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USD Resilience in the Face of Aggressive Fed Easing Expectations

Summary:
News that despite the disappointing jobs growth and weaker earnings growth, the engine of the US economy--consumers--remain resilient helped lift the dollar, which retraced most if not all of the previous week's losses.  The dollar rose against all the major and most of the emerging market currencies.  The Mexican peso was the best-performing currency, gaining almost 2.5% in the aftermath of an agreement that avoided US tariffs.   The back-and-forth of the dollar and an improved outlook for Q2 GDP has not altered market expectations for Fed policy in H2.  The implied yield of the January 2020 fed funds futures contract fell half a basis point last week to 1.69%.  The headwinds from tariffs, retaliatory action, and the still flooded midwest, Boeing's woes (likely highlighted at

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USD Resilience in the Face of Aggressive Fed Easing Expectations
News that despite the disappointing jobs growth and weaker earnings growth, the engine of the US economy--consumers--remain resilient helped lift the dollar, which retraced most if not all of the previous week's losses.  The dollar rose against all the major and most of the emerging market currencies.  The Mexican peso was the best-performing currency, gaining almost 2.5% in the aftermath of an agreement that avoided US tariffs.  

The back-and-forth of the dollar and an improved outlook for Q2 GDP has not altered market expectations for Fed policy in H2.  The implied yield of the January 2020 fed funds futures contract fell half a basis point last week to 1.69%.  The headwinds from tariffs, retaliatory action, and the still flooded midwest, Boeing's woes (likely highlighted at this week's Paris Air Show) remain in place.  China's recent data showing weaker than expected industrial output and investment increase the likelihood that new stimulative measures are announced shortly.  Meanwhile, many see the risk of a no-deal Brexit increasing, while we suspect that an early election and another delay is more likely.   Market expectations for a Trump-Xi meeting continue to be scaled back.  Now the most the optimists hope for is another tariff freeze (at higher levels) and resumption of talks, not a deal.  

Dollar Index:  The Dollar Index has a three-day rally in tow.  The nearly 0.6% gain after the retail sales report at the end of last week was the single largest daily advance since March 21, and more than doubled the recovery seen in the previous four days combined.  For the week, it rose a little more than 1% after falling almost 1.25% the previous week.  The pre-weekend high (~97.58) was just shy of the (61.8%) retracement (~97.65) of the fall seen since the 18-month high was set in late May, though it was sufficient to lift it on a closing basis above the 20-day moving average for the first time this month.  The Dollar Index approached the 200-day moving average in the middle of last week.  It is the fourth such test this year, and although penetration has been recorded, even on a closing basis, there has not bee follow-through selling, and the takeaway is the Dollar Index continues to trade above its 200-day moving average, a sign of its continued relative strength.   

Euro:  Like a mirror-image of the Dollar Index, the Euro's sharp sell-off ahead of the weekend, stopped just short of the (61.8%) retracement of the recent move, which comes in near $1.12.  The euro finished last month near $1.1170 and has not traded below $1.12 since June 3.  Still, it fell four of five sessions last week for a 1.1% decline, the largest in three months.   A break of $1.12 will excite momentum players for a test on the 18-month low that is found a cent lower.  Optionality in the  $1.1300-$1.1350 may continue to frustrate the upside, though initial resistance may be encountered near $1.1250.    

Japanese Yen:  The dollar recorded an outside up day against the yen before the weekend by first making new lows for the week (~JPY108.15) before recovering to marginally new three-day highs (just shy of JPY108.60).  The dollar snapped a three-week slide against the yen with a nearly 0.35% gain.  It was the largest gain in two months. It is only the fourth weekly gain here in Q2. Recall it finished Q1 around JPY110.85.   The technical indicators are constructive for the dollar, but JPY109 offers formidable resistance.  The dollar has not been above JPY108.80 this month. The JPY108 support was frayed earlier this month, but the greenback did not close below it.  A break of JPY107.75 area would target JPY107.00. The Bank of Japan meeting poses some headline risk, but no change in policy can be expected.  Governor Kuroda is likely to reiterate that, like other central banks, the BOJ has the will and the tools to respond to shocks.  

British Pound:  Sterling had a tough week, it lost (0.66%) the most since late March and finished below $1.26 for the first time this year.  It has fallen against the euro for the sixth consecutive week, indicating that it is not just the dollar's fortune's that explain sterling's movement.  Many perceive the risk no-deal exit increasing, and Johnson's success in the first round of the selection process for the next Tory leader does little but elevate such concerns.  Sterling finished a little beyond the lower Bollinger Band, though given the narrowness of the band (i.e., low volatility) it may be less significant technically, and the band itself is likely to move lower.  There is not much chart-based support ahead of the $1.2440-$1.2480 area, but psychological support is seen around $1.2500-$1.2550.  

Canadian Dollar:  Diverging employment data on June 7 helped push the US dollar to its lowest level against the Canadian dollar since March 1 to start last week (~CAD1.3225).  It has recovered and by mid-week was testing the (38.2%) retracement (~CAD1.3355) of the slide seen since the start of the month.  The greenback's broad surge in response to the retail sales lifted it to nearly CAD1.3425; nearly at the (61.8%) retracement objective (~CAD1.3435). Above the retracement target is the former cap around CAD1.3500.   The 200-day moving average has offered a good dollar buying opportunity, even if not the exact low, two other times this year.  It was after the employment data and to start this past week.  It is found near CAD1.3280 now.  Ahead of that, previous resistance (~CAD1.3355) may serve as initial support.  

Australian Dollar:  The Australian dollar's three-week rally came to a screeching halt with a 1.8% slide, twice the previous week's gain.  The outside down day on Monday, signaling the reversal and the combination of weak Chinese import data and industrial production figures and firmUS retail sales and industrial output sent the Aussie through $0.6900 to approach the shelf that was carved last month near $0.6865. The $0.6900-$0.6930 may serve as resistance.  It is not so much that the odds of an early July rate cut increased--the derivatives market says it was virtually flat, but investors seem to have greater confidence of another cut after that.  The two-yield was pushed below 100 bp for what appears to be the first time.  Additional support is seen in the $0.6830 area, and the flash crash low near $0.6740 may be the next target.  

Mexican Peso:  After some follow-through losses at the start the week, the dollar consolidated in a well-defined range between MXN19.09 and MXN19.24. The adjustment to the tariff threats and policy adjustment appears complete though there is some risk in the first half of August as the 45-day period draws to a close.   The wider range may be MXN19.00 to MXN19.33.  

Oil:  Crude oil prices were first driven lower by the unexpected build in the US and then higher by the attack on two ships in the Gulf.   The US rig count continues to fall.  In fact, the weekly tally has only increased in five weeks so far in H1 19.  The 969 rigs compare with 1059 a year ago.  The inventory increase has been relentless.  There were drawdowns in five weeks in Q1 and three here Q2.  The average over the past 13 weeks is 2.8 mln barrels.  The year-ago period saw a small draw.  The August WTI contract peaked near $55 at the start of the week, and this is the nearby cap.  It could be a neckline of a double bottom.  A move above there would target around $59.  Support is pegged at $50-$51.  Easing 

US Rates:  The end of the tariff truce between the US and China has turned investors more pessimistic on the economic outlook.  The US two-year note yield has fallen every week since the infamous tweet.  The yield has fallen from 2.33% to 1.84%.    But in fairness, the move began much earlier and was accelerated by the escalating tariffs.  Although equities recovered smartly in Q1, US yields did not return to status quo ante.  In fact in Q1, during the tariff truce, the two-year yield fell from a little more than 2.50% to about 2.25%.  It moved from the upper end of the target range to the lower.  Since the tariff truce ended, the 10-year note yield has fallen every week for a cumulative 44 bp to 2.08%.  In Q1 19, it had dropped to 2.40% from a little more than 2.70% at the end of last year.  Even the better than expected retail sales and industrial output data failed to arrest the drop in yields.  Indeed the decline in yields after the data ensured the extension of the weekly declines.  The momentum indicators are stretched as one would expect given the recent run.  The pre-weekend data were sufficient to encourage the aggressive speculators that were waging on a rate cut this coming week to temper their enthusiasm.  However, the risk of the July cut remains high.  Both the CME and Bloomberg models suggest a little more than a 68% probability has been discounted, leaving only a 1 in 7 or a 1 in 8 chance of stand pat policy.  The CME's model suggests about a 1 in 5 chance of a 50 bp move in July has been discounted.  

S&P 500:  The benchmark index saw its gains extended to start the week and extend the streak to a fifth session.  Follow-through buying faded near 2910, and the pullback found new buyers near 2975 in the middle of the week but couldn't get above 2895 before the end of the week. The MACD and Slow Stochastics are warning that the consolidative/corrective phase may not be over, though Hong Kong's decision to suspend the extradition bill from consideration may reanimate the animal spirits at the start the week and encourage risk-taking.  That said, the gap from the higher opening on June 7 has not been filled (~2852.1 to 2852.9) and could still attract prices.  

Disclaimer



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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