Technical Correction Spurred by Fundamental Trigger

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The US dollar appeared to have entered a corrective phase that was sparked by the BOE’s hawkish hold.  Oil prices rose before and after OPEC reached an agreement.  US 10-year yields are in the middle of their 2.85%-2.95% range.  S&P 500 snapped a four-week advance, though the Dow Jones Industrials ended an eight-day slide ahead of the weekend  

The Bank of England seems to purposefully like to surprise investors and managed to do so again last week, as three of the nine MPC members, including the chief economist, dissented in favor of an immediate hike.  The move caught the market leaning the wrong way. A few hours before the announcement, both sterling, and the euro were sold to new lows for the year.  The short-covering rally that ensued appears to have signaled the start of a broad corrective phase in the foreign exchange market.

The Federal Reserve and the European Central Bank try to prepare the market before the fact through word cues in addition to the formal forward guidance.  The Bank of England is most transparent after the fact, insofar as it releases the minutes of the meeting, which offers a rationale for its actions, immediately.  Other central banks wait several weeks.

The market is discounting about a 70% chance of a BOE rate hike in August, if we extrapolate from the OIS.  Before the decision, the derivatives implied slightly less than a 50% chance.  Sterling posted a key reversal in response and follow through buying ahead of the weekend lift it to $1.3315.  That corresponds to the 20-day moving average, and the 61.8% retracement of sterling’s last leg down that began with the reversal after the ECB meeting on June 14.

The technical indicators allow for additional near-term gains.  We suspect there is potential toward the high set earlier this month’s near $1.3470, ahead of which $1.3400 offers initial resistance.  It seems only fitting that if a fundamental development (shift in monetary policy expectations) could spur a technical correction, that a fundamental consideration (EC criticism of the lack of UK progress toward a Brexit agreement) could stall sterling’s recovery next week.

Sterling’s recovery took the euro along for the ride.  It made a marginal new low for the year before reversing higher with the pound.  The euro also managed to return to its 20-day moving average (~$1.1675) ahead of the weekend.  It also corresponds to the 50% retracement (~$1.1680) of the loss since the initial high posted on the ECB’s announcement on June 14.  Additional resistance is seen near $1.1720, but given the technical indicators, there is little to stand in the way of a run toward $1.1800 or a bit higher.  The $1.1600 area should now offer support.   The euro finished May near $1.1650, and although it is little changed net-net, it has risen for three of the past four weeks.

The speculators took advantage of the futures contract roll to slash their long euro exposure.  In the CFTC reporting week ending June 19, the bulls cut their gross long euro position nearly 46k contracts, leaving a still substantial 191k contracts.  The bears have been emboldened and added a little more than 6k contracts to lift the gross short position to 155.6k contracts.  The result was a dramatic fall (36k contracts) in the net long position to 52k, the smallest since May 2017.

More broadly, speculators liquidated gross long foreign currency positions, with the notable exception of the Canadian dollar.  In terms of positioning in the futures market, the large decline, perhaps exacerbated by the contract cycle, maybe the closest thing to capitulation that has occurred during the greenback’s recovery.

The dollar fell against the yen last week.  The direction itself is newsworthy.  It is only the second week here in Q2 that the dollar has fallen against the yen.  Moves have been modest and the nearly 0.6% loss over the past week gives back roughly half of the gains scored in the past three consecutive weeks of gains.  A shelf was carved over the past few sessions near JPY109.80, but it will take a convincing break of JPY109.50 to signal anything of note.  The dollar has not traded above JPY111 since May 22.

Like sterling and the euro, the Australian dollar also made a new low for the year before the BOE decision, and also bounced into the weekend.  It recovered nearly a cent from the roughly $0.7345 and closed on its highs. It posted its first back-to-back gain since May 10-11. It finished virtually unchanged on the week following a 2% drop the previous week. The technical indicators are somewhat supportive.  Overcoming nearby resistance near $0.7450 would quickly see $.0.7500 and the 20-day moving average near $0.7530.

Disappointing inflation and retail sales data threatened what had appeared to be an upside correction for the Canadian dollar,   Judging from the OIS, investors had downgraded the likelihood of a Bank of Canada rate hike to about 55% from closer to 75% a week ago.   The US dollar stalled near CAD1.3380 and proceeded to reverse lower and closed below CAD1.3285, the previous day’s low.  Follow-through selling would confirm the key reversal.  Initial support is seen near CAD1.3220.

Oil prices rallied on news that OPEC and non-OPEC producers agreed to boost output.  At the start of the week, WTI for August delivery set a new two-month low ($63.40) a barrel, and it stabilized over the next few days before rallying to finish the week near $69.35, recouping 61.8% of the decline from the multi-year high set on May 22 at $73.70.  The 5-day moving average crossed above the 20-day average for the first time since May 29.  The weaker dollar in the past two sessions may have given oil an extra boost.

The RSI and MACDs suggest a strong rally may lie ahead, while the Slow Stochastics are flat.  A return to the highs cannot be ruled out, but just as supply increases, risk to demand by one downside.  Recent weak industrial output and investment data from China, flash EMU, and US PMI showed weaker manufacturing, and Japan is expected to report that its industrial production fell 1% in the month of May.  Central bank chiefs participating in the ECB conference in Sintra last week all noted that risks posed to escalating trade tensions.

Fed Chair Powell shared that some US businesses have confided their concern and that policymakers may have to take it into account in their forecasts.  The market is on board with another Fed hike in September, but it is less convinced of another move this year.  Looking at the Fed funds futures, the odds of a second hike in H2 has fallen over the course of the past week to about 43% from 52%.   The 10-year Treasury yield finished the week in the middle of the 2.85%-2.95% range, down two basis points on the week.   Range-trading in the note futures has neutered the technical indicators.  A move above 120-05 in September contract would likely be seen as a breakout and could spur a retest on the 121 area, the high from last month.  Support is seen around 119-16.

The Dow Industrials snapped an eight-day skid ahead of the weekend and the S&P 500 edged 0.2%.  The S&P 500 still finished lower and ended its four-week rally.  The close was soft, at the lower end of the session’s range and below the 20-day moving average for the second consecutive session for the first time since early May   The benchmark is holding a downtrend line off the June 13 high.  It is found near 2767.5 at the start of the week ahead and finishes near 2754.5.  There is an old gap from earlier this month found between roughly 2737.0 and 2739.5 that may attract prices. The MACDs and Slow Stochastics are moving lower.

Growth stocks suffered disproportionately last week.  The Russell1000 Growth Index ended their four-week run with a 1.1% drop.  It leaves the index up 8.4% year-to-date.  The Russell 1000 Value Index fell slipped 0.6%.  It has risen in only one week in May and one week here in June.  It is off about 1.8% here in H1.