US as Revisionist Power Remains Biggest Risk for Investors

A new front opened in the effort by the Trump Administration to re-orient the global political economy.  Trade actions, including the claim that steel and aluminum from Canada, Europe, and Japan are threats to US national security,  have been coupled now with an attack on EU commercial practices (allowing the Nord Stream II gas pipeline from Russia while the US is trying to sell more energy to Europe) and a shot across the bow about alleged currency practices. 

Ahead of the weekend, Trump complained about “China, the EU and others have been manipulating their currencies and interest rates lower.” He also went on to double down on his dissatisfaction with higher US rates, claiming that it is countering his efforts to speed growth and makes debt servicing more expensive.

The dollar was sold.  Corporate America may not like the protectionism and threats of tariffs on autos and auto parts, but concern about the dollar’s recovery this year has already been heard in this earnings season and in the forward guidance.   Over the medium and longer-term, foreign exchange prices driven by fundamentals.  We tend to emphasize monetary and fiscal policy, interest rates and differentials.  Another school of thought puts more weight on external balances.

However, in the short-term, market positioning, sentiment, and technical factors can offset the fundamental drivers.   With the Dollar Index having risen to new highs for the year, sterling trading at 10-month lows, the yen at six-month lows, the momentum players were blinded sided Trump’s comments.  Many investors had recognized that “a currency war compliments a trade war”  and were aware of this risk, which would seem to have materialized. 

Nevertheless, no need quite yet to stock up in can goods and fresh water.  Given the seeming modus operandi of the Trump Administration, it would not be surprising to see someone like the Treasury Secretary to walk-back the comments and twist them back inside the constraints of the G7 and G20 rules.  It would not be the first time, and the G20 meeting in Argentina provides an obvious forum.

Since the June 14 ECB meeting, which followed Fed’s decision the day before to hike the fed funds target rate for the second time this year, the Dollar Index has traded in a range between 93.70 and 95.50.  A few hours before Trump’s comments on July 19, the Dollar Index had made new highs for the year and looked to be breaking higher, reaching 95.65. The price action reinforces the range, and it finished the week near the middle of this five-week trading range.   

The technical indicators for the euro are mixed as befits a currency that is trending between roughly $1.15 and $1.1850 nearly two months. The euro is recovering from the first dip below $1.16 in two weeks, a move back into the upper end of the range ought not surprise.  At the same time, the interest rate differentials are such that shorting the dollar against the euro may be too expensive if one expects the range to remain intact or break to the downside.  The euro was unable to make a new high for the week despite the US President’s apparently best efforts. 

The dollar fell to a seven-day low against the yen ahead of the weekend.  For momentum players and trend followers, the short yen positions had been a cash register.  The dollar fell against the yen in only two weeks in Q2. This past week’s 0.5% loss is the second weekly decline here in July.  Many threw in the towel and the dollar briefly traded below JPY111.40.  It traded as high of almost JPY113.20 before Trump’s comments.   Initial chart support is seen in the JPY111.25 area.  If this area is convincingly violated, next important support zone is the JPY110.50-JPY110.75 area, where a trendline drawn off the April, May and June lows and comes in around JPY110.75, retracements, and moving averages.  

Trump’s comments helped sterling recover from the 10-month low near $1.2960 seen on the back of disappointing retail sales, soft CPI, and heightened risks that the UK leaves the EU without an agreement.  Brexit continues to tear the Tory Party apart, and it has reached a point in which Labour is edging above the Conservatives in a couple of polls.  Sterling approached resistance is seen near $ $1.3165. A move above there would re-target $1.33. A rate hike by the Bank of England on August 2 remains the most likely scenario and is around 85% discounted.  

The Canadian dollar initially did not respond to Trump’s comments about interest rates as the euro, yen, and sterling did, but after stronger than expected retail sales and inflation reports, it made up for lost time.  It rallied over one percent making it easily the strongest major currency ahead of the weekend.  The US dollar had encountered strong offers ahead of CAD1.33 and finished fell to approach support near CAD1.31.  A trendline off the April and May lows is found there, but a break of the CAD1.3060 area may be needed to signal a resumption of the correction of which the first leg day may have already been recorded.  The next target in the correction may be CAD1.2950, with potential toward CAD1.2850.  

The Australian dollar was threatening to fall through the lower end of the $0.7300-$0.7500 trading range that is a bit more than a month old.  Trump’s comments helped it recover a little above the middle of the range.  The technical indicators are mixed, suggesting it may be best to assume the range remains intact until proven otherwise.  

After taking another leg down to start the week, the September light sweet oil futures contract traded higher until the pre-weekend session during which it consolidated the recovery of the past three sessions.  The two-week drop in oil prices stalled near the 61.8% retracement of the leg up that began last month (~$66.80).   The recovery faded as $69 was approached.  The technical indicators are mixed.  Given the conflicting forces, it may be comfortable in a $65-$70 near-term trading range.  A convincing break of the $63 area could see more over to the view that oil prices may have peaked.  

The US 10-year yield has been locked in a 2.80%-2.90% range for nearly four weeks. The September note futures slipped briefly out of the 120-00 to 120-13 narrow range that has dominated this month but quickly snapped back.  The technical indicators are not generating a clear signal. On balance, we look for a downside break of the range in the futures market, perhaps to build a concession for next week’s supply when the President appears to be talking the dollar down. The Treasury will raise a little more than $100 bln in coupon (2-7 years) and over $100 bln of bills.  The US yield curve (2-10yr) steepened last week for the first time in six weeks.  The two-year was stable, it was the long-end that backed-up.   

Investors seem undecided.  The S&P 500 closed on July 13 slightly above 2800 and its best level since the February drop.  However, this past week it traded sideways in a one percent range between 2789 and 2816 as if investors are not sure this is a breakout.  We suspect that more work is needed below 2800 to solidify a base off which another run to the highs can be made.  There is a gap from July 9 (~2764.4 to 2768.5) that may attract prices.  

Perhaps facilitated by Chinese officials, the Shanghai Composite posted an upside reversal before the weekend.  Given the dollar’s decline after China’s markets closed for the week, the yuan may strengthen as officials also appear to have more overtly tried to moderate the decline.   A move above 2850 could lift the technical tone and spur a move toward 3000.   The MSCI Asia Pacific Index made a new low for the week before rallying to close at new highs for the month ahead of the weekend.  A move above the 167.50 area would lift the technical tone.  The Dow Jones Stoxx 600 eked out a small gain for the week, allowing it to extend its advance for the third consecutive week. That said it has been in a roughly 381-387 range for past two weeks.  It looks as if Asia markets which have underperformed can play a bit of catch-up.   


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