotiations will
continue over the weekend, time is of the essence and a vote in the Senate
could be held Sunday December 30.  With Tokyo markets closed on December
31, liquidity may be even thinner than it has been in recent days,which could
make for some dramatic price action.  

The debt ceiling, which
is a separate issue from fiscal cliff, does not appear likely to be resolved as
the Republicans seem likely to hold on to it a part of the political fight the
President.  It means that the navel-gazing, rancorous fighting, largely
over relatively small differences will not end with whatever fiscal compromises
are struck in the coming days/weeks. 

The new week then begins
with fiscal wrangling in the US and finishes with the December jobs data.
 Although the US economy appears to have slowed considerably in Q4 from
the 3.1% annualized pace in Q3, private sector job growth should remain near
the recent (3-month) trend near 150k, which is above the H2 average of about
136k.  In addition, December auto sales are expected to remain at
relatively elevated levels, near the four-year high set in November.  

The monthly purchasing
managers' surveys will also be released.  Taken together, they will likely
show that Europe and Japan remain in contracting modes, while slow growth is
still evident in the US.  

Given the lighter
participation in the foreign exchange market due to the holiday and year-end
considerations, it is difficult to find strong signals in the recent price
action, which was largely consolidative in nature.  As the table below
illustrates, both longs and shorts moved to the sidelines in most of the currency
futures.  The exceptions were the euro and Swiss franc futures, where
small new longs were established and small shorts were covered.  

The Canadian dollar was
the other exception, where longs were cut and shorts grew.   The
dollar-bloc more generally lagged behind the European currencies in the modest
moves against the US dollar.  The weakness of the yen, driven by both
carry and momentum strategies, and the recovery in the Chinese stock market
(amid talk of more economic and financial support for the economy) did not
bolster the Australian dollar.   On balance we are hesitant to attribute
too much significance to the recent price action, but anticipate additional
near-term dollar losses.