Dollar Bulls Reassert Themselves, But…

The US dollar gained against most of the major currencies last week. A notable exception was the Japanese yen.  Steep equity losses and drop in bond yields provided the yen with the customary fillip.

The various economic reports, including the August jobs data and the volatility of the stock market, left Fed expectations unchanged.  The September Fed funds futures contract closed at 99.83 (implying a 17 bp effective average Fed funds rate this month). It has closed each of the past three weeks there.

It is clear that the prospects of a rate hike by the Fed later this month have become somewhat murkier due to the volatility of financial markets and potential global headwinds.  However,  the divergence theme, which in our assessment is the main driver of this, the third dollar bull market since the end of Bretton Woods, was not tied to the precise timing of the Fed’s lift-off.  

The divergence was driven by both sides of the equation–other areas, including continental Europe, Japan, China, and many emerging market countries easing policy, as well as the eventual start of the normalization of US monetary policy.   This theme remains very much intact, despite some fears that the US was slipping back into a recession and some high-profile calls for another round of asset purchases (QE4).

The dollar’s technical tone is mildly constructive.  The five-day moving average of the Dollar Index is about to cross above the 20-day average for the first time since August 12. The RSI is neutral though the MACDs are pointing higher.  Initial support is seen just below 96.00.  A move above 97.00 is required signal gains toward the upper end of the three-month range near 98.00.

The euro finished the week with two consecutive closes below the 20-day moving average for the first time in a month.  The euro’s five-day average crossed below the 20-day average.   With the week’s losses, the euro has completely reversed the gains scored amid the large position unwind spurred by the mini-devaluation by the PBOC.  There is a band of support between $1.1000 and $1.1030.  Without more clarification of the September FOMC meeting,  it may be difficult to sustain a break of this area.  On the topside, initial resistance is seen near $1.1180 and $1.1240.

The role of the yen as a financing (funding currency) rather than a flight of global investors to the Japanese bill market, as is the case for the US, helps account for the yen’s strength during chaotic market episodes.  With steep equity losses before the weekend, and the prospects of more volatility from China, which re-opens after being closed September 3-4, leaves the dollar vulnerable to additional losses.  These concerns likely outweigh the prospects of additional easing by the BOJ, which many continue to see as likely as early as next month.

The dollar could slip back to JPY118, if not a little further.  The lower Bollinger Band is near JPY117.55.  We suspect the spike to JPY116.20 on August 24 is unlikely to be repeated given the significant clearing of positions that has already been seen.  Resistance is pegged in the JPY120.20-JPY120.50 range.

Sterling has fallen for nine consecutive sessions against the US dollar.  This is the longest losing streak since 2008.  Over this period, it has depreciated 4.1% or 6.5 cents.  It overshot our $1.5200 target, and finished a touch below the lower Bollinger Band     (~$1.5177).  Although it appears over-extended, there is no compelling technical evidence that a low has been reached.  The next target is in the $1.5080 area.