Dollar Correction Spurred by Sell-Off in Stocks and Bonds

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The US dollar turned in its best week so far in 2018, even though the Swiss franc and euro extended their weekly advances for a foruth and seventh week, respectively.   The jump in yields and retreat in equities suggest a larger portfolio adjustment and not simply a short-covering bounce in the dollar.  The price action in the days ahead is key to verification. 

The Dollar Index rose for the first week since the weekend ending December 15.  The 0.15% gain is nothing to write home about, but the sharp downside momentum has been arrested.  A shelf has been carved in the 88.40-88.55 area.  Initial resistance is seen near 89.65.  A convincing break gives it potential toward 90.85-91.00.  The technical indicators are constructive, with the RSI moving higher, the MACDs about to turn up and the bullish divergence in the Slow Stochastics remains intact.

The euro continues to be resilient.  It did not fall to new lows for the week after the US jobs data.  It held above $1.24.  Nevertheless, the upside momentum has stalled, and interest rate differential is such that it costs to be long the euro if it is going to move sideways, if not lower.  Important support is not so much at $1.24 as last week’s lows near $1.2335, and a break of it, and ideally $1.2300 would suggest a correction rather than consolidation.  The Slow Stochastics are rolling over and the MACDs may cross in the coming days.  The RSI has turned down and is at two-week lows.

The US dollar rose 1.45% against the Japanese yen last week; its best performance in around 4.5 months.  The rise in US interest rates and actions by the BOJ that demonstrated its commitment to both Qualitative and Quantitative Easing and Yield Curve Control drove the yen lower, offsetting whatever safe haven is associated with the dramatic fall in stocks.

The dollar finished above JPY110.00 but stalled near the 20-day moving average in front of JPY110.50.  If the dollar is going to continue to correct higher, it needs to overcome offers likely around JPY110.80, and then JPY111.45.  The RSI and MACDs favor additional dollar gains, while the Slow Stochastics are moving sideways in their trough.  Initial support may be pegged near JPY109.70.

Sterling posted about a 0.3% decline last week, which snapped a six-week, 7.8% rally.  Disappointing UK economic data, more internal woes for the Tories, and a harder line from the EU provided the incentives for the mild profit-taking. Still, the pound finished well above the week’s lows near $1.3980 but appears headed for a test.  A break would initially target the $1.3800-$1.3900 area.   The RSI and Slow Stochastics are moving lower, and the MACDS are poised to cross in the coming days.

The Australian dollar ends its seven-week with aplomb.  It lost more than 2% against the dollar for its biggest weekly fall since mid-November.  We had seen the Aussie as among the most vulnerable to a turn in the US dollar, and often see it leading the other major currencies.  It had broken down even before the US jobs data, which pushed it lower still, and the other majors joined the move.  The Aussie has lost its interest rate support.  First, it was the US two-year yield that rose above its Australian counterpart.  Then it was the five-year, and before the weekend, the US 10-year yield traded above Australia’s 10-year yield.  Weaker metals prices and the general risk-off move did the Aussie no favors.

The Aussie’s technical indicators are poor.  The correction to the move that began in the middle of last December is well underway.  That move began near $0.7500 and finished on January 26 around $0.8135.  The 38.2% retracement of that rally is found a little below $0.7900.  The low before the weekend was about $0.7920.  The technical indicators favor additional weakness.  The 50% retracement is found near $0.7820.  Bounces should be capped in front of $0.8000.

In the second half of last week, the US dollar forged a shelf around CAD1.2250.  An outside up day was recorded before the weekend and the close was strong, CAD1.2400.  It tested the 20-day moving average (~CAD1.2410) but did not close above it. It has not done so since December 20.  The CAD1.2420-CAD1.2460 area offers a nearby cap, but CAD1.25 may be more significant.  The MACDs and Slow Stochastics did not confirm the losses that took the greenback to its lowest level since last September.  Support may be pegged near CAD1.2330 now.

Light sweet crude oil for March delivery finished off about 1% last week, which was the second week in the past three that prices moved lower.    A stronger US dollar and supply concerns seemed to be the main considerations, even though the two biggest US oil explorers (Exxon and Chevron) reported disappointing production-and profits-).  The technicals indicators are decidedly bearish.  The Slow Stochastics did not confirm late January high, leaving a bearish divergence in its wake.  The RSI and MACDs are moving lower.  The low for the week was set on Wednesday near $63.65, ahead of that, there maybe bids near $64.15, where the 20-day moving average is found.

The US 10-year yield finished the week near 2.85%.  Surveys at the end of last year suggested that the median forecast for year-end was 2.9%-3.0%.  While many understood that the supply and demand considerations–more of the former and less of the latter (e.g. Fed will buy $420 bln less than in 2017), pointed to higher yields, but the magnitudes may have been underestimated. Also, about a third of the increase in the nominal 10-year yield (15 of 45 bp increase this year) can be accounted for by the increase in inflation expectations (e.g.,10-year breakevens).  The technical indicators for the March futures contract are extended but have not turned.

Much ink has been spilled discussing the break of the long-term downtrend in US yields with the recent rise in rates.  We suspect that too much is being made of it.  The break of the trend line does not mean the yields will inexorably rise back to the double digits.  The violation of the trend line should not distract from the appreciation that we still live in a modest growth, low inflation environment.  This will cap interest rates.  In addition, the business cycle has not been repealed and it appears that the US is showing an increasing number of late-cycle behavior.

The nearly 3.9% drop in the S&P 500 last week inflicted significant technical damage.  The gap lower before the weekend, partly responding to a jump in US yields and strong hourly earnings (2.9%, the highest since 2009) is ominous.  It extends a little below 2809 to almost 2813.  That gap follows the gap lower opening on January 30.  Attempts to fill it (~2837.7-2851.5) were stymied ahead of the pre-weekend gap.

The losses were tantamount to a little more than half of this year’s gains. The 61.8% retracment is near 2750.  The MACDs and Slow Stochastics suggests patience may prudent before trying to pick a bottom.   Pullbacks in the S&P 500 since late 2016 have often tested the 100-day moving average.  It is found now near 2632.

The Canadian, German, and Swiss markets are down on the year.  With the dismal performance in the US, Asian markets and European markets risk gapping lower on Monday.  If so, the gap would likely appear on the weekly bar charts, giving it more technical significance.

At the same time, we note that Russell 1000 Growth Index fared slightly better than the Russell 1000 Value Index (-3.5% vs. -3.2%).  The growth sector has easily outperformed the value sector, and while one week means very little in this, the fact that there was not more selling of growth, at least for now, this is seen as a correction, which means a buying opportunity (at some point).