USD: S/T Correction To Extend Vs Core FX, But Staying Bullish Into 2017
The USD is losing ground, retracing some of its post-employment report gains vs the EUR and JPY.
There was not obvious catalyst for the reversal yesterday, although
the USD retreat did coincide with a weaker risk sentiment: a pullback in
US yields, a 0.3% drop in the S&P 500 and a slide in front-month
crude prices to new lows for the year.
We remain quite constructive on the USD as we move into 2017, but,
with US nominal and real yields well-off their December highs now and
the market already long USD according to our metrics, we see some scope for a near-term pullback vs the core currencies, particularly if equity markets give back some ground.
The U.S. dollar extended its losses on Thursday as investors continued to unwind their Trump trades. With just over a week until his inauguration, they hoped that Donald Trump would spend some time outlining the scope of his infrastructure plans. Unfortunately, the President-elect failed to do so Wednesday and the U.S. dollar dropped as a result. U.S. equities and Treasury yields also fell as investors across different asset markets expressed their unified disappointment. The selling on Wednesday carried through to Thursday but began to lose momentum during the New York trading session.
We believe it won’t be long before the dollar -- USD/JPY specifically -- find a bottom although we can’t rule out a final flush preceding the base. If we take a step back, the positive outlook for the U.S. economy has not changed since November. American companies are adding jobs, paying more wages and optimism is on the rise. Yes, there are concerns about Trump’s conflict of interests, his alleged relationship with Russia and other issues, but they don’t compromise his plans for tax cuts and big spending. While we are still waiting for Trump’s policy details, there is no reason to believe that he won’t be following through with his promise for tax cuts and spending. Even members of the Federal Reserve believe that the President-elect will deliver. A number of Federal Reserve Presidents spoke Thursday but only 2 are voting members of the FOMC this year (Evans and Harker). Both gentleman said 3 rate hikes in 2017 is plausible. Thursday morning’s U.S. economic reports also showed improvements in the economy with jobless claims increasing less than expected and import prices ticking up. Retail sales, producer prices and the University of Michigan consumer sentiment numbers are scheduled for release on Friday and these reports should confirm the improvements in the U.S. economy. Stronger data should be positive for the dollar with one small wrinkle -- the forecast for spending is very high. So if the data misses slightly, we may have an initial drop in USD/JPY that should be recovered quickly as investors realize that, ultimately, the data reflects a stronger economy.
The correction in the capital markets began shortly after the Federal Reserve hiked rates on December 14. The correction or consolidative phase follows an otherwise strong trending quarter, where moves accelerated after the unexpected victory by Trump. Last week we still anticipated the correction could persist even after the January 4 US jobs report showed more earnings growth than expected. However, now after the additional losses, the dollar appears ready to turn.
Interest rates remain integral to our dollar narrative. It is not coincidental that the dollar's downside move coincided with a pullback in yields and a narrowing of the US premium. Interest rates may be the place to begin our review of the technical outlook.
The 10-year yield fell to nearly 2.30% on January 12, new lows since the end of November, before recovering to close at new session highs of 2.36%. Before the weekend, and despite if anything, softer PPI and disappointing retail sales figures, the yield rose another six basis point. The March note futures stalled at 125-10. It tried separate sessions sine January 6. After failing for the third time before the weekend, a sell-off ensued that brought the contract toward the week's low of 124-07, which is also a 38.2% retracement of the gains since December 15. The 50% retracement is found at 123-28, and the 61.8% retracement is at 123-17.
The 2-year yield peaked on December 15 at 1.30%. It pulled back to near 16 bp through January 12, when, like the 10-year note, the yield recovered and saw follow-through gains ahead of the weekend. After five closes below the 20-day moving average, the two yield closed above it (~1.21% ) before the weekend. The technical tone of the March 2-year note futures contract is deteriorating, which is also consistent with the completion of the corrective phase.
The Dollar Index completed a 38.2% retracement of its gains since the US election on January 12. The small gains before the weekend saw the RSI turn higher, while the MACDs and Slow Stochastics are getting ready to cross higher as well. A move above 102.00 would lend credence to this view and suggest a retest on the January 11 high near 103.00. On the downside, a convincing break of 100.65 could spur a move to the next retracement level near 99.80.
The technicals look further away from turning in the euro than the Dollar Index. A move above $1.0710 could signal a further recovery toward $1.0820. The euro has not closed below its five-day moving average, (~1.0590) since January 3. A potential trendline drawn from this year's lows comes in near $1.05 on January 16 and finishes the week near $1.0575. A violation of the five-day average on a closing basis or a break of the trendline would likely signal the upside correction phase for the euro has run its course.
The dollar initially saw follow through buying in Asia though Japan was on holiday, after the US employment data. The greenback was buoyed from JPY117.00 to JPY117.50. However, it was greeted with fresh selling versus the yen that ultimately drove the dollar to JPY113.75. The technical indicators we use have not turned, but they are getting stretched. A move above JPY115.60 could signal a move in the JPY116.20-JPY116.80 band.