Will USD’s Recovery in the Second Half of Last Week be Sustained?  

Will USD's Recovery in the Second Half of Last Week be Sustained?

The US dollar turned in a mixed performance last week.  It recovered in the second half of the week against the euro and yen.  It was an unusual week in that the New Zealand dollar was the strongest of the major currencies, gaining 1.8% against the US dollar, while the Australian dollar was the weakest, losing almost 1% against the greenback.

The US dollar turned in a mixed performance last week.  It recovered in the second half of the week against the euro and yen.  It was an unusual week in that the New Zealand dollar was the strongest of the major currencies, gaining 1.8% against the US dollar, while the Australian dollar was the weakest, losing almost 1% against the greenback.

Disappointing US retail sales and a split among the Federal Reserve Governors over the appropriateness of a rate hike this year weighed on the dollar.   NY Fed President Dudley’s comments and the better than expected consumer confidence report helped spur a six bp recovery in the US 2-year note yield and a recovery in the dollar.

To be sure, it was not only the US side that was driving the exchange rates.  The dollar recovered smartly from the JPY118 area tested at mid-week and managed to finish the week just below JPY119.50.   This was aided by the Japanese government downgrading its economic assessment and the final estimate of August industrial production.

Recall when the preliminary estimate was first released on September 26, the 0.5% decline shocked the market where the consensus forecast was for a 1.0% increase. The revised estimate compounded the injury; showing that August industrial output actually declined 1.2%.    Even though the BOJ has shown no sign that it is preparing new stimulative measures, many in the market, still smarting from last year’s surprise (when on a 5-4 vote the BOJ increased the base target to JPY80 trillion from JPY60 trillion) expect additional easing to be announced at the end of the month.

In a similar vein, the message from the ECB is that the asset purchase program can be adjusted in terms of size, length of operation, and composition.  Despite the introduction of rotating voting on the ECB, the institution works by consensus.  That consensus is still being forged.  Draghi’s press conference following next week’s ECB meeting can be expected to take another step in this process.   Many in the market expect a consensus will be reached by the end of the year.

The Australian dollar was capped with the help of increased expectation for another rate cut this year. What spurred the shift in the pendulum of expectations was one of its largest banks raised a variable rate mortgage rate by 20 bp.   The risk of an offsetting RBA rate cut rose from about a 1 in 7 chance to a 50/50 call.

Foreign officials just as much as most investors expected the Federal Reserve to hike rates in June or at least September at the start of the year.  Yet US monetary tightening has not been delivered and this, so the argument goes, led to a tightening of monetary conditions abroad, at least through the exchange rate.  That tightening impulse needs to be offset, hence the greater pressure now on Europe and Japan to ease.

We would not want to push the logic of this argument too far.   Conventional wisdom and the IMF argued that it was best for the world economy if the Fed did not hike rates this year.  The best thing for the world economy is a strong and vibrant US economy.  However, and this is critical, what it means to be strong and vibrant has downshifted.

Given labor forces growth and productivity, it is unreasonable to expect US growth to sustain the 2.7% four, and eight-quarter average annualized growth pace that it has delivered.  This is to say the US has been delivering above trend growth for two years.  As the business cycle matures, the pace of growth may moderate.  The risk for Q3 GDP, which will be reported at the end of the month, is on the downside of the consensus 1.9% expectation, as net exports and inventory drawdown weighed on growth. Still, final demand (GDP minus inventories) may be a better indication in this context of economic health.

The euro reversed lower after testing $1.1500.  Before the weekend, it made new lows for the week and closed near it, a little below $1.1360.  This has left a potentially bearish hammer pattern on the weekly euro charts.  The euro has advanced about 3.5 cents since the start of the month.  The stalling of the upside momentum in recent days is important.  The shorts are betting that the longs that are squeezed out now are unlikely to re-establish ahead of the ECB meeting.  The immediate target is near $1.1315, but a break of the $1.1265 area, which corresponds to a retracement objective and the 20-day moving average, would be more significant.

The end of the week stock market rally and the move in US 10-year yields back above 2.0% helped the dollar recover against the Japanese yen. It had slumped to JPY118, the lower end of the recent range but snapped back toward JPY119.65 at the end of the week.   The shooting star candlestick pattern may have been recorded last Thursday and follow through buying was seen on Friday.  The JPY120.00-JPY120.60 band of resistance block the way higher.

Sterling did a better job than the euro and yen in holding on to the gains scored in the first half of last week.  Sterling reached a high near $1.5530 on Thursday before finishing the week near $1.5440. It stalled near the downtrend line drawn from the August 25 high (~$1.5820), and the September 18 high (~$1.5660).  It was marred last Thursday but closed well below it.  Indeed, it closed on its session lows.  Old resistance near $1.5380 should now offer support, and may extend to $1.5350.  A break of the $1.5280-$1.5300 area would confirm the third consecutive lower high since the year’s high was recorded in June near $1.5900.

From a technical perspective, the US dollar stopped at an interesting place against the Canadian dollar last week as it approached the CAD1.2800 area.  This area corresponds to a 50% retracement of the last leg up the greenback recorded which began in mid-June near CAD1.2130.  It peaked at 11-year highs at the end of September near CAD1.3460.  The RSI and stochastics suggest that the 4.7% slide in the US dollar may be complete.  The initial hurdle is cited in the CAD1.2950-85 area, and a move back through CAD1.3070 would bolster the credence of this view.

The Australian dollar briefly traded above the 100-day moving average (~$0.7350) and stalled in front of $0.7400.  A band of congestion extends toward $0.7440.  It finished the week near $0.7265. The $0.7200 area is key to the near-term technical picture.  A break signals scope for another cent decline, initially.  If it holds broad, sideways trading is likely.

In contrast, the New Zealand dollar has been above its 100-day moving average for over a week.  Recall that the Kiwi tumbled 16 cents (~20%) between late-April and mid-August.  Last week’s gains brought it within striking distance of the 50% retracement objective found near $0.6940. Initial support is seen near $0.6750.  If this does not hold, it may warn of the risk of a return to $0.6600.

The December crude oil futures contract stabilized at the end of last week.  It slid for four sessions after poking through the $51 on October 9.  Nearby resistance is seen in the $48.60-$49.30 area.  It has largely been confined to a $45-$50 a barrel range since late-August.

The US 10-year yield also stabilized after briefly falling below 2.0%. It is difficult to get excited about the upside unless the 2.10%-2.13% area is breached.  Moreover, early in the week ahead, the 50-day moving average of the yield is likely to move below the 200-day average (golden cross). Those moving averages crossed over in the futures market (continuation contract) in early October. On the downside, it noteworthy that the 1.96% area, which corresponds to a 61.8% retracement objective, on a closing basis repeatedly.

The S&P 500 closed above the 2020 area, which was the top of a bullish “W” pattern.   It closed the week near its highs for the third consecutive week.  Despite the positive momentum, it is approaching some potentially formidable technical levels.  The 2032 area is the 61.8% retracement of the decline from the record high (~2135) in May to the lows seen in late-August and again in late-September (~1867).  Above there lies the 200-day moving average now near 2040.  The downtrend drawn off the record high comes in near there at the start of the new week.  There was shelf before mid-August around 2050 that also may offer technical resistance. A move below 2020 would be disappointing, but it may take a break of 1990 to signal the upside attempt has been aborted.

Observations from the speculative positioning in the futures market:

We look at the speculative positioning in the futures market as a proxy for short-term trend and momentum participants.  We are interested in gross positioning more than net because it reveals more insight into exposures.  It is also more true to our experience that differentiates buying to go long and buying to cover shorts, for example.

Gross position adjustments were among the smallest of the year.  There were no significant (10k+ contracts) gross position change.  In fact, only two of the 16 gross currency position we track saw more than a 5k adjustment.  The gross long euro position rose 5.7k contracts to 71.1k.  The gross short Australian dollar position fell by 6.5k contracts, leaving 76k.

However, there were three clear patterns even from the minor position adjustments.  First, the net short position fell among all the currency futures, but British pound.  Sterling’s net short position rose to 7.5k contracts from -4.5k in the prior reporting period.  It is the third week they have risen after being net long for a week.

The second clear pattern is the short-covering.  All the gross short currency futures positions were reduced without exception.  The small short-covering in the New Zealand dollar (1700 contracts) was sufficient to switch the net position to the long side even if barely (700 contracts) for the first time since May.

The third pattern is risk reduction.  Thirteen of the 16 gross positions saw a reduction of exposure.  Exceptions included the gross long New Zealand dollar position that we rounded to 0 from a small decline.  The other exceptions were the 5.7k contract increase in the long euro position and the less than 1k contract increase in the Australian dollar.

These patterns in speculative positioning were also seen in the 10-year Treasury and crude oil futures market.   Position adjustments were small, bias toward short-covering and risk reduction.

In the crude oil futures, the longs were pared by 3.4k contracts to 487.7k.  The shorts were trimmed by 10.1k contracts leaving 222.7k.  This resulted in a 6.7k increase in the net long speculative position to 265k contracts.

The net speculative position in the 10-year Treasury futures switched back to being net long.  This reflected a counter-pattern 20k increase in gross long positions (to 470.9k contracts).   The gross shorts were slimmed by two hundred contracts (leaving a gross short position of 222.7k contracts). The net long position stands at 17.7k contracts.  Consider at the end of last year the net short positions stood near 250k contracts.