Dollar Bulls Regain Upper Hand

The powerful divergence theme re-emerged and effectively ended the dramatic correction throughout the capital markets. The FOMC statement strengthened conviction of a mid-2015 lift off, even if the pace of tightening may be somewhat slower than previously anticipated. At the same time, the Swiss National Bank's decision to move to negative interest rates, partly in anticipation of the ECB expanding its asset purchases as early as next month, underscores that Europe remains well behind the US in the credit cycle.

Rather than attribute the downdraft in the dollar and equity markets to a shift in underlying fundamental drivers, we had seen the hand of a technical correction, driven by short-term market positioning, and aggravated by year-end portfolio adjustments.      Indeed the euro peaked within a few ticks of the 50% retracement objective of its losses from the October 15 high near $1.29. For its part, the dollar's dramatic slide against the yen stopped just shy of a key retracement objective of its rally from both October 15 and October 31 that was found near JPY115.50.

We expect the dollar's higher trend to continue.  However, the lack of participation over the next two weeks could obscure this trend.    The Dollar Index made a new high before the weekend near 89.65.  A move above 90.00, which has held back previous dollar bounces since the onset of the Great Financial Crisis, would signal an acceleration of the dollar 's advance.   Initial support is pegged in the 88.80 area.   

The euro recorded a new low for the move just before the weekend near $1.2220.   A break of $1.2200 would suggest losses toward $1.20.  It has not been able to resurface much above $1.2300 since breaking below in response to the SNB's decision. 

Technical indicators suggest the dollar's uptrend against the yen will resume.  The move above JPY119.50 strengthens the conviction that the greenback is on its way back to the December 8 high near JPY121.85 and beyond.   Initial dollar support is seen in the JPY118.50-80 area. 

Sterling is not particularly interesting at the moment.  It caught between the strength of the dollar and the weakness of other currencies, including the euro, Swiss franc, yen and Australian dollars.  Against the greenback, it has been confined largely to a $1.56-$1.58 trading range since mid-November.    There has been a handful of violations of the two-cent range.    Technical indicators suggest risk remains to the downside.  Sterling set a low near $1.5540 on December 17, but the snap back into the range seemed halfhearted.  Resistance is seen $15680-$1.5700.      

The dollar-bloc currencies are still headed lower.  They did not participate in the bounce that the euro and yen enjoyed.  Resistance in the Australian dollar is now pegged near $0.8200.  Our next important target is near $0.8000, ahead of that are the lows from 2010 around $0.8060-70.    The US dollar reached a high of roughly CAD1.1675 on December 15, this was the lower end of the range we have been suggesting the greenback had near-term potential toward.  The upper end of that range is near CAD1.1725.  Since recording the highs, the US dollar has not been below CAD1.1560. 

The dollar peaked against the Mexican peso on December 12 near MXN14.95.  Five days later it had slumped to MXN14.37.  By the end of the week, the dollar's bull move appears to have  had recovered to above MXN14.70  In the days ahead, the dollar may consolidate its gains.  It could pullback toward MXN14.50, though, over the medium term, it appears the dollar can retest the 2009 high near MXN15.60.  

The US 10-year yield bounced off of the 2.0% level to near 2.25%, where the rally faded.  Economic data out next week are expected to show stronger capex (durable goods orders) and stronger growth momentum (upward revision to Q3 GDP to above 4%).  This may limit the pullback in yields.

At the same time, we note that the premium the US pays over Germany widened out to almost 160 bp this week.  This is the largest premium since mid-1999.  It began the year near 110 bp.  The widening was a result of German bund yields falling further than US yields fell.  

Although the US 10-year yield remains relatively low, the 2-year yield has firmed, and at 65 bp is 1-2 bp below the five-year high set earlier this month.  The US premium over German at this tenor is about 73 bp, which represents a new three-year high.  These relative interest rate developments are understood to be constructive for the dollar.

The S&P 500 gapped higher December 18 following a strong close the previous day after the FOMC meeting and seemingly aided by the Swiss National Bank's move to negative interest rates.    It had advanced further before the weekend.   From the mid-week low to the pre-weekend high, the S&P 500 gained about 95 points or 5.2%.

That gap is between 2016.75 to 2018.98.  We do not look for this gap to be filled in the near-term.  Rather the gap, like the one on October 21,  signals the end to the corrective losses and the resumption of the bull advance that carries it to new highs.

There is a reasonable chance that the February crude oil futures contract has put in a short-term low around $54.30-60.  The RSI is turning up, and the MACD is about to cross. The sellers were pulling back, and bargain hunting was reported.   The $60.00 level is the first hurdle and near $63.00. 

Observations based on the speculative positioning the in futures market:

1.  There was only one significant position adjustment of more than 10k in the latest CFTC Commitment of Traders report for the week ending December 16.  It was the 12.4k  contract reduction in the gross short euro position, leaving 182k contracts still short.  The net short position has been reduced by 52k contracts since peaking in early November, which is fully accounted for by short covering.  

2.  There were several other gross currency positions that changed by almost 10k contracts.  The short yen position was reduced by 9.6k contracts to 132.6k.  The gross long Swiss franc position doubled to 18.9k.  The speculative gross long Australian dollar position increased by 9.4k contracts to 26.8k.  

3.   All the currency futures we track here but the Canadian dollar saw gross short positions trimmed in the latest week.  This seems very much consistent with squaring up ahead of the holiday season.   For its part, the gross short Canadian dollar position rose a by 300 contracts.  

4.  The speculative net short US 10-year Treasury futures position increased by 20% to 258k contracts.  A full 10% of the gross long position was liquidated, or 32.3k contracts were sold to leave 273.4k still long.   The gross short position increased by 24.6k contracts lifting the short position at 531.6k contracts.  It has risen by 70k contracts over the past three reporting weeks. Over the same period, the gross long position has fallen by 110k contracts.  

week ending Dec 16		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-127.0	-137.0	56.2	-2.1	182.8	-12.4
Yen	-86.9	-104.0	45.6	7.6	132.6	-9.2
Sterling	-14.5	-23.6	37.9	0.2	52.4	-8.9
Swiss Franc	-3.7	-22.9	18.9	9.9	22.6	-8.5
C$	-15.7	-14.4	32.4	-1.0	48.1	0.3
A$	34.3	-45.0	26.8	9.4	61.0	-1.4
Mexican Peso	-52.8	-48.6	25.8	-6.3	78.6	-2.1