While few will be trading in the week between Christmas and New Years, we thought it might be helpful to review the dollar’s technical condition. We make two overall points.
First, although the dollar’s rally strengthened and extended after the November US election, this leg up of the dollar’s longer-term rally began at the end of Q3. The anticipation of new policies by the Trump Administration, part of the story, but other forces that were also impacting, such as the divergence of monetary policy. The US economy was approaching the Fed’s targets, and the December hike was telegraphed in earnest starting in September (when we had thought a hike was likely).
The eurozone economy is expanding near trend, but the low price pressures meant that it was premature to expect the ECB to abandon its asset purchase operations. It is more difficult to assess BOJ monetary policy, which shifted toward targeting the 10-year yield. The BOJ appears to be buying fewer JGBs, so its balance sheet growth has slowed. Perhaps the significance will be better appreciated if the rise in US rates continues to exert a pull on Japanese bond yields.
Second, the technical readings are getting stretched and the technical indicators suggest a correction is in the offing. Thus far, where they have occurred, the dollar pullbacks have been shallow, and mostly shy of technical retracement targets. The dollar’s rally has truly climbed a wall of worry. As they have for several weeks, many remain concerned that the market is getting ahead of itself. Trump, they say, will be unable to deliver the kind of fiscal stimulus the market expects. Also, they argue that the market is gone a long distance toward pricing in three Fed hikes next year. Investors who put much stock in the dot plots could be disappointed (again).
Nevertheless, the value of appreciating the technical condition of the market is that allows the quantification of the risk. It is far from perfect, to be sure, and admittedly, it is more an art than a science (though some would say the same about macroeconomics), but it can assist in risk (money) management.
Most broadly, the Dollar Index rose in four of last week’s five sessions. It has risen seven of the past 10 sessions and 10 of the past 15. It has risen for three consecutive weeks, and in six of the past seven, and nine of the past 12 weeks. This could be a definition of an uptrend. Yet a yellow light is flashing, meaning that the market is likely to have a proper correction soon. The Slow Stochastics and MACDs are about to turn down.
The euro did fall to new multiyear lows last week near $1.0350, but that seemed to be more a function of thin trading. Consolidative trading, even if choppy, characterized the euro’s price action. It closed little changed on the week. A move above $1.0510 would likely signal that the consolidation is morphing into a correction. That level corresponds to a 38.2% retracement of the drop since the Fed’s hike. Above there, the $1.0550-$1.0570 area beckons, but corrective potential extends toward as $1.0675.
The dollar broke down to JPY116.55 after finishing the previous week near JPY118, but it happened at the start of the week. And for the rest of the week, the greenback consolidated at higher levels, spending practically no time below JPY117.00. It appeared the dollar was tracing out some wedge of pennant formation, which is most often continuation patterns. However, our reading of the technical indicators suggests that maybe it is not a wedge but a gradual grind lower. The downtrend is clear. It comes in near JPY117.65 at the start of next week and JPY117.50. The technical indicators are consistent with a retest and possible break of JPY116.50. The next target is in the JPY115.25-JPY115.50, which corresponds to retracement objectives and congestion area from earlier this month.
After sterling, the Australian and Canadian dollars were the poorest performers among the major currencies last week (-1.7% and -1.4% respectively). Although the unexpected contraction in Canada’s October GDP (-0.3%) weighed on the Canadian dollar before the weekend, the Australian dollar fell more. Recall that among the currency futures; the Australian dollar was the only one (that we track) in which speculators were net long.
The Aussie has fallen in seven of the past eight sessions. It is down three consecutive weeks and eight of the past 12. Before the weekend it neared the May/June lows (~$0.7145). There weekly close below $0.7200 is important because it corresponds to the 61.8% retracement of this year’s rally. A move above there would help to stabilize the tone, but the technical indicators suggest this is unlikely. The next downside target is found around $0.7065.
The US dollar has approached the 50% retracement of this year’s drop against the Canadian dollar from multiyear highs in January. The retracement is found near CAD1.3575 and repulsed the greenback last month. It has a running start, with oil prices easing and the interest rate discount to the US widening. The technical indicators are consistent with a continued uptrend. The 61.8% retracement is near CAD1.3840, but before it gets there, the CAD1.3760 area may be important. It corresponds to the measuring objective of the earlier flag pattern.
The February light sweet crude oil futures contract was little changed last week. A break of the $52.00-$54.00 range is potentially important. The technical indicators are not generating strong signals. The rally spurred by the swing in market sentiment from OPEC is dead to it has re-established order appears to have run its course, and the market has reverted to watching US inventories. Technically, a break of the $50.80-$51.00 area, the neckline of a potential head and shoulders top, would warns of a more significant pullback.
US 10-year Treasury yields drifted lower last week. Yields slipped a few basis points at the start of the week and then went sideways in narrow ranges. Unable to push through 2.52%, but the high yield print generally slipping to 2.56%. The low on the March 17 10-year futures contract has been steadily but slowly climbing since December 15. Indeed before the weekend the futures contract returned to the closing level on December 14 when the Fed announced its hike with the median dot plot suggesting three hikes next year. That level 123-13 also corresponds to the 50% retracement from the December 14 high. The next retracement objective is 123-21. The technical indicators favor additional near-term gains.
The S&P 500 were virtually flat last week. Momentum has evaporated, but rather than correct lower, it is moving sideways. This may be serving to keep some nervous longs invested. A break of 2250 would be the first sign that the correction may have begun. Since November 4, the S&P 500 rallied 9.3% before the consolidation began. The Slow Stochastics rolled over first, and the MACDs are in the process of turning lower. The RSI is drifting lower. It is also unusually rich relative to its 200-day moving average. It has been more than two standard deviations (2~253) above its 200-day moving average since December 7.