Collective Sigh of Relief may Weigh on the Greenback

Developments in both Europe and China will likely encourage risk taking in the days ahead. Our reading of the dollar's technical condition warns of near-term vulnerability. The yen is likely to underperform as the crosses adjust.

Neither the US economic data nor Yellen's testimony before Congress will likely alter expectations for one hike before the end of the year. It is possible that by the end of next week, Greece is no longer a key driver of the global capital markets.

Provided an agreement to re-start negotiations and bridge financing is struck, the ECB meeting can be largely a non-event. Draghi can point to the continuing cyclical recovery, improving lending conditions, and continued implementation of its asset purchases. He may also note the resilience of the eurozone and the contained contagion as achievements of monetary officials.

At the same time, there is the risk of further easing from the dollar-bloc countries. The Bank of Canada meets on July 15. Speculation has been increasing in favor of a cut. The RBNZ has an easing bias. The RBA is formally in neutral, but the market's bias is for another cut.

The determination of Chinese officials to arrest the collapse of equity prices appears to have spurred domestic and foreign buying. A few large international fund managers signaled their intent, and trackers report flows into ETFs focused on China. The implications for China's broader market-oriented reforms and capital market liberalization has yet to be seen. The importance in this context is that whatever wave of risk-aversion was associated with China's equity market meltdown now seems likely to diminish.

Anxiety over Greece saw the euro slip into the lower end of the of its largely $1.0850-$1.1450 range that has prevailed since late April. Optimism that prevailed before the weekend pushed the euro back through the middle of the six cent range. Some euro buying done on rumors of a deal could be unwound when the news is official, but the technical indicators point to additional near-term gains. Support is seen near $1.1120. On the upside, the $1.1240-50 area may resist the initial assault. That is the main obstacle to a run toward $1.14.

The dollar appears to have put in a low of some importance just below JPY120.50. At the lows, the dollar closed three standard deviations below its 20-day moving average, something apparently not seen in four years. As the haven flows unwind, the recovery in equity prices and US yields sparked a recovery in the greenback. The JPY123.00-20 area is the next springboard.

Sterling's 3.8% decline from its June 18 high (for the year) near $1.5930 appears to have been completed. A three-day base has been built in the $1.5330-60 area. Despite intra-week penetration, it finished the week above the 200-day moving average (~$1.5435). With the strong pre-weekend recovery, sterling recovered nearly 38.2% of this recent decline (~$1.5560). Above there is scope toward $1.5630. Note the sterling's recover is also being supported by the backing up of rate hike expectations, The implied yield of the June 2016 short-sterling futures contract rose 11 basis points in the second half of last week.

The US dollar pushed against the upper end of this year's range near CAD1.28 this past week. While the combination of the softer general tone of the US dollar and firmer commodity prices may have helped stabilize the Canadian dollar, it still looks vulnerable. It has lost about 4% of its value since June 18, but the price action remains weak as poor as last Tuesday's range (~CAD1.2645-CAD1.2780) is consolidated.

We suspect there may seem to be a perverse reaction to the Bank of Canada's rate decision. If the BoC stands pat, the market may ease for it by pushing the Canadian dollar lower. If the central bank delivers a rate cut, the Canadian dollar may be bought on ideas that it is the last cut.

The Australian dollar was the weakest of the major currencies last week, losing 1.3%. While the fall in the first half the week was quickly attributed to events in China and the drop in commodity prices, its failure gain when the news cycle turned in the second half of the week warns of the downside risks. The $0.7500 area that had been a longstanding bear target is now likely to prove just as formidable a cap.

The main technical note of caution for Aussie bears is that price action remains stretched as it hugs the lower Bollinger Band (~$0.7390). Technical support is less significant for the Aussie (and New Zealand dollar) that are trading near multi-year lows. The next important downside target is cited nearer $0.7240.

The August light crude oil futures contract gapped lower at the start of last week. This appears to be measuring gaps that can take place around mid-way of a move. The target of the gap was approached in the middle of last week. The price of oil bounced, but it was half-hearted, and it finished before the weekend on its lows near session lows. The price action is more bearish than the technical indicators The March low was set near $48.70, but only once did the contract close below $50. The longer-term technicals look poor and warned the new lows are likely after the three-month-old correction ended.

Gaps are less common in the US Treasury market, yet there were two last week. The yield gapped lower on Monday in response to the Greek and Chinese developments. The yields gapped higher on Friday as Chinese stocks (that traded) stabilized, and there was some cause of less pessimism over Greece. This island bottom this creates points to sharply higher yields, we are less sanguine. As the 2.50% yield level is approached, we suspect that will attract buyers as it did on two occasions last month. The market appears to have taken on-board that US Q2 GDP is 2.0-2.5%. How the economy does at the start of Q3 may determine whether the Fed hikes in September. The market may be particularly sensitive to the data.

The S&P 500 closed twice last week below the 200-day moving average but managed to finish the week on a strong note above it (~2056). Suggestions that the long awaited deeper correction is at hand, seem to be jumping the gun. Weak longs have been shaken out, creating pressure of its own kind to re-load. A move now above the 2085-2088 area would suggest a run to new highs is possible in the broad range trading environment.

The DAX is interesting. It spent Q2 retracing Q1's stellar rise. It had appeared to have been bottoming when the Greek referendum, and perhaps the Chinese meltdown, took the DAX a new leg lower. It bottomed just ahead of its 200-day moving average (~10620). It rose smartly on Thursday before gapping higher on Friday. Several technical tools point to the significance of the 11400-11600 area. If this area can be surmounted, many will conclude the downside correction is over.

Of course, it was the Chinese equity markets that were of greatest interest. While cognizant of the government efforts and the fact that around half the issues are not trading, technical considerations suggest a climactic low has been reached. The Shanghai Composite's steep decline did no more than a deep (60%) retracement of the rally that began a year ago. In fact, the sell-off did not even push prices below mid-March levels. The direct wealth effect is likely to prove marginal. There are indirect effects, such as stemming from equity used as collateral, which has to be reassessed.

The first important test for the Shanghai Composite is found in the 3975-4065 range. Above there 4275-4300 beckons, however, from a policy point of view, the 4500 area is key. This is the level that domestic brokerages are committed to maintaining long positions. There was increased concern that official efforts to stem the stock market slide would fail, but if it succeeds, will this simply being a violent correction, on the way to new highs, it too will pose new problems for investors and challenges for policy makers.

Observations based on speculator positioning in the futures market:

1. In the holiday-shortened reporting week ending July 7 that saw dramatic price action, half of the gross positions we track changed by at least 10k contracts. This makes it one of the busiest weeks of the year. The overall pattern noted last week remained intact. For the most part, the gross short positions of the dollar-bloc and Mexican peso rose while the others fell. The Swiss franc is the exception. Its gross short position increased by an inconsequential 400 contracts.

2. The gross short yen position was cut 14.6k contracts, leaving 109.7k. The gross long position rose by only 600 contracts. This disaggregated look reveals an important point about the yen's so-called haven. The yen's appreciation during volatile periods may be more a function of unwinding a short position, perhaps related to its use as funding currency that flocking to it as a haven implies.

3. The gross long sterling position was cut by 14.1k contracts to 39.6k. Sterling appears to have bottomed shortly after the reporting period ended. This reduction of longs was the primary cause of the doubling of the net short position to 23.0k.

4. Both Canadian dollar bulls and bears saw opportunity. The bulls added 2.8k contracts to the gross long position (to 35.9k) while the short rose by almost 50% (21.6k contracts) to 68.2k. Similar behavior was evident in the Australian dollar, but less so. The bulls added 200 contracts to 55.1k, while the bears added 10.3k contracts to the gross short position, raising it to 77.3k.

5. In the Mexican peso, the bears were in control. The bears increased the gross short peso position by 21.7k contracts, lifting it to 96.5k. The bulls cut their gross long position by a third of 12k contracts to 24.1k.

6. The bears sold into the US Treasury rally. The gross shorts added 12.7k contracts, lift the gross short position to 467.8k contracts. Some bulls cashed out, liquidating 16.6k contracts, leaving 435.1k. The net short position increased to 32.7k from 3.5k in the previous week.

7. The speculative net long oil futures position was trimmed by 32k contracts, pushing the balance below 300k contracts for the first time in 2 1/2 months (296.2k). Some brave longs saw the pullback as a buying opportunity and increased the gross position by 2.8k contracts to 485.8k. The shorts were emboldened and added 34.9k contracts (to 189.7k) to their gross position.

7-Jul		Commitment of Traders
	(speculative position in 000's of contracts)
	Net	Prior	Gross Long	Change	Gross Short	Change
Euro	-99.3	-100.0	66.2	0.6	165.4	-0.1
Yen	-63.6	-78.8	46.1	0.6	109.7	-14.6
Sterling	-23.0	-12.8	39.6	-14.1	62.6	-3.9
Swiss Franc	6.1	6.9	9.2	-0.3	3.1	0.4
C$	-32.3	-23.5	35.9	12.8	68.2	21.6
A$	-22.2	-12.0	55.1	0.2	77.3	10.3
Mexican Peso	-72.4	-38.8	24.1	-12.0	96.5	21.7
(CFTC, Bloomberg)