Currency Positioning and Technical Outlook: Skeptical of Breakouts

The technical outlook for the dollar against the major currencies is not clear.  Yet, given the key events over the next two weeks, we are suspicious of the market's willingness to sustain breakouts.  This seems particularly true for the euro, where it has drawn within striking distance of the old nemesis in the $1.3800 area.

In the week ahead, the two pillars of the ECB's monetary policy, money supply and inflation, will be reported.  Soft reports, following the disappointing PMI survey data, may influence the outcome of next month's ECB meeting, at which time new forecasts will be presented, and for the first time, extended to 2016.  

The weaker the data, the more the speculation will likely mount that the ECB will take additional action on March 6.  Many talk about a small cut in the repo rate.  It would only be token as it is arguably not the key rate right now.  The problem is not that that it is not that the repo rate is 10 or even 15 bp too high.  To reduce the volatility of EONIA, cutting the lending rate, the ceiling, currently at 75 bp, could be more effective. The underlying problem is access to capital for small and medium businesses and households, when banks are de-leveraging.  We continue to believe that a negative deposit rate is an extreme and unprecedented move, for which there is a reasonable risk of significant disruptions.

The point is that between the data, ECB meeting and the US employment data on March 7, there is sufficient event risk to deter a strong euro gains from here.  It is in the upper end of its 5-month 5-cent trading range, roughly $1.33-$1.38.  This may help explain why implied volatility made new multi-year lows in recent days.  It is hard to be bullish the euro, if you have a 3-6 month horizon or longer, even if you recognize, as we do, risk that the euro could see $1.40.

Sterling may be in a somewhat better position.  The market has largely taken on board the probability that the BOE is the first of the major central banks to hike rates and at is not, most likely until early 2015.   There is some risk of an earlier than a later move.  Yet, even here the technical indicators are not generating strong signals and market positioning appears stretched.  The price action on Friday was poor; an outside down day was recorded.  This warns of risk of a deeper correction if the $1.66 area is violated.  A break could signal another leg down, perhaps a little more than a cent, though some chart-based support seen in the $1.6530 area.

The dollar's three-week uptrend against the yen remains intact.  The uptrend line drawn off the Feb 2 and 17 lows, caught the Fed 20 low.   It comes in near JPY102 at the end of the week ahead.  On the top side, there is immediate scope toward JPY103.10, but the real test is probably nearer JPY103.45.  

The US dollar is near a breakout against the Canadian dollar, having tested the CAD1.12 multi-year high set at the end of January in response to the exceptionally poor December retail sales data (-1.8% rather than the consensus call of -4%) released just before the weekend.  Recall that at midweek, the US dollar had approached CAD1.09 for the first time in a month.  The rebound did not appear to be initially sparked by fresh US or Canadian data, though some attribute it to the disappointing Chinese data.    In lieu of a breakout, if a consolidative phase emerges, it means a somewhat softer US dollar.

The Australian dollar ran out of steam the day before the Canadian dollar did against the US dollar near $0.9080.  It proceeded to fall to $0.8930 before staging an impressive recovery on Feb 21.  However, despite the intra-day reversal, the Aussie could not build on extend its recovery before the weekend.  A convincing break now could quickly see $0.8880.

It is difficult to get excited about the Mexican peso in the near-term.  The US dollar continues to trade largely in  a MXN13.17-MXN13.40 range and the technical indicators are not pointing to an imminent breakout.  Economic data continues to disappoint and even the longer-term peso bulls, like ourselves, are not in a particular hurry.

Observations from the speculative positioning in the CME currency futures:  

1.  The net euro position switched to a small long (8.6k contracts) from a small short (6.9k contracts). On the other hand, the small net long Swiss franc position (600 contracts) switched to small net short (2.8k contracts).

2.  There were four significant position adjustments (over 10k contracts) among the 14 gross positions were examine.  The gross long euro position rose 13.6k contracts to 88.6k.  The gross short Mexican peso position was cut by 12.2k contracts to 31.4.  Sterling account for the other two:  gross longs jumped 23.1k contracts to 76.3k and the gross short positions increased by 11.4k contracts to 53.9k.  

3. One theme that stands out from the latest reporting period is greater involvement.  Of the 14 gross positions, only 5 fell:  short euros were trimmed by almost 2k contracts to 80.0 and gross longs and shorts were reduced in the Australian dollar and Mexican peso.  Outside of the little more than a quarter decline in the gross peso shorts we noted above, the other position reductions in the Aussie and peso were minor  (less than 4k contracts)

4.  Sterling positioning is extreme in the sense that rarely over the past two decades has the net long position exceeded 20k contracts.  It stands at 23.3k at the end of the reporting period that ended February 18.  The gross long positions are approaching the highest level since 2012.  That both gross longs and short rose warns of the risk of further consolidation, which makes neither bull nor bear happy.  

5.  Although it was not large, the 4k contract increase in gross short yen positions (to 96.5k contracts) is the first rise since before Xmas. 

week ending Feb 18		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	8.6	-6.9	88.6	13.6	80.0	-1.9
Yen	-79.8	-78.8	16.7	3.1	96.5	4.0
Sterling	23.3	10.7	76.3	23.1	53.9	11.4
Swiss Franc	-2.8	0.6	14.2	2.0	17.0	5.4
C$	-65.0	-58.9	27.8	0.0	92.8	6.1
A$	-44.4	-47.4	9.4	-0.8	53.8	-3.8
Mexican Peso	-23.3	-33.9	8.1	-1.6	31.4	-12.2