Currency Positioning and Technical Outlook: Correction or Trend Reversal?

Heightened speculation that the ECB will move next month, coupled with frustration with the euro offers in front of $1.40 level held, triggered a reversal of the dollar at the end of last week against the European currencies. As they weakened, cross positions were unwound, and the soft US Treasury yields lent the yen support.

The key issue for market participants is whether the price action is a technical correction or a change in underlying fundamentals. At this juncture, we are more inclined to view it as a technical correction, albeit one that may have more room to run, than a change in the underlying fundamentals.

We have yet to be persuaded that the real drivers of demand for the euro are going to be addressed by ECB action in early June. The demand for euro is coming from the large regional current account surplus, the strong foreign demand for euro area bonds, and continued deleveraging and capital raising by euro banks, including the sale of portfolios of distressed loans to foreign (largely US) investors.

US economic data is generally pointing to a strong rebound after the world's largest economy stagnated, or worse, in Q1.  However, Fed policy is seen as practically on auto-pilot and most of the data in next few weeks is not going to impact the pace of the tapering operation or bring forward expectations of the first rate hike.

The Dollar Index staged a key reversal on May 8 and was lifted further by following through buying on May 9 ahead of the weekend. Despite the sharp recovery, the Dollar Index failed to rise above the previous week's high. The band of resistance between 79.90 and 80.20 is the key to a stronger recovery. A break of the 79.25 area would warn that that upside correction is over.

The euro briefly traded below the 10-month uptrend drawn off last July lows and the February and April lows this year. It came in around $1.3780. Resistance is now seen in the $1.3840-55 area. On the downside, the once that trend line is convincingly violated the next immediate target is near $1.3740 and then $1.3675.

Initially, Draghi's comments saw the euro blow through the upper end of its Bollinger Band near $1.3910 but stopped shy of the psychologically important $1.40 level. It staged a key reversal and tested the lower Bollinger Band near $1.3765 ahead of the weekend. This seems to suggest the likelihood of some consolidation in the early part of next week.

The dollar recorded lower highs each session last week against the yen. However, in the second half of the week, the dollar's downside momentum eased as it hugged the lower Bollinger Band. We had anticipated the dollar would bottom below JPY101.50, and that view is still intact. Additional support is seen nearer the 200-day moving average (~JPY101.10). The JPY102 area offers immediate resistance.

A constructive dollar view is at least partly predicated on the rise in US 10-year yields. The yield had flirted with the year's lows below 2.6%, but looks like it can rebound in the coming days.

Sterling neared $1.70 on May 6, but then proceeded to record lower highs for the three consecutive sessions to finish the week. It tested its 20-day moving average (~$1.6835) for the first time in over a month. Trend line support, drawn off the late March and early April lows comes in near $1.68. This also corresponds with a retracement objective of the advance off that late March low. Below there, the next retracement objective is about $1.6730.

The Canadian dollar's rally was stopped cold in its tracks by the unexpected weakness in April jobs data (-29k vs. expectations of +12k) before the weekend. Prior to the employment report, the US dollar had been pushed through bottom of its lower Bollinger Band, which at CAD1.0860 coincided with other chart-based. The US dollar bounced off the CAD1.08 area to test the CAD1.0920 area in reaction to the dismal employment report. There is near term potential toward CAD1.0935-60.

The Australian dollar was the strongest of the major currencies last week, gaining about 0.8% against the US dollar. The technical tone did not deteriorate as much as most of the other major currencies before the weekend. However, the Aussie needs to move above the $0.9400 area, and ideally, April's multi-month high near $0.9460 to sustain the upside momentum. The technical indicators are mixed and are not generating a strong signal. A break below $0.9320-35 would be an early signal that $0.9200 may be seen first.

The US dollar slipped to almost MXN12.90. Disappointing real sector data and soft inflation data provides the peso bulls little on which to hang their hats. Assuming the MXN12.90 area holds, the US dollar can trade back toward the MXN13.05-MXN13.10 area.

Observations on speculative positioning from the CME currency futures:

1.  With large price swings after the recent reporting period ended on May 6, the Commitment of Traders report seems somewhat less relevant that is often the case.  In particular, the euro and the Swiss franc both declined by more than 1% between May 7 and May 9.   Sterling sold off about 0.7%.  The Canadian dollar was little changed over that period net-net, but that conceals both a sharp rally and then the just as dramatic of a decline.

2.  The largest gross position adjustment was the 8.4k contract increase in euro longs to 110.7k. This is the most since mid-March.   There were two other gross position adjustments more than 5k contracts.  Long yen positions rose by 6.5k contracts to 20.4k. Long Australian dollar positions were cut by 5.2k contracts to 44.8k.

3. While the late long euros and Swiss franc positions were vulnerable to the reversal, gross long sterling positions have been trimmed for the past two weeks and three of the past four.

4.  It is difficult to conclude that the yen bears have capitulated with 81.1k gross short contracts outstanding.  However, this is smallest short position since last October.  It should not be surprising if next week's report shows that the gross short euro position surpasses the gross short yen position. It would be the first time in about a year.

week ending May 6		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	32.6	25.7	110.7	8.4	78.1	1.6
Yen	-60.7	-70.4	20.4	6.5	81.1	-3.1
Sterling	40.6	44.2	83.8	-2.1	43.1	1.5
Swiss Franc	13.2	13.7	25.1	3.1	11.9	3.7
C$	-31.6	-30.3	28.8	-2.0	59.6	-0.7
A$	8.6	10.7	44.8	-5.2	36.2	-3.1
Mexican Peso	47.9	49.6	67.7	-0.4	19.8	1.3