Greenback’s Downside Correction is Over, or Nearly So

The US dollar fell against most of the major currencies last week, the notable exception of the Japanese yen.  The greenback has trended higher against the yen, bolstered by the rise in US rates and equity market gains, including last week’s 2.2% rally in the battered MSCI Emerging Markets Index.  The pound managed to eke out a minor gain of less than 0.1%. Sterling had been moving higher and reached its best level in two months on September 20.  It was up 1.5% for the week before pessimism over Brexit returned with a vengeance. 

Broadly speaking, we expect the FOMC meeting on September 26 to re-focus attention back on the continued divergence, which on rates and growth, continue to favor the US.  At the same time, the optimism that the US and China will work out a trade deal after the November elections and that a bottom in emerging markets, as an asset class, is at hand, seem misplaced. 

Dollar Index:  After closing below important support near 94.00 on September 20, the recovery before the weekend helped neutralize the negativity.  The MACDs and Slow Stochastics have not turned up, but they are poised to do so early next week.  A move above 94.60, which houses a retracement objective and the 100-day moving average would lend credence to the favorable outlook.  On the other hand, a break of the 93.65-93.70 area would signal a deeper and more protracted correction is unfolding. 

Euro:  The euro traded at its best level against the dollar since the June ECB meeting, briefly poking above $1.18.  The euro surpassed but did not close above the initial retracement objective (38.2%) of this decline since reaching the high for the year in February near $1.2555.  With the help of cross rate demand ahead of the weekend, the euro’s pullback was limited to about $1.1735. A  move below $1.17, and ideally $1.1665 would suggest the upside correction is over.   The more favorable sentiment toward Italian bonds, which has seen the Italian premium over Germany (10-year yields) narrow 60 bp since the start of the month will be tested as the government has until September 27 to share it fiscal and economic projections ahead of the formal budget presentation next month. 

Yen:  The dollar almost touched JPY113 ahead of the weekend, reaching its best level in a couple of months.  The technical indicators are constructive.  The positive momentum and sentiment were reflected in the price action.  The dollar traded on both sides of the previous day’s range last week (September 18 and 20).  It illustrates the willingness to buy the greenback on pullbacks.  The year’s high was set in the first part in July, a little above JPY113.15, and the above there, the high from last December near JPY113.75 will come into view.  The greenback has not been above JPY115 for 18 months. 

Sterling;  Constructive economic data and signs from the EC that seemed to play up positive developments on Bexit talks helped lift sterling to almost $1.33 late last week, its best level since in a little more than two months.  It was also just shy of the 38.2% retracement of its decline since putting in the year’s high near $1.4380 in mid-April.  However, the summit in ripped the veneer away to reveal that the UK and the EU remain far apart on a few issues, including importantly the Irish border   May’s bind is tightening.  The EC had given the UK six weeks to amend its proposals, while in two weeks, May is set to deliver a key speech at the Tory Party Conference.  May says it is her Chequers plan or no deal.  But there is another moving part:  Her.   And that means a leadership challenge, probably shortly after her speech.  A break of the $1.3050 area would support our idea that sterling’s upside correction since August 15 is over and the resumption of the downtrend means a return to $1.2660.  Nearby support is seen near $1.2980 and then $1.2900. 

Canadian dollar:  Canada reported better than expected July retail sales (and an upward revision to the June series) and a modest acceleration of underlying August inflation before the weekend.  The data boosts confidence that the Bank of Canada will hike rates next month. Nevertheless, the Canadian dollar was unable to extend its rally for a fourth session.  If the inability to respond favorably to constructive economic news signals the potential end of the Canadian dollar’s upside correction, the greenback needs to rise above CAD1.2950 to confirm it, and ideally CAD1.30.  The technical indicators have not turned yet, but the MACDs and Slow Stochastics are stretched.

Australian dollar:  It felt a bit like deja vu.  The Australian dollar rallied in the first four sessions of last week before profit-taking was seen before the weekend, which is the same pattern as the previous week.  The Aussie set a new high for the month on September 21, just above $0.7300 before reversing lower.  It stopped shy of the 61.8% retracement (~$0.7310) of the retreat from last month’s high (~$0.7450).  Alternatively, the Aussie may have formed a head and shoulders bottom pattern this month.  The neckline is in the $0.7230-$0.7235 area, and the measuring objective is near $0.7385.  It is not unusual in this pattern to retest the neckline after a violation. 

Oil: US oil inventories have fallen for the past five weeks and in six of the past seven weeks (through the middle of September).  It means that US oil inventories have risen in one week since the end of July.  The drawdown leaves US oil stocks at the lowest level since early 2015. Initially, it seemed that with the US having irritated many countries, its embargo against Iranian oil might not be that effective.  Also, China yuan-denominated oil futures contract would also offer a helpful vehicle.  OPEC (Saudi Arabia) agreed to boost output.  However, as the thinking evolved, and several countries have taken action well ahead of the effective date, there is speculation the embargo could be effective, especially in the beginning before output can be boosted to offset.  Reports suggested that some Saudi officials can envisage crude rising about $80 for a short period of time.  The front-month Brent futures contract has been bumping against the $80 for the past five months while holding above $70.   At nearly $82 a barrel. Brent would have retraced 61.8% of its decline from those mid-2014 highs over $115.   Light sweet crude oil for November delivery made a new high ahead of the weekend near $71.80.  The technical indicators caution against picking a top. There is a trendline drawn off the mid-August lows begins next week near $68.80 and rises to $69.60. 

US 10-year rates: Investors appear to require higher US rates to attract their savings.  The US deficit is growing spending increases, and revenues are squeezed by the tax cuts.  At the same time, US corporates can no longer (September 15) deduct their pension fund contributions at last year’s higher tax rate.  This removes one source of demand.  Also, starting next month, the Federal Reserve will increase the pace of its balance sheet reduction to $50 bln a month.   Consider that since August 22, the US 10-year yield has risen by 30 bp, while the 10-year breakeven increased by a little less than 10 bp, providing evidence that it is a rise in real yields rather than inflation expectations.  The December note futures contract fell from 119-16 at the start of the week to 118-16 at the end of it.  The technical indicators a stretched but have not turned.  The mid-May low near 118-10 on the continuation contract may be sufficient support given the over-extended condition.  On the upside, there is a small, one tick, gap from the lower opening on September 20.  The gap is found between 118-23 and 118=24.  A move through the gap, and ideally 119-00 would indicate a near-term low is in place.  

S&P 500:  The S&P 500 rose to new record highs ahead of the weekend, but the soft close suggests there may be scope for a pullback at the start of the new week.  That said, the futures and options expiry may warn against giving the close much significance.  The S&P 500 gapped higher on September 20 and gapped higher on September 21.  The latter gap was closed, the former was not.  The open gap is found between roughly 2912.35 and 2919.75.  As it enters the last week of the quarter, the upside momentum remains strong.  It has fallen in only two weeks since the end of Q2. Moreover, it has declined in one quarter (Q1 18, -1.2%) since Q3 15.   The 60-day rolling correlation between the S&P 500 and the US 10-year yield is near 0.47, the highest in three months.  


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