by Marc Chandler
My articles My offerMy siteAbout meMy videosMy books
Follow on:LinkedINTwitterSeeking AlphaAmazon
Anticipating a yawning divergence of monetary policy between the world's largest central banks, market participants continued to drive the dollar higher over the past week. In fact, the greenback appreciated against all the major and emerging market currencies except the Malaysian ringgit and South Korean won.
Next week is one of the most eventful weeks of the year, and the speculative community has amassed a very large long dollar position. It begs the question of whether the ECB cannot help but disappoint market expectations and spur a serious correction to the dollar's rally, whose most recent leg higher began in the middle of October.
Depending on one's risk tolerance and ability to use derivatives, there are various strategies one can deploy that can minimize the impact of a dollar correction. The cost is full participation of any additional dollar advance. In any event, disciplined money management skills require respecting the price action, even if not anticipating it.
The Dollar Index closed above 100 for only the second time since 2003 (the first time was March 13). It has held a clear uptrend this month, which has been tested five times, including yesterday. It is found near 100.40 at the end of next week. The euro has not traded below its 20-day moving average since October 22. It is found now near 99.00. The technical indicators are mostly constructive. However, the MACDs are rolling over and have not confirmed the latest extension of the rally.
The euro is holding below its own trendline, which is found near $1.0650 now and $1.0550 at the end of next week. The technical indicators are similar to the Dollar Index, with only the MACDs suggesting a correction could be imminent. A short squeeze that lifts the euro through the $1.0660 area could carry it up toward $1.0750-$1.0800. In some ways, the downside speaks for itself. Although we recognized the $1.0525-$1.0550 area as the downside target ahead of the March low near $1.0460, we do not think that area is particularly significant. Parity beckons.
The dollar tested the lower end of its new trading range against the yen in recent days. A trading range between roughly JPY122 and JPY124 has been carved out over the past two and a half weeks. This sideways movement was enough to push the five-week moving average below the 20-day average. The rule of alternation says that after a test on the lower end of a range, the next move is a test on the upper end. The close above the short-term trendline drawn off the November 18 highs (~JPY122.70) give some immediate technical credence to this scenario.
The euro has depreciated against the yen for seven consecutive weeks, the longest streak since the late-1990s. Although it settled firmly before the weekend, there is no convincing technical sign that a reversal is at hand. It has been flirting with its lower Bollinger Band all week. When a short squeeze in the euro does take place, it will likely recover against at the same time. The initial objective would be near JPY132.40.
Sterling continued to trade like a dog. It has lost about 2.5% against the dollar over the past month as the market adjusts its interest rate expectations to the latest signals by the BOE that it is no hurry to raise rates. It fell almost 1% last week, the second worst major performer after the Australian dollar. The adjustment does not appear over. The $1.50 level is obvious psychological and technical support. The technical indicators warn of the risk of penetration, in which case the next immediate target is near $1.4950
After losing more than 5 pence against sterling since mid-October, the euro found support GBP0.6985. It had recovered toward GBP0.7080 before the bears made a stand. The technical indicators look constructive. The MACD's have crossed up from oversold, and the RSI is trending higher. A close above GBP0.7065 may part of a larger euro short-squeeze.
The Canadian dollar found little traction. Oil prices are chopping around near the recent trough. The 2-year interest rate differential with the US was little changed. Weighed down by the resource sector, Canada had the only equity market in the G7 that lost ground last week.
The push to CAD1.34 at the start of last week was turned back, but dollar buyers emerged ahead of the previous week's lows (~CAD1.3250). The Bank of Canada meets next week. While no change in policy is expected, the market will be sensitive to any official nuance suggesting that the rate cycle may not be complete. The multi-year high set in late-September near CAD1.3460 is the next target.
The Reserve Bank of Australia also meets next week. There may be a slightly greater chance that the RBA would cut rates than the Bank of Canada, but still the odds cannot be considered very high. The shockingly poor Q3 capex figures (a record 9.2% quarterly decline, after a 4.4% decline in Q2) prompted the chins to wag, but manufacturing capex rose nearly 7%. The RBA is no mood to be forced into a rate cut as Governor Steven's warned investors to "cool it" and revisit the issue in Q1 16.
The capex figures, however, stopped the Australian dollar's rally cold in its tracks after making a new high (~$0.7285) during the recovery from the test on $0.7000 earlier this month. There is potential for the Aussie to slip further ahead of the RBA meeting. The $0.7145-$0.7155 area may offer initial support.
OPEC meets at the end of next week. The market may not make a big move ahead of it. Given the need to accommodate Indonesia and Iran, there seems to be a greater risk of an increase in the cartels quota rather than a cut. Saudi Arabia is gaining market share in the US and Europe from non-OPEC producers. From its long-term view, and contrary to what appears to be the conventional view among many traders and reporters, the Saudi strategy is just beginning to pay-off. Speculation that it would abandon its peg seems wide of the mark, as we have argued in the episodic speculative fevers that emerge from time to time.
The front-month January 2016 light sweet crude oil futures contract remains near the $40 a barrel lows seen in August and the start of this past week. We look for a break of the $40 to $44 range to signal the next direction.
The December 10-year bond futures contract has been surfing an uptrend since the start of the month. It comes in near 126-22 before the weekend and 126-30 at the end of next week. The five-day average crossed above the 20-day average for the first time in a little over a month. Technically there is scope toward the 127-12 to 127-25 area.
The 10-year yield peaked near 2.375% on November 9. It fell to 2.20% this week. The move does not seem complete, and the risk extends to 2.15%. In the coming days. In the bigger picture, a repeat of the Greenspan conundrum should not be surprising. This refers to a period in which the Fed was raising short-term interest rates, but long-term interest rates did not rise. Another way to think about this is that Fed hikes may produce curve flattening.
The S&P 500 gained about 0.5% last week, which brought it close to the 2100 level. This area has proven a formidable barrier for the much-tracked index. Although it has approached the upper end of the year's range, the record high was set in May near 2134.75. The risk-reward appears to favor reducing exposures, especially for short-term traders, though the technical indicators themselves are not offering robust signals.
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
Tags: Bank of Canada
