Will the Bullish Outlook for Treasuries Weigh on the Dollar?

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The US dollar fell against all the major currencies last week.   The downside reversal after the employment data on October 6 set the stage for the pullback.  From a fundamental perspective, we cautioned the good news for the dollar had been discounted.  With two months before the December FOMC meeting, the market had priced in a high degree of confidence (over 80% chance at its peak) of a hike and the 10-year yield reached the top end of its six-month trading range near 2.40%.  

The ECB meeting on October 26 is the next key policy focus.  The ECB is expected to reduce the amount of asset is buys starting next year.   While officials may try to facilitate a dovish interpretation of its tapering, it is not clear that they will succeed.  The speculative participants, judging from the positioning in the futures market, remains favorably disposed to the single currency.  The net long speculative position was the largest in six years as of October 10.  

There also appears to be growing skepticism over the prospect of tax reform in the US.  One of the controversial measures that the White House proposed was to eliminate the deduction (from Federal tax obligations) taxes paid to state and local government, is reportedly being reconsidered.  As was the case with health care, the debate within the Republican Party is key as it seeks to take full advantage of its majority position and sideline the Democrat minority.   The IMF’s latest World Economic Outlook dropped its assumption that the US will deliver fiscal stimulus next year.  

The Dollar Index snapped a four-day drop on October 12 and managed to close higher on October 13, despite the fact that the core CPI did not rise as economists forecast.  The last leg up in the Dollar Index began on September 20 near 91.50 and peaked after the employment report close to 94.25.  The low before the weekend frayed the 50% retracement (~92.90).  The 61.8% retracement is closer to 92.25.  The MACDs and Slow Stochastics on the daily bar charts are moving lower, and the five-day moving average appears poised to fall below the 20-day average in the coming days.  That said, we remain impressed by the fact that the technical indicators on the weekly charts, especially the MACDs and Slow Stochastics, remain quite constructive for the Dollar Index.  

The euro recorded a bullish hammer candlestick bottom pattern after the employment data, and a week later, it appears to have formed a shooting star candlestick pattern top.  The euro tried three times to push above the $1.1880 area which corresponds to a 50% retracement objective the drop that began on September 8.  We would be inclined to be short until that area is penetrated.   A move above $1.1880 now could signal a move to $1.1930.   When the euro has poked through $1.20, it does appear that some official (unnamed sources) seem to talk it down. On the downside, the $1.1750-$1.1775 area offers support. 

The US 10-year yield continues to appears to be a powerful contemporaneous indicator of the dollar-yen exchange rate.  The correlation between the two, on  a percentage change basis appears to be near a record high. The US 10-year yield fell 13 bp since the post-US jobs data high near 2.40%.  It has fallen through its 20-day moving average for the first time in over a month.  The dollar recorded its lows against the yen for the year on September 8, the same day the 10-year yield bottomed just above 2.0%.

If this marks the end of this leg up in the dollar, then we should look at some retracement objectives.  The first is near JPY111.10, and a break would bring the next retracement into view.  JPY110.40 finds it  The daily technical indicators are consistent with additional dollar losses, and the five-day moving average is set to cross below the 20-day average for the first time in a month.  However, here too we remain impressed that the technical indicators on the weekly charts remain dollar-friendly.  

EU’s chief negotiator for Brexit, Barnier, injected volatility into sterling.  When he first formally acknowledged that the talks reached an impasse, sterling sold off on ideas that the UK could leave the EU without a deal.  Later, when he suggested a willingness to consider a two-year transition phase, sterling recouped its losses and more.  There was some follow-through buying ahead of the weekend that lifted sterling to $1.3340.  This is an important area from a technical perspective.  It corresponds to a 50% retracement of the leg down in sterling that began on September 20 from nearly $1.3660.  It is also where the 20-day moving average is found.  The daily technical indicators are supportive, and the next the 61.8% retracement is found near $1.3415. 

The prospects of a UK rate hike as early as next month has protected sterling’s downside.  Next week, the UK reports on inflation, labor, and retail sales.  We anticipate that the investors will be particularly sensitive to the data.  The market, according to Bloomberg calculations of the Fed funds futures strip and sterling Overnight Index Swaps, investors a little more confident that the BOE hikes rates in November than the Fed hiking in December.  Data that makes the market question this would spur sterling sales.   

The Canadian dollar was among the worst performers against the US dollar over the past week, gaining about 0.3%.  The greenback’s softer tone appears to reflect consolidation rather than an outright correction  The pullback has stopped shy of testing the minimum retracement objectives (~CAD1.2395).  Official comments have encouraged investors not to be so aggressive about the trajectory of monetary policy.  The technical indicators are mixed.

The market has taken the guidance to heart.  A month ago the market was pricing in about nearly an 80% chance of another hike this year.  Now, according to Bloomberg, about 53% change has been discounted.  Canada reports retail sales and CPI on October 20.  Both reports are expected to be firm.  

Between a jump in China’s imports and lower US rates, the Australian dollar jumped before the weekend.  The 0.8% gain was the largest in two months and extends the advance for the fourth consecutive session.  It finished with its 20-day moving average (~$0.7870) for the first time September 20.  The advance has also completed the 38.2% retracement of its decline since September 8 (~$0.7885).  The next retracement is near $0.7930.   The daily technical indicators warn of the likelihood of additional gains in the days ahead.  The weekly technical indicators are not nearly as favorable.  

Light sweet crude oil for November delivery rallied nearly 4.5% last week.  A third of these gains were recorded before the weekend amid reports that China increased its imports in September (by almost 9% on the month).  Since the start of the year, China’s oil imports have risen by a little more than 12%.  US inventories and the oil rig count fell.  There is more talk of OPEC and participating non-OPEC countries extending their production restraint after March 2018.  The technical indicators are mildly positive, and there appears to be scope to return to the $53 a barrel level.  Initial support is seen near $50.  

The December 10-year US note futures contract finished the week on firm footing.  It closed above the five and 20-day moving averages for the first time since September  11, when it gapped lower after peaking on September 8.  The technical indicators are consistent with further price gains in the period ahead.  It seems as if that the rise in US yields from September 8 through October 6 is over.  The first target is in the 125-28 to 126-10 range.   Retracement targets, past congestion, and the 50- and 100-day averages converge that range.  

The S&P 500 made another record high before the weekend.  It marked the fifth consecutive weekly gain.  It has only recorded four weekly losses since the end of June. However, momentum has faded recently.  Even though it made a higher high every day last week, it was often by pennies.  Daily technical indicators are looking a bit toppish, signaling the risk of a near-term pullback.  We expect initial support to be seen in the 2540 area.  The driver remains growth.  The Russell 1000 Growth Index rose (~0.6%) for a third consecutive weekly advance.  It brings the year-to-date advance to nearly 22%.  The Russell 1000 Value Index snapped a four-week advance by posting a 0.3% loss.  Year-to-date it is up a more modest 6.7%.