Dollar Underpinned by Ideas that the Fed has more Room but less Urgency to Cut

Some naysayers who insist on cursing the thorn instead of being inspired by the beauty a rose find something or other to fret about in the June employment report that easily exceeded expected job growth and was the best since January.  It succeeded in doing what several regional Fed presidents were unable to do, and that is to force a reassessment of the likely trajectory of Fed policy. 

The yield of the January 2020 fed funds futures contract, which is among the best metrics for expectations of Fed policy in H2, rose nine basis points after the employment data, the largest increase in six months.  The yield has risen by more than 20 bp since the day after the FOMC met in June.  This, in the context of Draghi’s dovishness and expectations that Lagarde will continue the course (shades of Bernanke-Yellen), has boosted the dollar.  Trump’s attempt to talk the dollar down fell on deaf ears, and the technical outlook that we review below suggests scope for dollar strength to carry into next week. 

To be clear, our suspicions that the third significant dollar rally since the end of Bretton Woods is over is a larger and longer-term view.  Closer to home, last week we suggested that the point of peak dovish had passed and that this favored a stronger dollar.  However, we thought the technicals were more supportive of sterling.  Instead, sterling slid to new lows since the early January flash crash before recovering a bit to close 1.3% lower.  Despite the 0.2% loss ahead of the weekend, the Canadian dollar managed to the only major currency that held its own against the dollar, rising about 0.15%. 

Dollar Index:  The Dollar Index initially rallied on news that Lagarde was nominated to succeed Draghi and after a few sessions consolidating (flag? pennant?) it exploded higher in response to the jobs data.  The rally lifted it to the 97.40 area, which corresponds to the (61.8%) retracement objective of the sell-off since the years high (~98.35) was reached in late May.  The next upside target is highs from mid-June near 97.75, where the upper Bollinger Band will start the week.  The technical indicators are constructive, and a retest of the highs cannot be ruled out.

Euro:  The euro began last week, pushing against resistance around $1.14 and finished the week threatening to break below $1.1200.  It overshot the (61.8%) retracement of the recovery since May 23 but managed to close ($1.1225) just above it.  Initial support is seen in the $1.1180-$1.1200 area.  The Lower Bollinger Band will begin a little below the lower end of the range.  The technical indicators reflect the momentum to the downside.  Three-month implied vol slipped below 5% ahead of the weekend and is approaching the year’s low set in late April near 4.80%.  Note that historical volatility (actual) over the past three months is a little below there and is the lowest among the major currencies.  

Yen:  The dollar began last week, gapping higher against the yen and filled the “normal” gap over the following couple of sessions before reaching its highest levels since June 18 (~JPY108.65) ahead of the weekend.  The yen’s retreat bodes well for Japanese shares to start the new week.  The Nikkei has a five-week rally in tow.  The dollar’s five-day moving average has moved above the 20-day moving average for the first time since the end of April. The JPY109 area, which also houses the (38.2%) retracement of the dollar’s decline since the year’s high was recorded on April 24 near JPY112.40, is the nearby hurdle.  A convincing move through JPY109 could target the gap from early May around JPY111.00 and is where the 200-day moving average is found.   

Sterling:   The pound fell nearly 1.4% last week to record its lowest close in more than two years (~$1.2520).  Contrary to our expectation that the shelf near  $1.2660 would hold, sterling fell in four of last week’s five sessions. The technical indicators warn of continued downside risk.  A convincing break of $1.2500 could see losses extend toward $1.2250.  Despite sterling’s breakdown, three-month implied volatility fell to 18-month lows (~6.39%) before the weekend.  Historical volatility over the past three months has been closer to 5.5%.  

Canadian Dollar:  The US dollar rose against all the major currencies but the Canadian dollar, despite the 0.2% gains ahead of the weekend.  Canada has emerged from the soft patch seen late last year and earlier this year.  The Bank of Canada will likely recognize this at the conclusion of its policy meeting next week, but it is unlikely to signal intentions to move off neutral.  In addition to another strong employment report (full-time jobs grew nearly 25k, and hourly earnings for permanent workers jumped to 3.6% from 2.6%), Canada reported an unexpected trade surplus (~CAD760 mln), the first in 10 months, helped by a 4.6% rise in exports.  The bilateral surplus with the US reached its highest level since October 2008. Non-oil exports rose 6.3% in the first five months of the year. Private-sector forecasts for Q2 have been lifted toward 3%.  However, the US dollar has fallen by nearly 3% over the past three weeks, and momentum appears to be stalling. The technical indicators are trying to turn higher.  While CAD1.30 is important technical support, the upper end of a new range may be in the CAD1.3150-CAD1.3200.

Australian Dollar:  The Australian dollar made a marginal new high for the week near $0.7050 on July 4 before selling off ahead of the weekend back to the week’s lows around $0.6960.  However, RSI (nine-day) failed to confirm the new high, leaving a bearish divergence in its wake, while the MACDs and Slow Stochastics are poised to turn lower.  A convincing break of the $0.6940 area would signal another cent decline. 

Mexican Peso:  The dollar dipped below MXN19.00 in the last two sessions but failed to close below it, though it still shed 1% against the peso last week.  The chase for yields helped the peso, but the dollar gained less than  0.1% ahead of the weekend despite the sharp backing up of US rates.  A soft June CPI reading (July 9) and a contraction in May industrial output (July 12).  The technical indicators are mixed. The peso’s strength may deter new carry plays, but the prospect of rate cuts may support the local bond market.  

Oil:  After rallying more than 10% in the previous two weeks, WTI for August delivery fell 1.6% last week.  Despite the recovery from the 4.8% slide o July 2, the technical indicators are mixed by bearish.  The Slow Stochastics have turned lower, and the MACD is poised to do so. The $55.60-$56.00 area offers initial support.  Resistance is seen in the $58.50.  

US Rates:  It took the stronger than expected jobs report to end the eight-week decline in 10-year US rates.  When everything was said and done, the 10-year yield rose two basis points last weeks.  The two-year also had fallen for eight consecutive weeks before jumping 10 basis points last week.  The implied yield of the January 2020 fed funds futures contract rose 12 bp last week after edging up by a little more than two basis points the previous week.  In effect, the market still has two rates cuts discounted and is around 50/50 for a third.  The September 10-year futures note closed below its 20-day moving average before the weekend for the first time in two months.   Bearish divergences exist in the technical indicators we use (as they did not confirm the news highs).  Support near 127-00 may attract buyers, but a convincing break could signal losses toward 126-00.  

S&P 500:  The S&P gapped higher on the first trading day of the second half and then again two days later.  The second gap was filled ahead of the weekend.  The first has not been filled and technical significance because it appears on the week and monthly bar charts as well.    It is found between roughly between 2943.5 and 2952.2.  Its strong recovery after the initial retreat on the jump in yields stopped shy turning positive on the session, but leaves it well-positioned for new record highs.  The MACDs and Slow Stochastics leave room for new highs, and the target we suggested around 3030 still looks attainable in the near-term.   Investors may turn more cautious as the corporate earnings season begins getting underway soon.  


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