FX Outlook: New Phase has Begun

The first two and a half weeks of the new year saw persistent selling of equities, commodities, and emerging markets.  In the foreign exchange market, the dollar-bloc and sterling were crushed.  The yen was the single biggest beneficiary, and speculators in the CME are net long the yen in the futures market for the first time since late 2012.

It was as if many equity sellers returned from the year-end holidays, and got the jump start on the buyers.  Some of the selling was passive as stops were triggered and money management considerations drove the liquidation.  The buyers are most notable by their absence.  However, the middle of last week, some buyers made a stand, and had reverberations throughout the capital markets.

The rubber band was stretched far and snapped back violently.   There was a dramatic role reversal.  The Canadian dollar, for example, had lost 4.6% in the year through January 20.  In the final two sessions of last week, the Canadian dollar was the strongest major currency, rallying 2.5%.  The yen, which had been the strongest of the majors, gaining 2.8% through the middle of last week, gave back 1.25% in the last two sessions.

The price action seems to have become unhinged from fundamentals, arguably as much on the rebound as it was on the decline.  Consider sterling.  It lost 3.7% through the middle of last week.    Despite a fall in retail sales that was three times larger than the consensus expected, sterling rallied around 0.75% before the weekend, making it the second strongest currency on Friday behind the Canadian dollar.     Given when seems to be an enhanced role for psychology and sentiment, the technical condition of the foreign exchange market may be more important than usual, and the break in the prevailing momentum makes it particularly timely.

The euro has remained stuck in the $1.08-$1.10 trading range since the ECB cut rates and extends its asset purchase program in early December.  There have been a few false breaks, and the euro closed the week a few ticks below the range. The technical indicators we use are not generating strong signals.  With Draghi kicking the door open to March action, there may be some interest in trying to push the euro lower.  However, the risk is for a dovish FOMC statement that recognizes the increased market volatility and the decline in market-based measures of inflation expectations (break-evens) to new lows.  This means that a potential push lower in the euro at the start of next week could be reversed after the FOMC.  The low from earlier this month is near $1.0710-15.

The technical indicators appear to be generating a stronger signal on the yen. The JPY116.20 low from late-August was frayed but ultimately held (on a closing basis).  Those lows were not confirmed by the RSI, which now shows a dollar-bullish divergence.  The MACDs have crossed higher from oversold levels.

The dollar finished the week near its 20-day moving average, the middle of its Bollinger Bands for the time since the BOJ met December.    A move above JPY119.00 could spur a move toward JPY120.  Our note of caution is not only the risk of a less than hawkish Fed statement and the likelihood that the BOJ disappoints those who expect it to ease policy.

From late-December through the January 21, sterling sold-off almost 10 cents.  It posted a key reversal on January 21.  After making new multi-year lows, it rebounded and closed above the previous day's high.   There is a sterling-bullish divergence in the RSI, and the MACDs are poised to cross higher.   Technically, sterling can move toward $1.4400-20 without much resistance.  The $1.4500-$1.4525 appears more formidable.  We would peg initial support near $1.4200.

Following the Bank of Canada's decision not to cut rates in the middle of last week, the Canadian dollar reversed higher and saw strong follow through gains into the weekend.  The US dollar finished the week below its 20-day moving average against the Canadian dollar for the first time in three months.  The greenback tested a trendline drawn off the early December and January lows.  It was near CAD1.4110 before the weekend and rises toward CAD1.4225 by the end of next week.  It retraced 61.8% of the gains since the start of the year at CAD1.4150.   Technical indicators suggest scope for US dollar weakness.  Provided external markets permit, the US dollar could fall toward CAD1.40.

The Australian dollar carved out a low near $0.6830, off which it launched an advance of more than two cents.  Technical indicators suggest scope for additional gains.  The first barrier is the $0.7065-$0.7075.   The price action before the weekend was uninspiring.  It could warn of a test lower, perhaps $0.6950, before testing higher again.

The Mexican peso has been crushed in the first few weeks of the year.  Its 7% decline was the largest not only in Latam but among the emerging market currencies as a whole.  And this is after its 1.2% recovery before the weekend.    Given the recovery in oil prices, equities, and other emerging markets, the peso's firmer tone was underwhelming.  The RSI has turned lower, but the MACDs are still, at least, several days away from crossing.  Initial dollar support appears to be near MXN18.25-MXN18.30 area at the start of next week

March light sweet oil rebounded from the push below $28 to approach $32 ahead of the weekend.  The 38.2% retracement of this year's decline is found a little above $32.   Technical indicators are constructive, and there is potential toward $33.50.

The US 10-year yield fell from 2.30% on New Year's Eve to 1.94% in the middle of last week.    The decline in yields appears over, barring new market turmoil.  There looks to be potential toward 2.15%.  The March note futures ran out of steam above 129-00 and finished the week near 128-08.   The RSI has turned, but the MACDs haven't yet.  A break of 127-25 would lend credence ideas that a high is in place, but a break of 127 may require encouragement from other markets.

Similarly, the RSIs have turned in the S&P 500, but the MACD is lagging.  It looks set to turn higher early next week.  Although it closed lower in the middle of the week, it recovered more than 2% of session lows (~1812).  Follow through buying, some of which was likely short-covering lifted the S&P 500 above 1900 before the weekend.  A move above 1915 could spur a move toward 1945, and possibly 1980.  A break of 1875 warns that the low may have to be retested.