Dollar Bulls Retake the Whip Hand

The US dollar had a good week. Indeed, the Dollar Index's 3.3% rise was its best weekly performance since last September.  After looking rather bleak, the divergence theme struck back with a vengeance.

  

ECB officials indicated that its sovereign bond buying program was turning more aggressive in the May-June period to get ahead of the summer markets.  And not only did officials deny speculation that it could end its program early (before September 2016), but they reminded investors it could extend the program if needed.  Remember every country that has adopted QE has had to do more than it initially anticipated. 

At the same time, research at two regional Federal Reserves (San Francisco and Philadelphia) emphasized the seasonal distortions that have depressed Q1 GDP, especially since the crisis. Although the  Board of Governor's economists has played it down, the Bureau of Economic Analysis will make some changes to better take into account "residual seasonality" when it reports Q2 GDP on July 30. 

The US economic data over the course of the week were mixed.  For the first time in nearly two months, investors began rewarding the dollar for good economic data rather than punishing it for weaker data.  There were three data highlights.  First was the out-sized jump (20.2%) in housing starts. The second was the new cyclical low in the four-week moving average of weekly initial jobless claims. Third was the 0.3% rise in core CPI matches the August 2011 gain, which itself was the largest advance since January 2008.  The year-over-year rate remained steady at 1.8% rather than slip lower as the consensus expected.  

Not only did the dollar gain against all the major and emerging market currencies, but it also finished near its session/week highs.    We caution against putting too much emphasis in the dollar's pre-weekend momentum.  The previous week (May 15) the dollar closed on its lows, which was not a helpful indicator of this week's direction, even at the start of the week.  Moreover, the US markets are closed Monday for Memorial Day.   Nevertheless, a technical case can be made that the dollar's roughly two-month downside correction has ended.  

The euro's technical tone has deteriorated sharply.  The five-day moving average moved below the 20-day average for the first time in a month.   Before the weekend, it recorded an outside down day by trading on both sides of the previous day's range and closing below the previous day's low.   The RSI and MACDs have turned lower.  The euro has retraced more than 38.2% of its two-month bounce. The 50% retracement is near $1.0960.  Below there support in seen in the $1.0840-80 area.   The $1.1060-80 may contain upticks if the euro bears are re-taking control.  

The dollar recorded an outside up day against the Japanese yen before the weekend.  The 5-day moving average crossed above the 20-day.  The dollar finished the week above JPY121.50 for the first time July 2007.   Both the RSI and MACDs are constructive.  Many participants are talking about a run at the year's high, a little above JPY122, and beyond there, JPY123.80.   Still, a word of caution is in order.  The dollar finished the week above the upper Bollinger Band (~JPY121.40), and on the rare occasions when this has happened over the past year, it has coincided with a dollar pullback.   Initial support is seen in the JPY120.60-80 area.  

Sterling's 1.55% loss last week makes it the best performing major currency (followed by the yen's 1.9% decline).  The pre-weekend drop more than reversed the gains scored on response to the heady 1.2% rise in April retail sales.  Sterling posted its lowest close in two weeks.  The RSI is heavy, and the MACD's have crossed to the downside. It held just above the 20-day moving average (~$1.5455), which also corresponds to the 50% retracement of the election rally.  There is not much chart-based support ahead of the $1.5340-65 area, but we suspect there is near-term potential toward $1.5200.  

The Swiss franc is interesting from a technical perspective.  A double bottom appears to have been carved out for the dollar near CHF0.9050.  The neckline is near CHF0.9350 and projects toward CHF0.9650.  Also before the weekend, the dollar had moved within a few ticks of completing a 61.8% retracement of its two-month decline.  

There are two interesting and bearish technical patterns unfolding for the Canadian dollar.  First, the US dollar's downtrend line drawn off the March 31 high (~CAD1.2785) and the April 10 high (~CAD1.2665) came in near CAD1.2280, which was successfully breached on a closing basis before the weekend.   That area also corresponded to a 38.2% retracement of the greenback's decline from the year's high on March 18 (~CAD1.2835).  The CAD1.2380 area (Friday's high was ~CAD1.2320) corresponds to the 50% retracment.  

The second technical pattern that we are monitoring is what appears to be a triple bottom below CAD1.1950.  The neckline is around  CAD1.2200.  The pattern projects into the CAD1.2450-CAD1.2500 area.  This corresponds with a 61.8% retracement of the US dollar's two-month decline (~CAD1.2485).

The Australian dollar posted a large outside down day before the weekend.  It was trading above $0.8150 on May 14.  It hit a low just above $0.7800 ahead of the weekend.  The drop means the Aussie has retraced more than 50% of the gains it had recorded since April 12 low near $0.7535.  The 61.8% retracement is found near $0.7775 though chart-based support may be a cent lower still.  The five-day average has crossed below the 20-day average for the first time in a month.  The RSI is heavy, and the MACD's have crossed lower from elevated levels.   Initial resistance may be seen in the $0.7860-80 area.  

The July light sweet crude oil contract fell for the third week.  Still it remains broadly flat at the upper end of the recent range.  The technical indicators are not generating strong signals.  Although the daily correlations are not particularly robust, a bullish dollar view would generate a small bias to the downside for oil prices.  

The benchmark US 10-year Treasury yield slipped 2.5 bp last week, but the generic 10-year yield rose four bp.  The generic yield tested the 20-day moving average for the first time since late-April and bounced off of it.   The pre-weekend yield low (~2.16%) also corresponds to the neckline of a  potential head and shoulders top that bond bulls are touting.  If the neckline is violated, it warns of a scope for a move back to 2.0%.   Alternatively, the 10-year yield may be consolidating.  It has traded above 2.30% earlier this month but was unable to close above there.  The range seems 2.16%-2.30% until proven otherwise.  

The S&P 500 edged to new record highs but was still essentially flat on the week (+0.16%). The much-was confined to a narrow range of less than 1% for the week (2120-2135).  While valuations may be elevated, as Yellen has noted, selling has been limited, whereas many are looking for a dip to buy.   The technical indicator offers very little insight at the present.  

Observations based on the speculative positioning in the futures market:  

1.  There were five significant gross position adjustments in the currency futures in the reporting period ending May 19.  The gross short euro position fell by 15.2k contracts to 207.1.  It had peaked in late March near 271k contracts.  The eight weeks of short covering left the gross short position at its smallest level since the start of the year.  Both the gross long and short yen positions rose sharply, which is something that goes unappreciated by the traditional approach of focusing on the net position (which was slightly changed) The gross long position rose by 25.6k contracts to 63.4k. These speculators were trying to pick a dollar top.  The gross short position rose by 24k contracts to 85.4k.  The yen bears are playing for a breakout. 

2.  The gross short Canadian dollar position was cut by more than a third to 20.8k contracts.  It was this reduction of short positions that swung the net position long (4.3k contracts) for the first time since September 2014. The gross longs were also pared (-3.9k contracts to 25.2k).  Lastly, gross long peso positions were chopped by 10.3k contracts to 23.7k.  

3.  As has been the case fairly consistently over the past two months, the general pattern continued to gross short currency futures to be pared.  The only exceptions in the past week were the yen and Australian dollar.  The fact that, for the most part, new longs were not established,  gives up confidence that the spot gains in the currencies was corrective in nature, and not the end of their bear markets.  

4.  Another shortcoming of the traditional focus on the net speculative position is that it misses the opportunity of looking at absolute levels.  What strikes us is the gross short Swiss franc position is extreme at only 2.7k contracts.  This is a four year low.  It dovetails nicely with the bearish technical view sketched out above.  

5.  The net short 10-year Treasury position was fell to 85.8k contracts, the smallest since February from 132k contracts.  However, very little short-covering took place.  The gross short position, in fact, hardly changed.  It fell by 2.2k contracts to 449.3k.  The change in the net position was a function of 44.4k new longs being established (to 363.4k).  After US yields rose, these new longs are picking a bottom to the prices (a top in yields).   

6.  The net long speculative sweet crude oil position increased by 23.2k contracts to 343.4k.  The increase was a function of shorts reducing positions faster than the longs. The gross long position was trimmed by 7.8k contracts, leaving 504.6k.  The gross short position was reduced by 35k contracts, and 161.2k gross short contracts remain.    

week ending May 19		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-168.0	-179.0	38,8	-4.6	207.1	-15.2
Yen	-22.0	-23.6	63.4	25.6	85.4	24.0
Sterling	-23.4	-30.8	41.1	3.6	64.5	-3.8
Swiss Franc	9.4	10.6	12.1	-2.7	2.7	-1.5
C$	4.3	-4.0	25.2	-3.9	20.8	-12.3
A$	7.3	4.5	65.1	5.7	57.8	2.9
Mexican Peso	-31.3	-27.0	23.7	-10.3	55.0	-6.0

(CFTC)