Currency Positioning and Technical Outlook: Dollar Poised for Additional Gains

The US dollar is poised to extend its gains against most of the major currencies in the week ahead.  The Japanese yen is the main exception.  A combination of equity market weakness, the smaller US interest premium and the large short position leave the yen bears vulnerable to further pressure. 

The yen is the only major currency to have appreciated against the dollar in January (3%).  The dollar's five day moving average crossed below the 20-day average for the first time since late October on  January 13.   Since the multi-week low was set on January 27 near JPY101.75, the dollar has hovered around JPY102.   There is some support in the JPY101.50-60 area, but if that were to be convincingly violated, it could signal another 1% slide in relative quick order.   

There is little reason to expect participants to seriously try picking a bottom in the euro ahead of the ECB meeting Thursday. Selling into the occasional bounce is preferred to buying dips.  At least one major German bank has predicted that the ECB adopt a negative deposit rate and cut the refi rate 5-10 basis points (from 25 presently).   We are considerably less convinced, but recognize that the two pillars of ECB monetary policy (money supply and inflation) were softer than expected.  At the same time, we recognize that Draghi has surprised the market more than once on the accommodative side.  

Yet, ECB officials appear to recognize that the main problem is not the price of money.  Recent comments by officials suggest more interest in rekindling lending via securitization, but do not seem prepared to unveil a new initiative next week.  Moreover, a negative deposit rate could potentially be disruptive to the very institutions that the ECB wants to lend more.

The euro had been largely confined to a $1.3500-$1.3740 trading range this year, but may be breaking out.  It spent the second half of last week below the 100-day moving average (~$1.3600 and rising).  The 2-year interest rate differential is at 6-month highs, which should be dollar supportive.  The euro finished last week at new lows for the year.  The break of $1.35 could signal a move toward $1.33-$1.34 in the days ahead.  

Sterling is faring better than the euro, but it too appears to be carving out a top.  Remember it has rallied from near $1.48 six-months ago to almost $1.6670 on January 24.    It probably requires a break of the $1.6240-$1.6300 area to get the bulls to capitulate.  With suspicions that the UK will have to raise rates sooner than the BOE anticipates, other currencies may offer a more efficient way to express dollar bullish sentiment.

The Dollar Index is nearing the upper end of its three-month trading range near 81.50.   A break of this cap could see the advance extend toward 82.00, with the 82.50 area being a more formidable barrier.

The dollar-bloc currencies continue to trade heavily and although these may be crowded trades, the wind is to the back of the bears.   Yet, the US dollar staged a key reversal against the Canadian dollar before the weekend.  First it rose above CAD1.12 for the first time since July 2009, before reversing to finish the day below the previous session lows.   It closed just above the trend line drawn off this month's lows that comes in near CAD1.1120.  We are suspicious that this marks an important high.   We would look at a pullback toward CAD1.1050 as a new USD buying opportunity in anticipation of a trend move in the medium term that could carry the greenback toward CAD1.15-CAD1.17.   

Even if the RBA is more neutral on rates at next week's meeting, as some suspect, it still wants a lower Australian dollar.  Official guidance suggests $0.8000-$0.8500 is desirable.   We see bounces back toward $0.8850 as an opportunity to build shorts.   

The weakness in the Mexican peso appears to be largely the result of contagion from the sell-off of risk assets, including equities and other emerging markets.   Technical signals are not particularly strong.  We are more inclined to sell into contagion-spurred dollar spikes, but prefer to wait until there is greater stability in the emerging market space.  A break below MXN13.20 could confirm a top is in place for the greenback.  

Observation from the speculative positioning in the CME currency futures:

1.  After the net speculative positioning in the euro went short in the period ending Jan 21, for the first in nearly two months, it swung back to the long side in the most recent reporting period.  We fear it may be premature as the euro may be (finally) breaking to the downside.  However, the reason the net speculative position shifted back to favor the longs had more to do with shorts being covered (10.5k contracts) than longs being added (7.6k contracts).  Except for the Mexican peso, the other currency futures all saw a reduction of gross short positions.  Given the subsequent price action, this could be a  sign of the capitulation of the bulls.  

2.  This past reporting period saw more large (more than 10k contracts) position adjustments than has been experienced in several quarters.  Like the euro, the yen and Canadian dollar saw large declines in the gross short positions (25.9k and 11.0 k respectively).  The decline in the gross short yen position was the largest since July 2012.   The decline in the gross short Canadian dollar position is the largest in six months. Reflecting the contagion from the risk-asset sell-off, the gross short Mexican peso positions jumped by 25.7k contracts. 

3. The gross short yen position has been reduced consistently since the last two weeks of December.  Now with 102.2k short contracts, it is near three-month lows.  The dollar is near 2-month lows against the yen.  

4.  The net long sterling position increased by about 13.5k contracts, due in roughly equal measure to longs joining and shorts covering.  At 22.2k contracts long, it is the upper end of where it has been since Bear Stearns failed.  It has been larger for only around a dozen weeks since then.  The gross long position (63.4k) is also at the upper end of where it has been since the onset of the financial crisis.    

week ending Jan 28		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	14.3	-3.8	87.0	7.6	72.6	-10.5
Yen	-86.2	-115.0	16.0	3.8	102.2	-25.9
Sterling	22.2	8.7	63.4	6.8	41.2	-6.7
Swiss Franc	-0.4	-1.9	11.4	-0.3	11.6	-1.7
C$	-62.8	-70.3	25.9	-3.4	88.8	-11.0
A$	-65.7	-64.6	14.0	-1.6	79.7	-0.6
Mexican Peso	-35.3	-3.6	20.7	-6.0	56.0	25.7