Dollar Surges, but Recent Gains Seem Exaggerated

The recent price action confirms the dollar’s break out of the spring and early summer ranges against most of the major currencies.  While our understanding of the macro drivers anticipates additional dollar gains, we are concerned that the technical condition is stretched and the markets may be exaggerating the systemic risk posed by Turkey. 

The US dollar surged at the end of the week, helped by a hawkish statement by a perceived dove at the Federal Reserve and dramatic drop in the Turkish lira, which spurred a broader rout in emerging markets and risk assets in general.  We remain bullish the dollar, based primarily on the US policy mix and the divergence in interest rates.

However, we suspect that the short-term market is exaggerating the systemic threat posed by Turkey.  The low credit quality, the simply terrible macroeconomic backdrop, policies that repel investors, and the erosion of the central bank’s independence mean that exposure by global funds already had been reduced.  European bank write-downs and write-offs appear manageable.  The indirect impact could aggravate situations that are already fragile, like the periphery of Europe.

The dollar’s surge has left it over-extended.  The Dollar Index closed above 96.05, the 50% retracement of last year’s sell-off, but also well above the upper Bollinger Band (~95.80). In fact, all the major foreign currencies, save the yen and Canadian dollar finished outside their respective Bollinger Bands.  It would be not unusual for the Dollar Index to return to the breakout, which we peg in the 95.50-95.60 area.  On the upside, the next retracement target is found a little below 98.00.

The euro’s lower Bollinger Band is seen near $1.1485.  It is the first time since late May that the euro closed below it and then proceeded to rally almost 3.5 cents.  The $1.1450 area corresponded to the 50% retracement of last year’s rally.  The 6.18% retracement is seen a little below $1.1200.   A break there would lend more credence to our conviction that last year’s dollar sell-off was, from a technical perspective, corrective in nature.  In the bigger picture, the euro may have broken below the neckline on a head and shoulders pattern on the weekly bar charts. (~$1.1460), which has a measuring objective of around $1.05.

The dramatic sell-off in emerging markets spurred the unwinding of short yen funding positions, underpinning the yen, which was the strongest of the majors, appreciating 0.5% against the dollar.  The dollar made lower highs and lower lows almost every day last week and made a marginal new low since early July.  Near-term downside risk extends toward JPY110.00.  The trendline drawn from the July 19 high above JPY113 starts the new week near JPY111.40, and a move above there may be needed to improve the technical tone.

Sterling shed a few pounds.  It will begin next week with a seven-day slide in tow.  It was fallen for five consecutive weeks and in eight of the last nine. It was trading above $1.40 in late April, and since then it has fallen 11.8%.  It was sold through the 61.8% retracement of the rally from the disputed flash crash low (Bloomberg says was ~$1.1840) that was near $1.2810, and which is where the lower Bollinger Band can be found.  The next downside target is in the $1.25-$1.26 area.   Initial resistance may be seen in the $1.2800-$1.2830 band.

The Canadian dollar was able to overcome a dramatic diplomatic response by Saudi Arabia to a tweet critical of the kingdom’s treatment of a government, but a disappointing jobs report, a sixth-weekly drop in oil prices, and a surging US dollar proved too much. The Canadian dollar finished at its lowest level in nearly three weeks.   A move above the CAD1.3120 area will confirm the failure of what had appeared to be a possible downside break for the greenback and give is scope toward CAD1.3220.  The technical indicators that we use have turned higher, supporting a constructive outlook for the US dollar.

The Australian dollar had been straddling the middle of the $0.7300-$0.7500 trading range before posting an outside down day on August 9 followed by another selling.  The Aussie was sent to a new low since early last year near $0.7280.  The lower Bollinger Band is around $0.7330.  It recorded an outside down week.  The next technical target is found in the $0.7140-$0.7160 band.

Oil prices bounced ahead of the weekend, posting a potential key reversal.  The September contract began the session with marginal new lows (~$66.15) since late-June and then proceeded to rally to the five-day average (~$67.90). Despite the late week recovery, oil prices finished 1.2% lower on the week.  It is the fifth decline in the past six weeks.   The focus has been on the changes in supply.  On one hand, the world’s three largest producers (Russia, Saudi Arabia, US) are committed to boosting output despite vagaries in short-term data.  On the other hand, the oil embargo in three months may not be as effective as the last one, but there seems to be a consensus that as much as a million barrels a day could be taken off the market.  Between $65 and $70 a barrel, it is a traders’ market.

We did not know what would be the precipitating but the large speculative short position in the US Treasury market was stretched and vulnerable to a short squeeze.  The next round of tit-for-tat tariffs between the US and China are announced, and the next round is a couple weeks away.  The sell-off in emerging markets, with US new sanctions against Turkey and Russia adding fuel to the mix.  After stalling in front of 3.0% near the middle of the week, the yield fell below 2.87% ahead of the weekend.  Participants at the quarterly refunding should be happy.  The September note futures had held the lower end of its range near 119-00 at the start of the month and is poised to test the upper end near 120-16.

While US bonds rallied in the second half of last week, the S&P 500 fell.  The S&P 500 had gapped higher on Tuesday but closed the gap the following day.  It gapped lower on Friday amid widespread sales of risk assets.  That gap extends from Thursday’s low (~2852) to Friday’s high (~2842).  New lows were recorded late in the session, suggesting the selling pressure was not exhausted, and warning of a possible gap lower opening on Monday and the weekly bar charts.  A break of the 2820 area would weaken the technical outlook and a break of 2790 coupled with the turning down of the RSI and MACDs could signal a deeper correction is at hand.