Dollar Losses Accelerate, Adjustment not Over

The US dollar had one of its worst weeks of the year, as its interest
rate support eroded. 
Despite prospects for a further upward revision
in Q2 US GDP above 3.0% and continued
above trend growth, the market continues to downgrade the chances of another
rate hike this year.  The CME’s model suggests the odds of a hike by the
end of the year fell to about 26% from 42% a week ago.  

The early retirement of the Federal Reserve’s Vice Chairman
Fischer and reports that suggest the chances of Cohn replacing Yellen have fallen may have contributed to the reduced
expectations and the weaker dollar. 
Cohn represents a key part of
Trump’s coalition, and if he does not get the appointment, or is otherwise sidelined, the energy behind the
economic program is diminishedThat, in turn, means that the current economic challenges, like the reduced
growth potential and weak productivity, aren’t likely to be addressed.  The
implication of this is that the US 10-year yield can return to levels seen
before last November’s election.  At the end of October 2016, the US
10-year yield was 1.85%, approximately the level of trend growth.   

The Dollar Index has now met the 50% retracement objective (~91.20) of
the rally that began in mid-2014  
The 1.6% decline last week was the
largest in Q3.  The technical indicators suggest this leg
down has more room to run.  The 61.8% retracement is found at 88.25.   On the upside, a move above 92.20
would help stabilize the tone.   One note of caution comes from the
magnitude of the fall that has pushed the Dollar Index below its lower
Bollinger Band (~91.50).  

The ECB’s concern about the euro’s appreciation has risen since July
meeting, but it still has not reached the official pain threshold.
 
The market’s enthusiasm for the euro has not waned.  The 50% retracement
of its decline that began in mid-2014 and through a low set at the start of the year is
found
near $1.2165.  Beyond there,  potentially extends toward $1.25-$1.26.   The technical
indicators are constructive, and buying on dips is still the preferred strategy
for trend followers and momentum traders.  We expect new buying to emerge on pull backs into the $1.1960-$1.1980 area.  

The dollar also fell to new lows for the year against the Japanese yen,
where the pull from the decline in US yields was particularly pronounced, spurring the covering of the short yen positions. 
 
That said, the MOF reported that foreign investors were substantial buyers of
Japanese bonds (JPY1.36 trillion) in the weekend ending September 1.  This is the most in six years.  We suspect
that some fund managers underweight Japanese bonds due to the low yield were underperforming their benchmarks given the yen’s strength.  We are still skeptical of the safe haven buying consensus thesis.  In
the week ending September 1, the dollar did not sell off against the yen, which
the safe haven thesis would have inferred
from the buying of Japanese bonds, but appreciated 0.8% instead, the most in two months.  

With JPY108 finally yielding, the next technical objective we suggested
was around JPY106.50. 
The technical indicators are consistent with
this bearish view, but the dollar is well beyond the lower Bollinger Band
(~JPY108.20).  Indeed the greenback traded nearly three standard
deviations below its 20-day moving average, an extreme not seen since early
this year (and happened four times last year). 

Sterling did not disappoint.  Despite our skepticism about the
UK Brexit strategy, we had recognized the improving technical tone for sterling
over the past few weeks.  Before the weekend it poked through $1.32 for
the first time since early August.  On the week, it gained almost 2%, which
is its best performance here in Q3.  The $1.32 area corresponded to the
minimum measuring objective of small
inverted head and shoulders pattern we had been tracking.  Sterling’s
gains seem to reflect the weak US dollar environment and what some see as the
prospects for a softer Brexit.  

We suggest that the next key technical objective is near $1.3430, which
represents a 50% retracement of the losses suffered since the referendum.
 
The technical indicators are still constructive, though the Slow Stochastics
may turn lower next week.  Sterling has not only gone through the upper
Bollinger Band, but it also flirted with three standard deviations from its
20-day moving average (~$1.3225).  We would peg initial support near
$1.3060.

The Canadian dollar had a great run last week, rising 2.0%, nearly
matching the yen and Swiss franc’s strength.
  The Loonie was aided by the Bank of
Canada rate hike that surprised many.  It
did not only lift rates, but seemed to keep the door open to more, though we
suspect a hike in October, which would be the third hike in as many meetings,
is too aggressive given the comments of the central bank and other macro
considerations, like inflation, the exchange rate, household indebtedness and
the housing market.
    The employment data was mixed before the weekend, but the report
seems skewed by the youngest cohort returning to school.  The US dollar
approached CAD1.20.  We expect this to hold in the near-term as the
technical indicators are getting stretched.  Housing data in the week
ahead may also spur some
caution.  

The Australian dollar reached its highest level since May 2015 near
$0.8125 before the weekend.  Near the highs, it was three standard
deviations above its 20-day moving average. 
Other technical
indicators are supportive.   The next target is seen near $0.8160, the high from May 2015, which is also the 50%
retracement of the sell-off since mid-2014 (when it traded $0.9500). 
Support is seen in the $0.7980-$0.8000
area.  

US yields fell further ahead of the weekend before firming a bit. 
The 10-year yield approached 2.0%, and
the 2-year yield briefly traded below 1.25%, the upper end of the Fed funds
range, which is also what the Fed pays on all reserves.  The December
10-year note futures contract reached almost 128-00 before the weekend before
reversing lower.  Support is seen
near 127-00, and the 20-day moving
average, which it has not closed below since late July is found near 126-20.   There appear to be some bearish
divergences created when the technical indicators, such as the Slow Stochastics
and RSI.  Still, the market may be hesitant to pick a top ahead of the
upcoming CPI report, where the core rate may have eased.  

Light sweet crude oil futures snapped a five-week losing streak with the October contract gaining 0.4%%.  The contract traded at one-month highs, a little above $49, but the sharp drop of 3.2% before the weekend wiped out most of the earlier gains.    Given the storms impact in the US, oil and gasoline have become a weather market, though we suspect that the fundamentals may be gradually improving.  Initial support now is seen near $47, and a break would suggest a retest of last month’s low near $45.60. 

The S&P 500 gapped lower on September 5 and spent the rest of the
week at the upper end of that day’s
range, without entering the gap. 
The gap is found between 2472.0 and 2473.8.  The technical indicators
are not generating a robust signal.  In the immediate term, a break of
2459 on the downside, or behavior around the gap will help clarify the
technical picture.  The Russell 1000 Value Index fell a little less than
1%, giving back the previous week’s gains.  The Russell 1000 Growth Index
eased about 0.4%, which surrendered a small part of the previous week’s 2.1%
gain.  

Disclaimer

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