The epicenter of the tremendous financial earthquake in 2008 and 2009 was in the US. There are many critics of the actions of the US (government and central bank), but it responded relatively early and relatively aggressively. The net result was FIFO as in first in, first out. It was that divergence fueled the dollar’s recovery from bear market lows that saw the euro trade above $1.60, sterling through $2.11, and the Canadian and Australian dollar to around $1.11.
The third significant dollar rally since the end of Bretton Woods was driven by the subsequent divergence. Later, the US policy mix of tighter monetary policy and looser fiscal policy provided additional fuel. For around nine months, the case this rally is ending has grown more salient. Broadly speaking, the policy mix is less supportive: Interest rate differentials have been moving against the dollar since November 2018, something associated with the last stage of a major bull market. The dollar is very rich on a valuation basis, for which the OECD’s measure of purchasing power parity offers a reasonable proxy.
A massive convergence has taken place as the market is rapidly adjusting expectations that the fed funds rate will return to the zero-bound. The US 2-year premium over Germany has fallen from about 220 bp at the end of last year to almost 130 bp now. It peaked over a year ago near 355 bp. The relationship with the dollar does not appear linear, but cyclical.
This pattern is repeated elsewhere. Consider the UK. The US premium peaked in November 2018 near 215 bp and by the end of last year had fallen to almost 100 bp. It finished last week near 35 bp. Consider Japan. The US premium is near 70 bp on top of a two-year JGB. It began the year more than 100 bp higher. When the premium peaked in late 2018, it was over 300 bp.
The trigger or duration of a large cycle is beyond the pale of such broad strokes. The near-term drivers often include momentum, positioning, and other technical indicators. It is to that we turn.
Dollar Index: The 2.2% drop last week, coupled with the 1.1% drop the previous week, is the biggest back-to-back decline since the first half of February 2016. It finished the week below 96.00 for the first time since early last year. The momentum indicators are reflecting the strong downside momentum, but the Slow Stochastic is leveling off. The abrupt adjustment is reflected in the fact that the Dollar Index closed below its lower Bollinger Band for four of last week’s five sessions, including Friday. This phase of the rally began in February 2018 when the Dollar Index was near 88.25. It peaked in early last month around 99.90, stopping just shy of 100. The two-week drop has nearly met the (38.2%) retracement objective a little below 95.50. Initial resistance is seen in the 96.50-96.70 band.
Euro: The single currency has risen against the dollar in eight of the last 10 sessions. It reached its highs around $1.1350 after the US reported better than expected jobs data. Pullbacks on Tuesday and Wednesday found new bids just below $1.1100 suggest that sentiment has shifted from sell rallies to buy dips. The euro is at its highest level since last July, and also closed several times last week above its upper Bollinger Band. The technical indicators are getting stretched. Initial support now is pegged around $1.1220-$1.1240. The next technical target is near $1.1450. For the first time in seven weeks, speculators in the futures market covered previously sold positions. The 33k contract reduction in gross short positions for the week ending March 3 was the largest since June 2010. Still, with a gross short position of 238k contracts (each one has a notional value of 100k euros), there is plenty of fodder for additional short-covering. The speculative longs have not begun building. The gross long position stands at a 151.9k contract as of March 3. It has fallen for the past two reporting periods. It is below the 13-week, 26-week, and 52-week moving averages.
Japanese Yen: Since the high on February 20 above JPY112.20, the dollar has depreciated by roughly 6.5% against the yen, reaching JPY105 before the weekend. BOJ officials will grow increasingly concerned if the dollar spends much time below there as the JPY100-level represents a critical area. The lower Bollinger Band is found just below JPY106, and the dollar has settled below it for the past two sessions. The MACD shows strong downside momentum while the Slow Stochastic is beginning to turn. A move JPY106.40-JP106.50 would lift the technical tone. The speculative yen bulls in the futures market have liquidated about 15% of their gross long exposure over the past two reporting periods. Commercials in the futures market also trimmed their long yen position in the week ending March 3 (~24k contracts, each for JPY12.5 mln). Speculators covered almost 16% (~17.3k contracts) of their gross short position, while commercials barely touched theirs.
British Pound: Sterling will take a four-day rally into next week. It settled on its best level of the session ahead of the weekend near $1.3050, which is the highest close since the end of January. Its apparent strength may be best conceived as dollar weakness. Sterling has fallen for three consecutive weeks against the euro and is around its lowest level since last October (GBP0.8660). Both the MACD and Slow Stochastic are turning up. Although sterling under-performed last week (1.75% gain put in in seventh place among the top 10 major currencies), technically, it is in good shape to play catch-up. There looks to be potential into the $1.3200-$1.3250 area.
Canadian Dollar: The Bank of Canada surprised most observers with a 50 bp rate cut, and the Canadian dollar is the only major currency that fell against the US dollar last week (-0.15%). It has fallen in eight of the past 10 sessions. The three forces that seem to explain the bulk of the Canadian dollar’s movement worked against it last week. Its premium over the US narrowed (from ~24 bp to ~18). Oil prices have fallen by about 23% over the past two weeks, and the CRB Index is off almost 11%. The MACD is edging higher, while the bearish divergence in the Slow Stochastic continues to unfold. A marginal new US dollar high (above CAD1.3465) may be possible, but that might be the last gasp before correcting lower.
Australian Dollar: The Aussie was resilient after the RBA kicked off the monthly central bank meetings with a 25 bp rate cut. New highs since February 20 were set before the weekend (~$0.6660). It finished the week above its 20-day moving average for the first time in two months. The MACD and Slow Stochastic are moving higher. There is near-term technical potential in the $0.6700-$0.6750 area. Still, if a larger upside correction has begun, the $0.6800-$0.6830 band offers a reasonable target (houses the 61.8% retracement of this year’s decline and the 200-day moving average).
Mexican Peso: Risk aversion continues to punish the peso. The US dollar has soared by more than 8% against the peso in the three-week slide. The dollar reached MXN20.38 ahead of the weekend, its best level since December 2018. The MXN20.50-MXN20.65 area is the next important chart resistance. However, the technicals warn against chasing the dollar higher. The MACDs are stretched, and the Slow Stochastic has failed to confirm the dollar’s recent highs and has turned lower. The dollar finished the week above its upper Bollinger Band (~MXN20.23). Look for a reversal pattern to confirm a high is in place.
Chinese Yuan: The US dollar has returned to levels against the yuan that were seen before the Lunar New Year holiday and confirmation of the novel coronavirus. It spent the better part of the last three sessions below the CNY6.95 level that had marked the floor of the previous range. It is difficult to know what officials want. A weaker yuan seems to be more consistent with its monetary stance. The next important support for the dollar is around CNY6.90.
Gold: New seven-year highs were set at the end of last week a little above $1692. Last week’s 5.5% rally was the biggest sine 2016. A move above $1700 will target $1750 and then $1800. The technical indicators are constructive. A break of $1640 would weaken the technical tone, and a move below $1615-$1625 would warn of a near-term top may be in place.
Oil: The breakdown of the OPEC+ talks, and in particular, the falling out of the Saudi-Russian marriage of convenience at the end of last week sent oil prices reeling. The April light sweet crude oil tanked 10% ahead of the weekend, sliding to almost $41. It has plunged nearly 23% in the past two weeks. The inability to coordinate the producers, which will boost output, is hitting at the same time that world demand has been weakened by the coronavirus and the disruption of commerce, trade, tourism. The supply and demand shocks point to lower prices, and a break of $40 may spur a move toward $30. Separate from the coronavirus, the precipitous drop in oil prices will have knock-on effects to weigh on measured headline inflation and inflation expectations. It will likely pressure the highly-leveraged shale producers in the US, which have been an important component of capex.
US Rates: After a series of mostly better than expected data, including the February employment report, the Atlanta Fed’s GDP tracker sees the US growth accelerating to 3.1% here in Q1. Even then, the March fed funds futures and the index of overnight swaps indicate investors are pricing in more than another 50 bp cut on March 18 after the FOMC meeting. Assuming that the effective average fed funds rate averages 1.09% until the end of the FOMC meeting and it delivers a 50 bp cut, and for the last 13 days of the month, the fed funds average 59 bp, fair value for the March contract is about 93 bp. The contract finished last week at 0.8775%, which includes the nearly nine basis point decline despite those job figures. The implied yield of the December fed funds futures contract fell 45 bp last week. This adjustment to overnight rate expectations continues to drive the longer-dated yields. The two-year yield fell 40 bp last week, while the 10-year yield dropped 38 bp.
S&P 500: One has to look hard through the news, and the gut-wrenching volatility (which so many had explained was structurally depressed by the expansion of central bank balance sheets) to recognize that the S&P 600 ended last week with a 0.6% gain and the Dow Jones Industrials rose about1.8%. The low seen the previous week, near 2855 in the S&Ps, was revisited ahead of the weekend with a test on 2900 and then rallying nearly 3% in the last hour of trading to set a new session high. However, that late bounce failed to close the gap created by the sharply lower opening. That gap is the first hurdle and is found between roughly 2986 and 3000. The MACD is stretched but shows no immediate sign of turning higher, while the Slow Stochastic has already crossed up. The bounce (to ~3125) in the first part of last week retraced half of its losses. If that was the first leg of the correction (A), and subsequent losses (B) are part of a three-part correction that some chartists often see, then the next leg up (C) could target 3185-3250.