The Dollar’s Underlying Trend Resumes

For the last several weeks, we have been looking for the dollar
correction that began around the Fed’s rate hike in the middle of December to
be completed and for the uptrend to resume. 
 The precise timing of the turn is
difficult to get right, but our view is anchored by our macroeconomic
assessment and understanding of the
key drivers. 
Our technical
work suggests the dollar indeed has been carving out a bottom, and we expect
the uptrend to resume. 
 Our confidence would be
raised if we saw confirmation in other markets. For example, the Fed
funds futures imply (slightly) less of a chance of a hike in March and June
from a week ago.  It would also be helpful if the next string of data
(CPI, retail sales, and industrial output) would be stronger than expected, as
the median forecasts are all for softer numbers.  
We suggest a
few considerations helped solidify the dollar’s bid.  First, regardless of
some disappointing data (wage growth, January auto sales, the first estimate of Q4 GDP), the Fed officials
that spoke still seemed confident in the economy and the appropriateness of a
gradual increase in interest rates.
  Second, it seems as if Trump’s
talking the dollar down was not the start of some campaign but likely his
blustering style.  He reportedly asked the National Security Adviser about
whether it is a weak or stronger dollar that is best for America.  He also
indicated that the issue of currency manipulation was not high on the agenda as
he met with Japan’s Prime Minister Abe.  
Third, Trump’s
tweets and off-hand comments may be losing their sting. 
 We see what happened to the shares of the retailer
who dared to discount his daughter’s line of clothes.  The Mexican peso
had fallen sharply but since January 19 is the strongest currency in the world,
gaining 7.8% against the US dollar.  Fourth, the President seemed to
moderate his whack-a-mole approach to policy last week  He signaled that
he would honor the US commitment to the one-China policy.  He made some
overtures toward NATO.  He maintained continuity with the US stance toward
Greek debt forgiveness.  He warned Israel that the construction on the
West Bank was not helpful.  
Finally, Trump
reaffirmed the campaign’s commitment to lower taxes. 
  A major proposal is said to be a few weeks away.
 Trump says it will be “phenomenal.” This is important.  Some economists think that lower corporate
tax rates will boost investment and the growth potential, and strengthen the
dollar.  Other economists, including the elder statesmen Martin Feldstein,
have argued that a 20% tax on imports will hit
most the dollar by 25% automatically.  
We have
expressed skepticism about what appears to us as a naive form of purchasing
power parity. 
 We do not think the foreign exchange
prices automatically adjust.  The market for capital is larger and
arguably more important at the beginning
of the 21st century than the market for goods in determining the exchange rates
of the major currencies.  Nevertheless, as talking with various market
participants, there seems to be a  general reluctance to reduce dollar
The Dollar
Index snapped a four-week drop and posted the biggest weekly advance since the
Fed hiked two months ago.
  It closed at the best level of the
month,  The Dollar Index’s low was recorded
on February 3, and with the recent gains,
it has not completed a 38.2% retracement of the decline (~101) since the start
of the year.  The 50% retracement is near 101.50, leaving the 61.8%
retracement around 102.  
The five-day
moving average crossed above the 20-day moving average for the first time since
January 5. 
 The RSI is trending higher, but both the MACDs and Slow Stochastics
have turned higher from over-extended levels.  The Dollar Index rose above
this year’s downtrend line, came back down to test it and it held.  At the
same time, a modest uptrend line can be drawn
off the lows since February 3.  It is found near 100.35 on Monday and rises toward 101 by the end of next
The euro lost
about 1.25% against the dollar last week
to reach its lowest level (~$1.0610) since January 19 low of $1.0585. 
 That low also corresponds to the 50% retracement of
the euro’s recovery this year after
slipping through the low near $1.0350
seen within a few days of the Fed’s hike in December.  
The lower
Bollinger Band and the 50-day moving average are near $1.06.  
The 38.2% retracement was found a little below $1.0645, which held on
the initial test.  The five-day moving average has crossed below the
20-day moving average for the first time since January 5.   The MACDs and
Slow Stochastics are trending lower, as is the RSI.   We recognize that a
move above $1.07 would negate this bearish outlook.  
The dollar
built a base in the JPY111.60-JPY111.80 area. 
 From there it made a run for the
downtrend line from the start of the year near JPY113.85.  To do so, it marginally surpassed the 38.2%
retracement of that decline that comes in
at JPY113.60.  The 50% retracement is JPY114.30, and the 61.8% retracement is JPY115.10, which also corresponds with the 50-day moving average.   
The MACDs are
crossing higher, but the Slow Stochastics are lagging.
    Although the US 10-year
premium narrowed a little week, in the last couple of sessions, it widened by 10 bp.  Trump’s signal that currency
manipulation was on the agenda for the
meeting with Abe may have also encouraged some pent-up demand for dollars.
Sterling was
the best performing major currency last week, which entailed rising less than
0.2%  against the rising dollar. 
 Prime Minister May is expected to
trigger Article 50 at the EU summit in early March.  As the details of the
radical surgery are negotiated, there may
be headline risk from time-to-time, but it may be
superseded in the short-term by a macroeconomics, the focus on EMU
politics, and the general dollar direction.  
The US rate
premium over the UK has begun growing again,
and this may also weigh on sterling. 
 However, sterling is resilient against the dollar, and we suspect it comes from the demand against the euro.
 Sterling held the 50% retracement level near $1.2345 last Tuesday, and
although the upside momentum faded, the underlying
tone remains firm.   Initial resistance may be near $1.2530, but the $1.2570-$1.2600 may be a stronger cap.
Watch the
GBP0.8470 area for the euro. 
It appears to correspond to a neckline of
some topping pattern.  It valid pattern and the neckline is successfully penetrated, the measuring
objective is below GBP0.8100.  Moreover, the charts suggest some risk that
if/when the break comes, it could accelerate quickly.  
A healthy
Canadian employment report saw the US dollar break down to test the 61.8%
retracement objective (~CAD1.3060) of the rally since the start the end of
January when the greenback reached CAD1.2970. 
 The Slow Stochastics are still moving
higher.  The MACDs may roll back over, and the RSI is trending lower.
 Even if the US dollar eases at the start of next week, we think the
downside is limited.  The two-year interest rate differential is flat in
the middle of the this year’s narrow range (~42 bp),
and the 10-year differential is flat this year in a six basis point range (~70
bp).   In a strong US dollar environment, the Canadian dollar often does
better on the crosses. 
The Australian
dollar is in a $0.7600-$0.7700 trading range.
seems stronger than supply, and the Aussie finished the week near the highs.
 The technical signals are mixed,
but none suggest that the $0.7700 area will hold.  We are not convinced it has
much farther to go, and consequently,  will be particularly attentive to a
reversal pattern or some technical
indication that the rally is faltering. 
Since January
19, the Mexican peso is the strongest currency in the world.
  However, we suspect the momentum is
fading.  Its third consecutive weekly gain was minor, less than 0.2%
despite a 50 bp rate hike.  The dollar approached a potential turning
point ahead of the 50% retracement of its gains since the US election.
 That retracement objective is near MXN20.10.  The Slow Stochastics
are curling up.  The MACDs may turn higher next week.  The RSI did
not confirm this week’s dollar decline, creating a bearish divergence.  A
move above the MXN20.55-MXN20.75 area would boost confidence that a dollar low
was in place.  
The US 10-year
yield continues to trade heavily. 
 The move down successfully tested
last month’s low near 2.30%.  Yields recovered toward ahead of the weekend
to as high as 2.43% before running out momentum. Essentially, the 10-year is in
a 2.30% to 2.50% range.  Despite concerns about China and other countries’
sales of Treasuries, the yield was nearly 30 bp lower than when the Fed hiked
last December.  The March note futures need to be sold below the 124-10 to
124-18 band to be of note. The note futures is
capped near 125-16. Should this ceiling be broken, there is scope a leg
to 126-15 and possibly toward 127-12.   
The March light
sweet crude oil futures contract staged an impressive rally starting at
 The 5.5% advance took the contract
to the upper end of the month-old trading range around $54 a barrel. News that
there has been strong compliance of the OPEC (and non-OPEC) agreement helped the contract
finish the week on a firm note. The RSI and MACDs are moving higher, while the
Slow Stochastics are heavy. Our near-term bias is toward higher prices, and above $54 lies the last two higher a
little above $56, which would be the next target.   
With promises
of tax reform soon and an emphasis on deregulation, equity prices advanced. 
 All three major indices, the S&P 500, the NASDAQ,
and the Dow Jones Industrials saw record highs before the weekend.  Our
reading of the technical condition and psychology suggest a new leg up in the
market has begun.  Many asset managers have been reluctant to commit more
money to the market without a pullback and clear visibility about the policies and
priorities of the new Administration.  
Some investors
appear more confident that the institutional constraints, including the
judiciary branch, and clear national interests (one-China policy, opposition to
Russian aggression, disapproval of Israel undertaking more construction on the
West Bank) may neutralize some of the more extreme impulses. 
 However, as we saw with Brexit, the
populist-nationalist efforts are made possible by the cooperation of the
conservative party, as opposed to continental European experience where the
center-right brooks little tolerance of the populist-nationalist parties.

Lastly, one
element of the tax reform that many are not focusing on is the promise to end
tax incentives for debt.
will have far-reaching
implications for companies and sectors.  Most attention appears to have
gone toward the border adjustment (tax on imports, a tax break for exports), which also would be a significant catalyst
for change and disruption.   


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