Where Do We Stand With Regards to the Dollar Rally?

We think that the market is overreacting to two Fed speeches and underreacting to ongoing firmness in the US data. Yes, the US economy is slowing but nothing beyond what was within expectations. Growth, while slowing from the blistering 4.2% SAAR pace in Q2, is still robust.

Indeed, Bloomberg consensus sees y/y growth for the US remaining above the trend rate of 2% through Q1 2020. We prefer looking at y/y readings to avoid issues with seasonal adjustment embedded in the SAAR readings.

The dollar has stabilized despite continued adjustment in Fed expectations. The implied yield on the January 2020 Fed Funds futures contract fell 5 bp to 2.72% yesterday but has recovered 2 bp today. Since peaking at 2.95% on November 8, the implied yield has fallen 21 bp to 2.74%. This is the lowest since early September and basically takes out the second 2019 hike that had been priced in.

We are going to go out on a limb and reiterate our strong dollar call. Fundamentally speaking, we do not think there have been any significant changes in the dollar-positive drivers that have been in play all year. That is, the US economy remains strong despite the sequential slowing now under way. Furthermore, the dollar continues to benefit from regular bouts of risk-off sentiment.

Looking elsewhere, risks abound. The odds of a no-deal Brexit continue to climb even as the European Commission looks likely to start excessive deficit procedures against Italy this week. Mix in a healthy dollop of ongoing US-China trade tensions for good measure. Below, we review our year-end targets for the greenback that were made back in October as well as market positioning as measured by the CFTC.

 

The dollar is up against virtually every major currency YTD. The best performers are JPY (flat) and CHF (2%) while the worst are SEK (-10%) and AUD (-8%).

EUR will post an outside down day if it closes below yesterday’s low near $1.1395. This reversal pattern sets up further losses and we foresee a test of the November 12 low near $1.1215, which is just above our year-end target of $1.12. Below that, the $1.1185 level is key and represents the 62% retracement objective of the big January 2017-February 2018 rally. Break below would set up a test of that January 2017 low near 1.0340.

Positioning: According to CFTC data, the market became net short euros back in early October. The net short position has since grown steadily but at -37k contracts for the week ended November 13, the market is nowhere near the -137k back in November 2016 or -183k back in December 2015.

 

GBP has been held hostage to the ongoing Brexit drama. However, as the risks of a no-deal Brexit rise, so too do the downside risks for sterling. We look for a test of the October low near $1.27 and then the mid-August low near $1.2660. We are beyond our year-end target of $1.28 and on our way to our mid-2019 target of $1.24. Longer-term, charts point to a potential test of the $1.20 low from January 2017.

Positioning: According to CFTC data, the market became net short sterling back in mid-June. The net short position grew steadily and peaked near -79k in mid-September but then fell back. At -47k contracts, the market is nowhere near the high of -108k contracts back in March 2017.

 

JPY performance has been problematic. While USD/JPY should be rising as part of the broad-based dollar rally, the yen tends to outperform during risk-off periods. As such, the pair has been stuck in a 112-114 range for much of Q4. We look for an eventual test of the October high near 114.55 but are likely to fall short of our 116 year-end target.

Positioning: According to CFTC data, the market became net short yen back in mid-June. The net short position grew steadily and peaked at -115k in early October. At -102k contracts for the week ended November 13, the market is not yet near the high of -136k contracts back in November 2017.

 

CAD is on track to test the June lows near 1.3385. Break above that would set up a test of the May 2017 high near 1.38, with intermediate targets in the 1.3535-45 range (highs from March and June 2017). Lower oil prices and the broad-based USD rally are overwhelming higher rates as the BOC continues its tightening cycle.

Positioning: According to CFTC data, the market became net short Loonie back in March. The net short position grew steadily to a peak of -53k contracts in July but has since fallen to -3k contracts for the latest week ended November 13.

 

AUD often leads the broader moves in the majors. It peaked near .7340 on November 16 and has since turned lower. With US-China trade tensions likely to persist into 2019, AUD is likely to underperform. We look for a test of the year’s low near 0.7020 from October. This is just above our year-end forecast of 0.7000.

Positioning: According to CFTC data, the market became net short Aussie back in April. The net short position has grown steadily to a peak of -73k contracts in early October before falling back. At -60k for the week ended November 13, the market is nearing the extreme positioning of -77k back in both March 2015 and August 2013.

 

We look at MXN here simply because it is the only EM currency that the CFTC data covers. USD/MXN bottomed near 18.50 on October 1 and has since turned higher. With political concerns linked to President-elect AMLO likely to persist into 2019, MXN is likely to underperform. We look for USD/MXN to test the year’s high near 20.96 from June, with an eventual test of the all-time high near 22.04 from January 2017.

Positioning: According to CFTC data, the market became net long pesos back in July. The net long position grew steadily to 74k in early October but then fell back. At 7k contracts for the week ended November 13, the market is not yet net short. In terms of extreme positioning, there is still room for this USD/MXN rally to continue.