US Dollar Recovery Extended

The US dollar recovery that began in North American yesterday continued
to in Asia and Europe. 
The geopolitical anxiety sparked by North
Korea’s missile over Japan subsided The US response was seen as measured and tempered.  North
Korea indicated that the missile test was to protest the annual military
exercises of the US, South Korea and other allies in the region.  During
the military exercises last year, North Korea also protested with a missile

Geopolitical tensions often seem to spur a short-lived even if the sharp reaction in the capital markets. However,
recall that the dollar was already selling off before the latest developments
on the Korean peninsula.  The geopolitical developments accelerated the move, and then the profit-taking was
triggered.  The Australian dollar was among the weakest of the major
currencies yesterday, and today it is the only major not weakening against the

The Dollar Index reached 91.62 yesterday, the lowest level since early
  The 91.20 area corresponds to the 50% retracement of the big
rally since the middle of 2014.  Our constructive
outlook for the dollar was
fundamentally anchored
into divergence theme, which we think is still
intact (balance sheet and policy rates have not reached peak divergence). 
Our more tactical bearish stance on the dollar was, in part, based on the understanding that the dollar’s down
move this year is a correction to the rally since 2014.  A break of the
91.20 area would suggest the risk of a new leg down to the 6.18% retracement, which is found near 88.25.  

The long dollar position was crowded
at the end of the year, but now formal
surveys, some speculative positioning in the futures, anecdotal stories, the
way implied vol moves in the options market, all point to the short dollar
position as being overcrowded. 
terms of
time, we have anticipated a better fourth quarter for the
dollar, but we are concerned that the US debt ceiling and spending
authorization deadlines looming can weigh on the dollar first. 

There is more talk that the strength of the euro could prompt a dovish
tapering from the ECB next week
. Tomorrow the EMU’s preliminary August CPI
will be reported.  Today the Spanish and German reports warn of upside
risks.  Spain’s CPI rose 0.2% in August for a 2.0% year-over-year
pace.  It was 1.7% in July, after peaking at 3.0% in February.  The
German states have reported firmer inflation figures,
and the risk is on the upside of the national report due shortly, where the
year-over-year rate is likely to rise from July’s 1.5%.  It peaked at 2.2%
in February.  

The euro closed last week at $1.1924, according to Bloomberg. 
It has been dipped briefly below $1.1940 today, after reaching $1.2070
yesterday.  The 50% retracement of its decline since 2014 is found just
below $1.2170.  The consensus narrative of the euro’s rally this year
emphasizes the disappointment with progress on Trump’s legislative agenda and
the softer US inflation data.  However, the one factor that does not get
its fair due, in our view, is changed the political
climate in Europe.  Specifically, what signaled in the euro’s move higher
was the gap higher opening on April 24
when it became clear that the populist-nationalist wave was going to be turned back in France.  

Last year, foreign investors sold roughly $100 bln of European
This year European equities have been a market favorite, and roughly $30 bln has returned.  Yet the equity performance has been disappointing.  The Dow
Jones Stoxx 600 is up about 2.4% year-to-date.  The real return for
foreign investors comes from the dollar’s slide.  For dollar-based
investors, the Dow Jones Stoxx 600 has returned 16.3% this year, compared with
a 9.3% return for the S&P 500.  

The Dow Jones Stoxx 600 is up about 0.4% in late morning turnover in
It has recovered about half of what it lost yesterday. 
Real estate and industrials are leading the market higher.  The utility
sector is the only one lower on the day. Asian markets mostly moved
higher.  The regional leader, Hong Kong’s Hang Seng, which was up 26.5%
for the year before today, tacked on another 1.2%.   Korea’s Kospi,
which recovered smartly yesterday and closed near its highs, recovered another
0.3% today, though foreign investors were small net sellers.   

Japan reported a 1.1% rise in July retail sales, well above the 0.3%
median forecast. 
The Japanese consumer has recovered in recent
months, and this is clearly helping to
support the economy.  Auto purchases have been particularly robust and rose for the 12th consecutive month
on a year-over-year basis.    The dollar staged a big potential
key reversal against the yen.  It fell sharply to the recent lows and recovered to close above the previous day’s
highs.  Follow through buying lifted
the greenback to nearly JPY110.20 before running out of steam.  Support is seen int he JPY109.40-JPY109.50 area. 
There are large options expiring today struck at JPY109.50  ($825 mln) and
JPY110 ($360 mln).  

Sterling reached almost $1.2980 yesterday before reversing lower and
settled on its lows near $1.2915.
  Selling brought it briefly below
$1.29 in early European activity.  It has since rebounded toward session
highs near $1.2940.   Part of the overcrowded euro trade was expressed against sterling and sterling is
recovering a bit on the cross after the poked through GBP0.9300 yesterday.
  Initial support is seen near
GBP0.9230.   There is a GBP225 mln option struck at $1.29 that expires

US data includes the ADP private sector employment estimate.  A
small increase from 178k in July is expected
It would not help fine tune expectation for the national report due out at the
end of the week but would be seen to
remove the downside risks.  The US will also report an updated estimate
for Q2 GDP.  It may have ticked up to 2.7% from 2.6%, helped by a consumer
sector that is aided by the continued
improvement in jobs and wages.  The US reports the Fed’s preferred
inflation measure, the core PCE deflator tomorrow.  It may have slowed from 1.5% to 1.4%, which would be the lowest
since the end of 2015.  Such a report could weigh on the dollar through
the interest rate channel.  

Canada reports its Q2 current account
.  The deficit likely grew.  Tomorrow Canada reports Q2
GDP.   It is expected to have matched the first quarter pace of 3.7% annualized, and will likely reinforce
expectations for the Bank of Canada to hike rates in October. 


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