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Outlook for the Dollar: Dissecting the Bull

Outlook for the Dollar: Dissecting the Bull
The US dollar remains strong against most currencies.  The exceptions are the Japanese yen, Swiss franc and euro though the franc and euro pulled back in the US afternoon before the weekend.  The greenback is still appreciating on a trade-weighted basis, which is the metric that counts in assessing its impact on the overall economy.  
The euro, yen and franc strength is not as is often portrayed as some kind of safe haven that is flocked to in turbulent times.  Rather those currencies have been used to fund the purchases of other assets. When those other assets are liquidated the funding currency has to be bought back. In addition, assets in Europe and Japan were often purchased over the past year or so on a hedged basis.   When the underlying asset is sold, the hedge, which is a short currency position, is covered.  It is true that in the futures market, speculators are net long the yen for the first time in a few years, but this seems to be an expression of momentum and trend following rather than a safe haven play.  
It is not about the dollar at the moment.  It may be more helpful to think of the dollar at the fulcrum, or the center of the see-saw.  On one side of are the funding currencies and on the other side are the assets.  The technical indicators are not encouraging traders or investors to resist the current forces.   The failure of the recovery in the US stock market on Thursday to lift Asia (and Europe) seems to be a strong hint that the reversal in the market has to come from somewhere else. 
The euro remain in a $1.08-$1.10 trading range.  There have been several false breaks.  Last week the ranges held.  The low was $1.0805, and the high was $1.0985.  Given the technical readings, and the fact that the US two-year premium over German has fallen by 20 bp since late last year, and is trending lower, the immediate risk is on the euro's upside.  
The $1.1010-$1.1015 area is important, housing a previous Fibonacci retracement objective  (50% of decline since October 15) and the upper Bollinger Band.   Above there is $1.1060, the high from December 15.   A break of this would target the $1.1120-40 area.  
The dollar fell to JPY116.50 before the weekend.  This is lowest it has been since late-August when it dipped briefly below JPY116.20.  In addition to the equity market drop that weighed on dollar, the US-Japan 10-year interest rate spread is at its narrowest since late-October, having fallen by 25 bp since late last year.   A break of the JPY116.00 targets JPY115.60-JPY115.85.  Below there is JPY113.70.  
It seems reasonable to expect Japanese officials to caution against too strong of a yen and reminding market participants that currencies should reflect fundamentals.   However, in the current environment, we do think actual material intervention is likely. A stronger yen, coupled with the drop in oil prices and disappointing economic data could change the dynamics.  If it were to persist, the risk of extending QQE would likely increase.  
Sterling has fallen in eight of the ten sessions here in 2016.  It has fallen nearly five cents over this period.  It closed below its lower Bollinger Band in three of last week's five sessions, including the Friday, when it fell to $1.4260.  During the down draft, the five-day moving average has been catching the highs.  It is found near $1.4415.   It is difficult to find meaningful support for sterling, but the next target is the 2010 low near $1.4230.  The big target that is looming nearer is $1.40.  
The US dollar pushed above CAD1.45 for the first time since April 2003.  If resistance is supposed to denote where supply comes in, the charts are not particularly helpful now.  However, perhaps, appreciating that the $0.68 round psychological level for Canadians is equivalent to CAD1.47 may be suggestive of the next target, on the way to CAD1.50, which is a much more important level.    
The speed of the greenback's recent ascent leaves support at a distance.  The upper Bollinger Band is comes in near CAD1.4450, and additional support is likely near CAD1.4400.  The five-day moving average, which the greenback has not closed below since trading resumed on January 2, is found near CAD1.4340.   
The Australian dollar posted a big outside down day before the weekend that carried it to its lowest level since March 2009.  The long-term trend, drawn off the 2001 and 2008 lows, comes in now near $0.7140 though the $0.7000 area is the first important hurdle.  There may be some interesting chart points near $0.6780, but $0.6500 is the next significant target.  
Volume and open interest is shifting the to June light sweet crude oil futures contract.  The five-day moving average has also acted as resistance on upticks.  The contract has not closed above this average since December 29.  It is found near $31.65 now.  It finished just inside the Bollinger Band.   The next psychological level is $25. 
The generic 10-year US Treasury note briefly yielded less than 2.0% before the weekend for the first since mid-October.   The March note futures rose to almost 129-00.  The highs from last October were 129-09 and 129-18.   That is the obvious target while the continuation contract points to potential 130-00.  Still, the March contract closed a little above its upper Bollinger Band (129-12).
The S&P 500 retraced about of third of its pre-weekend loss before the close, and only after falling to its lowest level since October 2014.  Since the high from late-December, it has surrendered about 11%.  There is no reversal pattern, nor divergences in the momentum indicators.  There is no technical evidence that a bottom is at hand.  The near-term downside risk extends to 1815-1820.  A break opens the door to 1740 and 1700.   
Sentiment is poor given the head fake last Thursday where a strong recovery was seen but did not lift global markets, and the sharp sell-off before the weekend that gave it all back plus some.  The 1900 level offers initial resistance while a move back above 1950 would begin repairing the technical damage. 
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Marc Chandler
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.
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