The US dollar is finishing the year on a soft note. The Federal Reserve’s real broad trade-weighted dollar index, which is updated at the end of the month, was lower at the end of November than at the end of 2018 (101.85 vs. 102.00). It has eased in five of the past six months, and December has not been kind. In nominal terms, the dollar has fallen against all the major currencies with two sessions left. It has also fallen against nearly all the emerging market currencies this month save the Turkish lira, which is off about 3.4% here in December.
Analysts and the media herald the risk-taking environment, fueled by the optimism over trade and the lifting of uncertainty over Brexit. While the narrative is fine for as far as it goes, but it does not appear to recognize that the equity rally, for example, began before the events. Consider that Europe’s Dow Jones Stoxx 600 declined in only three weeks in Q4 and five weeks in Q3. The S&P 500 fell in only two weeks in Q4. And as the two benchmarks reached new record highs, gold, a traditional safe-haven asset rallied strongly. Last week’s advance of 2.4% was the most in four months, and the three-week advance was also the longest since August. The precious metal closed above $1500 for the first time in eight weeks. Benchmark 10-year bond yields were mostly lower during the holiday-week as stocks and gold rallied.
US, German, and Japanese yields are up 10-12 bp this month, which is consistent with the reflation story. December will be the fourth consecutive month that US, German, and Japanese 10-year yields have risen. The US yield has risen from about 1.50% at the start of the streak and finished last week near 1.87%. The German yield has risen from minus 70 bp to little more than minus 25 bp ahead of the weekend. The 10-year Japanese government bond yield has increased from minus 26 bp to 0 before the weekend. At the peak in August, there were approximately $17.03 trillion of negative-yielding bonds, and now there are about $11.5 trillion.
The CRB Index and oil prices are at eight-month highs, but the Baltic Dry Index has fallen by almost 30% this month and is at six-month lows. One of our macro points is that the low monthly inflation readings in the US and Europe from the end of 2018 and early 2019 will drop out from the year-over-year comparisons, creating the optics of higher inflation and potential of an inflation scare that will likely ease by the end of Q1 20.
Dollar Index: At the start of the week, the Dollar Index held below 97.80, the (61.8%) retracement objective of the decline from the late November high (~98.55). Although it did not manage to post a higher close last week, it broke down in thin pre-weekend turnover and tested the 97.00 area and the lower Bollinger Band. The 0.5% loss ahead of the weekend was the largest decline in four months. The MACD is turning lower from the middle of its range, while the Slow Stochastics are poised to cross down from extended levels. It finished last year just below 96.55. The 200-day moving average (~97.70) may offer an important cap now. Note that the 50-day moving average is set to move below the 200-day moving average (Golden Cross or Deadman’s Cross) for the first time in 18 months.
Euro: The euro was firm last week, but jumped ahead of the weekend. The 0.7% gain was its biggest single-day advance since early August, and it closed decisively above the 200-day moving average (~$1.1145). Key resistance is seen at $1.12 from which it was turned back dramatically on December 13, and a little above there is the (61.8%) retracement objective (~$1.1210) from the late June high, which was the last time the euro traded above $1.1400. The Slow Stochastics are poised to turn higher, while the MACD has already turned from the middle of its range. The euro finished above its upper Bollinger Band (~$1.1165). The last time it did (early October), the euro lost a cent in the following week.
Yen: The dollar traded between JPY109.00 and JPY109.70 on December 13 and has not been out of that range since then. Still, the dollar has closed higher for three consecutive weeks. The sideways price action leaves the MACD and Slow Stochastic flatlining. Given the technical readings on the weekly bar charts, the downside may be preferred, but there is little near-term conviction.
Sterling: After reaching $1.35 as the exit polls showed a Tory majority, sterling fell victim to “buy the rumor sell the fact” activity. It sold off six cents before finding new bids near $1.29. We had anticipated the price action and saw risk extending to $1.28, the lower end of its previous range. Sterling snapped a five-day decline on Christmas Eve and closed the week with about a 0.75% rally that saw it briefly push through $1.31. The next technical target is near $1.3140 and then $1.3210. The MACD and Slow Stochastics are set to turn higher.
Canadian Dollar: The drivers that we identify for the Canadian dollar turned positive, and the Canadian dollar finished last week at two-month highs. Oil prices rallied 2% for the fourth consecutive advance. A broader measure of commodity prices, the CRB Index, has also rallied for four weeks and is at eight-month highs. Equities, which is a proxy for risk-taking, have rallied. Canada offers a small premium over the US on two-year rates. The US dollar approached the lower Bollinger Band (~CAD1.3065) in its pre-weekend slide. The October low was set near CAD1.3040, and the low for the year was set in July by CAD1.3015. The CAD1.3150 area may now be the near-term cap. While the MACD reflects the downside momentum, the Slow Stochastic had been gently rising in recent days.
Mexican Peso: The dollar broke out of its consolidative range against the peso to the downside, falling the MXN18.80 before the weekend, its lowest since May 1. The broader weakness in the greenback and Mexico’s unexpected November trade surplus may have given it the necessary push. The MACD and Slow Stochastics are going sideways at their lows. The market looks vulnerable to a short squeeze. Initial resistance is likely to be encountered in the previous support band of MXN19.00-MXN19.10.
Chinese Yuan: The yuan has fallen by about 1.7% year-to-date. It has been gradually paring this year’s decline since the dollar reached a little above CNY7.18 in early September. For the past two and a half weeks, it has been straddling the CNY7.0 area. For the last five weeks, it has been alternating between gains and loss in a sawtooth pattern. The dollar fell by about 0.15% last week. On the other hand, against the offshore yuan, the dollar has fallen for five consecutive weeks and has only risen for two weeks here in Q4.
Gold: The yellow metal rallied 2.4% (or about $35) last week to $1515, its highest level in four months. It broke above a three-month downtrend (~$1480) and the start of last week and did not look back. The MACD shows room to run, while the Slow Stochastics are getting stretched. The October and November attempt to rally faltered in the $1515-$1520 area, but if this is overcome, little may prevent an attempt on the six-year high recorded in early September just above $1557.
Oil: The February light sweet futures contract rallied a little more than 2% to bring the four-week advance to almost 12% and approaching $62 a barrel. Since the early October low near $50.45, the price of crude has risen by nearly a quarter, and this will likely show up in headline measures of inflation. Market-based measures of inflation expectations are also particularly sensitive to oil prices. The MACD is stretched at an eight-month high, and the Slow Stochastics has not confirmed the new highs. That said, the big drawdown in US inventories and the reflation narrative is a bullish cocktail of less supply and more demand. Above $62, there is potential into the $63-$64 area that would allow a test on the 2019 high.
US Rates: The US 10-year yield eased four basis points last week to trim this month’s rise to ten basis points and leaves the yield near 1.87%. The two-year yield was flat on the month coming into last week, and it fell five basis points. The 2-10 curve is near 30 bp, a new steepness for the year. In the March futures contract, the base at 128-00 held and this may have spurred some short-covering. It finished the week just below the 20-day moving average (~128-25). The technical indicators are trying to turn higher, suggesting the bears may have to wait to see the two-handle on yields. The implied yield of the December 20 fed funds futures contract ended a four-week rising trend with a 1.5 bp decline to 1.38%, compared with the current effective average of 1.55%. Lastly, we note that the last three-term repos offered by the Fed to cover funding for the turn of the year have been undersubscribed. While some pressure is still evident, it is not the apocalypse that some feared.
S&P 500: The benchmark gained almost 0.6% last week to reach new record highs and extend the winning streak to six. It has fallen in only two weeks here in Q4, during which time it has risen by about 8.8%. The nine-day Relative Strength Index is at its highest level since January 2018. The MACD and Slow Stochastics are stretched but have not turned down either. Initial support is seen near 3230, the five-day moving average, for which the index has not closed below in three weeks. Below there is a gap created by the sharply higher opening on December 20 (~3205.5-3216.0).