Currency Positioning and Technical Outlook: Fundamentals Needed to Clarify Charts

Over the past week, sterling, bolstered by news of a 0.3% expansion in Q1 and reduced chances of fresh BOE action before Carney takes the reins in July, was the best performing major currency.  A short squeeze in the yen helped it almost match sterling's 1.6% gain against the dollar.

Defying our expectations for more weakness, the Canadian dollar was also among the top performers,  helped by a rally in crude oil.  The 30- and 60-day correlation of returns (percentage change) between WTI and the Canadian dollar is the highest six months.  Crude oil prices were higher six of the past seven sessions. 

Looking forward, the bad news is that the technical outlook has been not clarified by the price action in recent days  The good news is that there are a number of key fundamental developments in the coming days that will help strengthen or crystallize the underlying trend.  These events include the euro area PMIs , the US employment data and the ECB and FOMC meetings. 

Our near-term bias is for a stronger euro, but the price action itself has been poor.  Technically, we think the euro has put in the first leg of the correction of its nearly 10-cent sell off from early February though early April.  The first leg up stalled near $1.32, just shy of the 50% retracement objective (~$1.3230).  We suspect there will be another leg up that can extend the recovery toward $1.3350.

The fundamental basis for this is a shift in the news stream.  For the past few years, the euro area moves from crisis to resolution to complacency.  Since the (at least temporary) resolution of the Cypriot crisis, Europe appears to have moved into the complacency phase and this phase is often supportive of the euro.  At the same time we suspect the market has gotten ahead of itself in terms of an ECB rate cut.  We suspect that if the market is not disappointed, a sell-the-rumor, buy-the-fact, type of activity may be supportive of the euro even if the ECB does cut the refi rate.

At the same time, the US news stream is poor.  Most of the regional Fed surveys and important economic data are being reported weaker than expected.  This weakness is seeing discussions of a Fed exit, well, taper off.  The Dollar-Index, which is heavily weighted to the euro and currencies that move in the euro's orbit (like the Swiss franc and Swedish krona) is also looking heavy, finishing near its lows for the week.

We have been talking about sterling's potential toward $1.56 for several weeks.  Although it has been frustrating, the move above $1.5425 and the new two-month highs seen before the weekend, boost credence in our constructive sterling outlook. 

We have argued that the dollar's advance from around JPY76 seen in mid-November was the market pricing in the stimulative monetary and fiscal policy associated the Abenomics.    The failure of the dollar to rise above JPY100 has prompted a bout of long liquidation.  The greenback appears to be carving out a potential double top.  However, the neckline is not seen until the JPY95.80 low seen on April 16.  If confirmed, the measuring objective is near the late Feb lows around JPY91.  The 38.2% of the dollar's rally since it became clear that Abe would be Japan's prime minister, comes near JPY92. 

Japanese markets are closed on Monday and Friday in the week ahead.  Japanese exporter and institutional investors have been thought to be the featured yen buyers.  While it may be tempting to try to take the dollar higher without Japanese resistance, we suspect that non-Japanese participants may be reluctant to do so given the large short yen positions already held by the short-term momentum and trend following market segment. 

The technical condition of the Canadian dollar improved as the greenback was turned away from the CAD1.03 area.  It now looks set to test the CAD1.0080-CAD1.0100 area.  A break of this band would signal a return to parity.  We note that the Commitment of Traders points to a market that is very short the Canadian dollar, though admitted the latest report does not pick up the strength of the Canadian dollar seen in the second half of last week.

Tame CPI figures got many players thinking the Reserve Bank of Australia could cut rates at its May meeting and at least a 40% chance of this has been discounted in the OIS market.   Since the sell-off from the near $1.06 level approached near the middle of April, the Aussie has struggled to find much traction  The recovery in gold prices and copper prices, both of which the Aussie's correlation with have increased in recent weeks, may help support it, but it needs to resurface above the $1.0320-40 area now to bolster confidence.

We also see that gold has retraced 68.2% of its recent plunge and the momentum seems to have waned as the 20-day moving average has been approached.  Copper prices bounced smartly off 18-month lows near $300, but reversed before the weekend from its 20-day moving average and a retracement objective.  The close was on  the session lows. 

The US dollar approached the cap we identified last week near MXN12.40.  The price action reinforces the significance of this area.  The dollar is will likely continue to be supported in front of MXN12.00.  We are concerned that the weaker series of US data and softer Mexican data, coupled with a political scandal that may sap some support for the PRI's reform efforts, may see the peso trade in a broad range in the coming period. 

Observations on the speculative positioning in the futures market:

1.  There were mostly minor position adjustments in the most recent reporting week.  Only the gross short yen positions and gross long Australian dollar positions were adjusted by more than 10k contracts.  Gross long positions were generally pared, with Canadian dollar the notable exception.  Gross short positions were also mostly reduced.  The exceptions were a small increase in the gross short euro position and gross short Australian dollar position.

2.  The reduction of more shorts than longs swung the net Swiss franc position to the long side.  This is the first time that the net speculative position in the Swiss franc futures has been long in two months.

3.  The net short yen position is the smallest since early March.  The gross short yen position is the smallest since late January.