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Falling US Yields Stymie the Dollar’s Recovery

We have been torn between our conviction that the dollar’s cyclical rally ended last September-October, and the near-term momentum indicators that warned that the dollar’s pullback was overdone. Aside from the Japanese yen, a consolidative phase dominated December, but the momentum indicators still seemed to suggest upside potential dollar.

A proper correction appeared to have begun in the days leading up to the US jobs report. While we correctly anticipated a “buy the rumor, sell the fact” activity after the employment report, the extent and momentum of the dollar’s sell-off was surprising. It could mean that its upside correction is over. The macro consideration we anticipated to spur the greenback’s gains, the increased likelihood of a 50 bp Fed hike on February 1, still has not been accepted by the markets. The perceived odds (Fed funds futures) of a half-point hike actually eased last week to a little less than 30% from around 35%. That said, of the G10 currencies only the Australian (~0.95%), Canadian dollar (~0.80%), and the British pound (~0.1%) rose against the greenback in the first week of the new year.

Dollar Index: Last week’s gains lifted the Dollar Index to almost 105.65, seen ahead of the employment report. It is best level since December 7. After the data, it traded below 105.00. The bearish price action ahead of the weekend frayed the 104 area. A sustained break would undermine the technical outlook and signal a test on the 103.40 lows, with the next important area near 102.00. Nevertheless, the MACD and Slow Stochastic are trending higher and the pullback may be bought especially the Fed comments in the week ahead protest the easing of financial conditions. The initial upside target is in the 106.00-30 area, which is a retracement objective and houses the 200-day moving average.

Euro: The euro rallied more than a cent after the US employment data to return to the $1.0650 area. It hovered in the $1.06 area in the last couple of weeks after peaking in mid-December near $1.0735. The single currency fell to about $1.0485 before the data, its lowest since December 7, but still shy of our initial target (~$1.0430-50). The five-day moving average fell through the 20-day moving average last week for the first time since mid-October, confirming the loss of momentum shown in the MACD and Slow Stochastic. In addition to the momentum indicators, the large net long speculative position in the futures market also made us cautious. That said, a convincing move now above $1.0650 would suggest the downside correction may be over and sets up for testing that mid-December high and, perhaps, toward $1.08.

Japanese Yen: Ahead of the jobs data, the dollar reached almost JPY134.80, its best level since the BOJ’s surprise on December 20. Although the correlation between the exchange rate and the US 10-year yield broke down, it appeared to return with vengeance ahead of the weekend. The 10 bp slide in the 10-year yield to a two-week low below 3.60% saw the dollar tumble to almost JPY132. The BOJ meets on January 18 and, having been taken by surprise in December, many participants are wary of another surprise. That may help keep the greenback between JPY130-JPY135. Here, too, the momentum indicators are still dollar constructive. Foreign investors sold a record amount of Japanese bonds in the week the BOJ adjusted the yield band of 10-year. The yen strengthened as short yen hedges were covered. Next week, Japan reports Tokyo CPI, which offers useful insight into the national figure that is reported with a delay. The Ministry of Finance reports the weekly portfolio flows and while long-dated JGBs have retreated, foreign selling likely eased as did the upside pressure on the yen, until the US employment report.

British Pound: The labor activity in the UK and pessimistic outlook for the British economy was probably not the key driver of the sterling’s decline to almost $1.1840, a seven-week low, ahead of the US jobs report. It was really about the dollar. And after the data, sterling rebounded strongly and ended a four-week downdraft against the euro. It traded to almost $1.2100 before the weekend, and recorded an outside up day by trading on both sides of Thursday’s range and then closing above Thursday’s high. At the end of last year, sterling was capped around $1.2125 and the 20-day moving average begins to new week slightly above $1.2110. It probably requires a break of $1.2145 to be important and signal a retest of the $1.2450 area approached in mid-December. Sterling’s momentum indicators have turned up. Sterling, alongside the Canadian dollar, seem in the best positioned technically for further gains among the major currencies.

Canadian Dollar: An unexpectedly strong Canadian jobs report, the rally in risk assets and the other dollar-bloc currencies helped lift the Canadian dollar ahead of the weekend. Canada grew 104k jobs last month. The median forecast was for 5k. It created 84.5k full-time positions and the unemployment rate eased to 5.0% from 5.1%, despite the 0.2% increase in the participation rate (to 65%). Still, the market is still not sure that the Bank of Canada will hike at the January 25 meeting. The swaps market has about a 72% chance of a quarter-point hike discounted. The US dollar posted a bearish outside down day against the Canadian dollar before the weekend by trading on both sides of Thursday’s range and closing below Thursday’s low. It closed at its lowest level in a month. The next target is around CAD1.3400 and then near CAD1.3340. The momentum indicators have turned back down after approaching the middle of their ranges. A note of caution is that the Canadian dollar often under-performs during period of US dollar strength. For example, while it turned in a strong performance after the employment report, it was up about 0.95%, while the Antipodean currencies rose around 1.85%.

Australian Dollar: The Australian dollar traded choppily within January 4 range (~$0.6715-$0.6885) in the following two sessions. Yet, it managed to close above its 200-day moving average (~$0.6845) for the first time since June last year. Optimism about China, as investors look past the Covid disruption, anticipate more stimulus and new efforts in the property sector, and better trade ties (including coal and wine) may have also helped the Aussie. While the Australian dollar gained 0.95% last week, the New Zealand dollar, which is not as exposed to China, was virtually unchanged. The Aussie’s momentum indicators are constructive. Initial resistance is seen in the $0.6900-20 area, and a break can open the door to $0.7000-$0.7050.

Mexican Peso: The peso had a good week. It rose almost 1.8% against the dollar, putting it in second place among emerging market currencies after the Russian rouble (~2.4%). The decline in short-term US rates (the US 2-year note fell 14 bp last week to below 4.3% after testing 4.50% may have lent the peso support. We have been looking for the dollar to return to the late November low near MXN19.04, and it traded to almost MXN19.12 before the weekend. The momentum indicators are not best positioned for the re-test but the price action itself is encouraging. Mexico reports December CPI figures on Monday, January 9. Unlike what many others have experienced, Mexico’s headline rate may be stickier than the core rate. A firm report could encourage speculation of a 50 bp hike by Banxico when it meets next on February 9.

Chinese Yuan: The combination of some optimism about new property initiatives, the stimulus to help the economy recover from the Covid shock and the dollar’s broad weakness saw the yuan climb to its best levels since August. The greenback fell below CNY6.83 to slip below the 200-day moving average (~CNY6.8315) for the first time in nearly nine months. There is some chart support around CNY6.80. We had thought there was a better chance of the dollar pushing back above CNY7.0. China is due to report December reserves, lending figures, CPI, PPI, and trade in the coming days. We expect the dollar value of reserves to have grown because of changes in assets and exchange rates. The other data is likely to have been impacted by the disruptions of ending the zero-Covid policy. Lending may have slowed a little from November. Exports would likely be impacted more than imports initially. The year-over-year decline in producer prices likely moderated, while the CPI may have edged higher, but the core rate probably remained below 1%.

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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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