Dollar’s Bounce: Nearly Over?

Often, there seem to be one or two drivers of the foreign exchange market, but now there are several cross-currents.  Sterling’s weakness is a phenomenon of its own making.  US-China tensions continue to run high as Washington has ratcheted up pressure on China and is insisting on the September 15 deadline for TikTok to change ownership or be banned.  Beijing would rather see it shuttered than sold.  The high-flying US NASDAQ has pulled back from the record highs set at the start of the month by 10%, but bottom-picker have been met with overhead supply and profit-taking.  Oil prices moved sharply lower for the second consecutive week. November Brent fell around 12%, and October WTI tumbled 14% over the past two weeks to levels not seen in three or four months.  
Then there is the dynamic within the foreign exchange market itself.  On September 1, the euro pushed above $1.20, sterling was approaching $1.35, and the Australian dollar poked above $0.7400.  The greenback push below CAD1.30 for the first time since January.  Comments by the ECB’s Lane about the role of the exchange rate as an input into its economic models and forecasts spurred a dollar short-squeeze rally.  We had anticipated that after the ECB meeting was out of the way, the market’s attention would turn to the FOMC meeting (September 15-16), where the outcome is likely to reinforce the dovish implications of adopting an average inflation target, around which there is extensive “strategic ambiguity.”   Below we fine-tune this scenario.  
Dollar Index:  With a couple of minor even if notable exceptions, the Dollar Index has been confined to a 92.00-94.00 trading range since late July.  It has been trending broadly sideways.  It traded at its highest level in nearly a month in the middle of last week near 93.65, just above the upper Bollinger Band for the first time in several months.  The MACDs are trending higher, and the Slow Stochastic is just below overbought territory.  The 92.70 level seen around last week’s ECB meeting corresponds to a (50%) retracement of the rally from September 1.   A move above the 94.00 area would target 94.75-95.50.  
Euro: The euro snapped a six-day slide in the middle of last week, a day before the ECB meeting.  It will begin the new week with a three-day advance in tow.  Lagarde’s effort to downplay the euro’s strength saw the market bid it a few ticks through the (61.8%) retracement objective of the slide that began after it poked above $1.20 on September 1.  Both the MACD and Slow Stochastics have nearly completely unwound the stretched condition and appear poised to turn higher in the coming days.  We continue to believe the break from this range takes place to the upside, but the range affair can persist a bit longer. 
Japanese Yen:   The dollar has been in an exceptionally narrow trading range against the Japanese yen.  The nearly 60 pip range was among the smallest weekly ranges of the year.  It did not stray more than 30 pips in either direction of JPY106.10.  For the third consecutive week, the dollar recorded lower highs and higher lows.  The momentum indicators do not appear helpful.  More broadly, the dollar is hovering around the middle of a JPY105 to JPY107 trading range.  
Britsh Pound:  Sterling was pounded last week.  It was marked down by almost 3.7%, the most in six months.  Part of it was dollar strength.  After all, the greenback strengthened against most of the major currencies.  However, the real driver was reneging on the Withdrawal Agreement that is seen as making a disorderly exit from the standstill agreement more likely.  The Bank of England meets next week, and some groundwork for additional easing as early as November seems reasonable to expect.  Sterling was pushing toward $1.35 on September 1 and made a low ahead of the weekend just below $1.2765.  The 200-day moving average is near $1.2735, and the (61.8%) retracement of the rally since the end of June is about $1.2710.   The (38.2%) retracement of the rally since the March low is a little below $1.2700.  The next important retracement (50%) is closer to $1.2455.  Initial resistance now is likely around $1.2950.  
Canadian Dollar:  The US dollar rose in four of last week’s five sessions to snap an eight-week slide against the Canadian dollar.  It was only the second weekly advance here in Q3.  The bounce faded in the middle of the week near CAD1.3260, a few ticks ahead of the (38.2%) retracement of the decline since the end of June.  The next retracement objective (50%) is around CAD1.3320.  The five-day moving average has crossed above the 20-day for the first time since July, and the momentum indicators are trending higher.  A loss of CAD1.3100 would confirm the correction is over.  
Australian Dollar:  The pullback from the high above $0.7400 on (September 1) stopped at the (38.2%) retracement of the leg up from the end of June found near $0.7190.  Initial support is now pegged around $0.7240.  The MACD is still headed lower, but the Slow Stochastic appears to be bottoming.  A move above last week’s high near $0.7330 would likely confirm the correction is over, and another run higher has begun. 
Mexican Peso:  The greenback’s slide was extended for the fifth consecutive week against the Mexican peso.  In an outside down day on Wednesday, the dollar was pushed below the 200-day moving average (~MXN21.59) for the first time since before the pandemic.  It has not been able to resurface above it.  The next big target is MXN21.00.  The momentum indicators are not helpful here, but it has been fraying the lower Bollinger Band (~MXN21.30).  A modest bounce just to the 20-day moving average (~MXN21.82), the middle of the Bollinger Band,  would be a large move of a couple percentage points. 
Chinese Yuan:   The greenback’s downtrend against the redback has now extended for the seventh consecutive week.   It has risen in only one week so far in Q3.  Since the end of June, the dollar has fallen by about 3.5% against the yuan.  Given that it is so highly managed, one must conclude that officials see the modest strength as desirable.  Some benefits cheaper imports from the US may attract international capital, as market-liberalization measures, some of which are part of the US-China trade agreement, are implemented.   It is difficult to know how far officials will allow things to go, but a near-term trading range between roughly CNY6.81 to CNY6.86 may be emerging.  
Gold:  The lower end of the recent trading range around $1900 was successfully tested last Tuesday, and the precious metal recovered to almost $1967 before consolidating ahead of the weekend.  The MACD and Slow Stochastic appear poised to turn higher.  While a gain above $1970 will appear constructive, gold has not been above $2000 for a month now.  
Oil:  October WTI fell for the second week for the first time since April.  However, in recent sessions, a shelf has been carved in the $36.00-$36.60 area, and the Slow Stochastic appears set to turn higher. That area also corresponds to a (38.2%) retracement of the rally since those April lows.  The next retracement target (50%) is around $33.50.  It managed to finish the week above the lower Bollinger Band (~$37.05). The $39-$40 area may offer a formidable cap.  
US Rates:  Both the core PPI and CPI readings were above consensus forecasts, but it did not prevent the 10-year yield from falling five basis points last week to about 66 bp.  In early August, the yield spent a few days south of 60 bp, but since the middle of June, it has mostly held above it.   At the same time, it has not been above 80 bp either, which is well below the current rate of CPI (1.3% and 1.7%, for the headline and core, respectively).  The Treasury re-opens previously sold 20-year bonds and 10-year TIPS in next week’s auction.  The 2-10-year yield curve eased to about 54 bp by the end of the week, which captures primarily the softer 10-year yield.  The curve is at its 20-day average.  The market anticipates a dovish Fed, noting downside risks and the lack of fiscal stimulus.   
S&P 500:  An outside down day on Thursday saw follow-through selling ahead of the weekend that took the S&P 500 to a new low since the record high on September 2. The benchmark bounced back after approaching 3300.  It closed slightly higher ahead of the weekend, but not higher than it opened.  The momentum indicators are still pointing lower.  The 3277 area houses the (38.2%) retracement of the gains since the mid-June low.  Pushing through, there could signal another 2% decline.   A move back above 3420 would stabilize the technical tone.  A rally to new record highs was beyond the imagination in the dark days of March, and many have doubted it ever since–the gap between Wall Street and Main Street makes it unsustainable.   The question is whether this pullback marks the end of the rally, or is it a correction?  While we still see it as most likely a correction, it does not mean that a bottom is in place.  


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