Currency Positioning and Technical Outlook: As You Were

The news stream has been busy, but as the dust settles, many investors may simply be encouraged to do what they were already doing. 

The US economy's contraction in Q1 was not the true signal of the underlying economy. Nor does it portend a new recession. Instead, the economy is rebounding back toward 3%. The Fed's tapering strategy, outlined by Bernanke, remains very much intact, and is still projected to wind down QE3+ completely in Q4.  

The ECB took action, and its rate cuts and forward guidance triggered a rally in European core and peripheral bonds. Equity market saw the news as favorable, and new highs were recorded. In the foreign exchange market, the euro's resilience has many investors (and policy makers) scratching their heads.

Our view has been straight forward. The euro's decline in May was corrective in nature as participants adjusted positions ahead of the ECB's action. A rather typical "sell the rumor, buy the fact" behavior unfolded which we had anticipated. We suspect the correction is completed and expect the euro to move toward $1.38 and sterling to $1.6900-25 initially.  

The yield on 10-year  US Treasuries may need to sustain a move back above 2.6% area to increase the likelihood of the greenback move through the JPY102.80 level against the yen. While the higher yieldss may underpin the dollar-bloc,  the Canadian dollar may under-perform in a generally soft US dollar environment and with a backdrop of disappointing data.

Dollar-Index: The Dollar Index staged a key reversal in reaction to the ECB. After hitting 81.00, the Dollar Index slumped to 80.25 before the weekend. This corresponds to a retracement objective of the advance from early May. Our initial target is near 79.70. A bounce into the 80.65-75 area may offer dollar-bears a new entry opportunity. The RSI is neutral, while the MACDs are about to turn lower.

Euro: The euro fell about 5 cents from early May through last week. It has begun retrace those losses. The RSI and MACDs are constructive and are consistent with a euro advance back to the $1.3800 area. Given the strong rally off the ECB induced low near $1.35, some consolidation at the start of the new week. A pullback toward into the $1.3570 is the most that can be reasonably expected, if the downdraft is over, as we suspect.

Yen: A trendline drawn off the early January and April highs comes in near week JPY103.00-20. This is just above the retracement of the down move from the April attempt at JPY104 (~JPY102.90). Support is seen in the JPY101.80-JPY102.00 area. With US Treasuries remaining firm, it is difficult to see the dollar breaking out to the top side against the yen. The euro tested the JPY140 level several times in the second half of last week. A break above the JPY140.20 area would likely coincide with a firmer dollar against the yen as well.

Sterling: The dominant technical consideration for sterling is the downtrend line down off the May highs caught sterling's pre-weekend high near $1.6845, which also corresponds to a retracement objective. A break of this are would be encouraging but additional resistance is seen in the $1.6880-$1.6925 band. A pullback into the $1.6755-70 range may be a new opportunity to participate from the long side.

Canadian dollar: Technical factors seem aligned with the disappointing fundamentals and suggest near-term weakness of the Canadian dollar. The RSI and MACDs are headed up. Provided the CAD1.09 area remains intact, the greenback may continue to recover from the April and May slide. The first retracement target is near CAD1.10 and then CAD1.1050.

Australian dollar: Over the past two months, the Australian dollar has carved out a base near $0.9200. On the upside, the there is a trend line down off the April and May highs that intersect near $0.9375 at the stat of the new week. The RSI is neutral, but the MACDs are turning up. A pullback toward $0.9280 may be a low risk opportunity for those who expect signs that the Chinese economy may be stabilizing and that Australia's high rates will offer it support in the post-ECB environment.

Mexican peso: The Mexican central bank surprised investors by aggressively cut the overnight rate by 50 bp. This arrested the move to push the dollar below MXN12.80. The trendline drawn off the January, and February highs caught the April high and stopped the US dollar's bounce at the start for last week. It comes in near MXN12.9550 early in the new week. The speculative community is very long the peso, and the risk is that some may have to be shaken out before it can post another leg up.

US 10 Treasury yields: The 10-year yield has been in a clear downtrend this year. The trendline drawn off the January and April high stopped the rise in yields last week at about 2.64%. A break of this area is needed to lend more credence to our suspicions that US rates have bottomed. If this view is right, the 10-year yield should stay above 2.50%.

Observations from the speculative positioning in the futures market:

1,  Speculative position adjustments were only significant in two currencies in the latest CFTC Commitment of Traders report that covered the week through June 3.  The first was gross long euro positions.  They were cuts by 13.6k contracts to 57.1k.  Gross short positions edged 2k higher to just over 90k contracts.  The second was the gross short yen positions. They grew to by nearly 11k contracts to almost 87k.  Of 14 gross speculative positions we track, 10 of them changed by less than 4k contracts.

2.  There was a tendency to add to gross speculative short positions.  The exceptions were the Swiss franc that as a 1.5k contract reduction to just less than 14k contracts; and the Australian dollar that saw less than a 1k contracts were pared to 35.3k.

3.  Going into the ECB meeting the speculators had the smallest long position since last July.  It has been halved since mid-March.  The gross short position was the largest since last August.  It remains larger than the gross yen position.

4.  Speculators extend gross short positions in the 10-year Treasury futures contract after the previous week's bout of short covering.  The gross short position was extended by 28k contacts to a little more than 426k contacts.  The gross longs rose 3.8k contracts to 383.1k, leaving the net position short 43.3k contracts (vs -19.1k the previous week).  

week ending June 3		Commitment of Traders
		(spec position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-33.0	-16.6	57.1	-13.6	90.1	2.7
Yen	-74.2	-59.0	12.6	-4.4	86.8	10.8
Sterling	35.0	35.3	79.5	1.0	44.5	1.4
Swiss Franc	-2.0	-3.9	11.9	0.3	13.9	-1.5
C$	-22.1	-21.8	32.5	0.0	55.3	0.9
A$	21.5	15.8	56.8	4.7	35.3	-0.9
Mexican Peso	86.0	83.3	105.7	3.9	19.7	1.1