The US dollar extended its gains against all the major currencies and most emerging market currencies over the past week. The ECB's asset purchase program was a key driver, but the euro, though it fell a little more than 5.5 cents from the mid-week high to Friday's low, was not the weakest of the majors. That distinction goes to the dollar bloc.
The New Zealand dollar lost 4%., encouraged by a soft inflation report. Next week central bank meeting will likely drive home the point that the tightening cycle is over. We suspect the next move will be a cut. The Australian dollar shed 3.6%. Expectations for a rate cut as early as next month are growing. The Canadian dollar lost 3.4%, spurred by the Bank of Canada's surprise 25 bp rate cut.
Given the price action and the long anticipation of the ECB's asset purchase program, we had thought there was a reasonable risk of a sell the rumor buy the fact type of activity. This did not materialize. Instead, the ECB's decision accelerated the existing trends: European stocks and bonds moved sharply higher, and the euro tumbled. The euro fell to $1.1115 before a modest short covering bounce lifted it back to almost $1.13 before the weekend, which is around where the lower Bollinger Band is found.
With the Greek election likely to be inconclusive in the early part of the week and the Italian presidential election process just beginning, political uncertainty is set to intensify. At the same time, while the FOMC statement is unlikely to change substantively, other economic data, including Employment Cost Index and Q4 GDP will likely show the continuing strength of the world's largest economy. Our fundamental analysis continues to point to a strong dollar and a weaker euro.
However, the technical indicators are still urging caution. The RSI and MACDs are stretched. The Stochastics did not confirm the move to new lows. A euro bounce toward $1.14-$1.1450 will likely be seen as a new selling opportunity. On the downside, the $1.10 area offers psychological support, but the low from 2003 near $1.0750 is the next important technical level.
The Japanese yen was the strongest of the majors against the dollar and was a little softer than flat. Despite repeated tries, the dollar was capped just below JPY118.90. The RSI leaves room for a further dollar pullback though the MACDs are trying to turn. It is difficult to get excited. We have often suggested that the dollar-yen pair is mostly range-bound. When it looks like it is trending it is moving from one to another. Since the middle of November, the dollar has been confined to a JPY115.50 -JPY121 trading range with few exceptions.
The weakness in the euro dragged sterling lower. It slipped below $1.50 for the first time since July 2013. There is a small bullish divergence in the RSI, which did not confirm the new lows at the end of the week. Even though the short euro positions are extended, we suspect that the political uncertainty there makes sterling the better candidate than the euro to try to pick a near-term dollar high if that was one's inclination. Initial resistance is seen in the $1.5080-$1.5120 area.
The dollar's high against the Swiss franc since the SNB's unexpected removal of the currency cap is just below CHF0.8840. A move above there could spur a move toward CHF0.9000-CHF0.9150. Support is pegged near CHF0.8500.
With the risk increasing of a rate cut by the Reserve Bank of Australia as early as next month, the Australian dollar broke below $0.8000 for the first time since 2009. It was like a small dam bursting (not a big one like when the SNB abandoned its cap). The Aussie fell almost to $0.7880 before stabilizing. Technically it is overextended. It finished the week well below its lower Bollinger Band (~$0.7985). On a medium term basis, we remain bearish. However, we suspect new shorts may be at a disadvantage.
The Canadian dollar is also over-extended. Technical indicators do not appear to be signaling an imminent top for the US dollar. The US dollar pulled back in response to the stronger than expected Canadian retail sales and the tick up in core CPI. However, that pullback was seen as a new US dollar buying opportunity. Some consolidation is likely near-term. Initial support is seen in the CAD1.2360 area.
While US Treasury yields are often seen as driving other rates, in the current environment, it appears that the sharp declines in European bond yields are giving US bonds a bid. The Federal Reserve statement is likely to be mostly the same as before, recognizing that it can continue to be patient. However, if the FOMC is going to prepare the market for a hike around the middle of the year, the March FOMC meeting, which is followed by a press conference, will be more important.
The large jump in US oil inventories and reports suggesting that some countries have boosted their output (apparently more than offsetting the loss of a couple hundred thousand barrels a day from Libya) will likely keep prices on the defensive. There has been a choppy consolidation over the past couple of weeks. This is helping to alleviate the over-sold condition, but there is no convincing technical sign that an important low is in place.
Observations from the speculative positioning in the futures market:
1. There were three significant speculative position adjustment of more than 10k currency future contracts. The gross short euro position grew 14.1k contracts to 232.7k. It has risen by 50k contracts since mid-December. The record was set in mid-2012 at 251k contracts. Speculators covered 16.1k gross short yen contracts, leaving 104.4k contracts still short. The net short yen position of 77.9k contracts is the smallest since early November last year. The speculative short Swiss franc position was nearly halved to 18k contracts (from 31.3k). It is interesting to note that the net speculative position remains short 9.8k franc contracts.
2. Despite the seemingly universal bearishness toward the euro, the gross speculative long position of 52k contracts is bigger than the gross position of the next two largest combined. The speculative community has 35.3k gross long sterling contracts and 26.5k gross long yen contracts.
3. The speculative net short sterling position of 37.1k contracts is the largest since July 2013. Since the end of October 2014, the gross short position has doubled to 81k contracts.
4. The net short speculative US 10-year Treasury futures position was reduced to 146k contracts from 182k. This was a function of 37.5k new gross long contracts (to 376.3k) and 1.5k new gross short contracts (to 521.9k).
