Global growth concerns spurred by disappointing PMI data and broadening trade tensions, as the US prepares to act against Europe to the full extent that WTO allows, drove the capital markets over the past week. The dollar was mixed. The yen, euro, sterling traded higher, while the Canadian dollar, Swiss franc and Swedish krona weakened. The short-end of the US curve that had shown some doubts about another Fed cut this year swung hard toward possibly two more cuts.
The US two-year note yield fell by almost 25 bp last week to a new two-year low near 1.35%. One of the under-appreciated developments has been the continued move in two-year interest rate differentials against the US. The US and German spread peaked last November near 352 bp. It made a new two-year low below 220 bp before the weekend. The US premium over Japan peaked in November 2018 as well near 310 bp. Before the weekend, it also recorded a two-year a little above 270 bp. The US offered a 12-year high of almost 82 bp more than Canada this past March, last week it offered a few basis points less than Canada.
We accept that interest rate differentials are not the only thing the drives exchange rates and that whatever the relationship between the two dimensions of the price of money (interest rates and exchange rates), it is typically not linear. We see it as a cyclical relationship and that the last phase of a long dollar bull market is characterized by the narrowing of short-term interest rate differentials.
Dollar Index: The Dollar Index began the quarter with new 2.5 year highs before reversing lower. The 99.65 area marks the highwater point. Follow-through selling over the next few sessions saw the Dollar Index fall to roughly 98.65 before consolidating ahead of the weekend. The MACDs and Slow Stochastics are have turned lower, highlighting the downside risks. A break of 98.20 set the stage for a deeper and longer correction. A convincing move back above 99.20 now would likely be an early sign that the downside correction is over. The Dollar Index will take a four-day losing streak into the new week.
Euro: The euro recovered smartly off the new low since mid-2017 seen at the start of the week near $1.0880. It gained four sessions in a row for the first time in 3.5 months. What appeared to be a largely short-covering fueled bounce saw the demand fade near previous support and now resistance near $1.10, where the 20-day moving average is also found. The $1.10 area also corresponds to a (50%) retracement of the leg lower recorded since the middle of September high, the last time the euro traded above $1.11. The little rounded bottom that was carved or a possible head and shoulders bottom projects toward $1.1080, the (38.2%) retracement of the larger decline since June high (~$1.1410). The technical indicators have turned higher.
Yen: The dollar reversed lower, posting an outside down day, on October 1, after testing last month's high near JPY108.50. With a headwind of falling equities and yields, the dollar dropped to about JPY106.50 before finding a good bid. The JPY107 area may be the neckline of a double top around JPY108.50, and the time spent below there, and the weekly close with a JPY106-handle, adds to the bearish tone. The measuring objective of the double top is near JPY105.50. The MACDs and Slow Stochastics point to further losses, but the proximity of the lower Bollinger Band (~JPY106.80) suggests selling the dollar into a bounce.
Sterling: The pullback from the run into a key technical area around $1.2550 early in the second half of September continued through early last week to $1.22. We had identified that area as important support and corresponding to a (61.8%) retracement of the rally from the multi-year lows set in early September near $1.1980. The heavier dollar tone and the prospect of a delay, which the government told a Scottish court it would respect the Parliament's instructions though the Prime Minister publicly continued to deny willingness to ask for an extension, seemed to provide some bids. The technical indicators mixed, but on balance, the path of least resistance may be back toward $1.2400-$1.2440.
Canadian Dollar: The US dollar posted outside up day against the Canadian dollar on October 2, reinforcing the importance of the CAD1.3200 support area. It rallied through the recent cap near CAD1.3300 and reached almost CAD1.3350 before some profit-taking was seen ahead of the weekend, The Canadian dollar did not react much to the new that the IVEY Purchasing Managers Index slid to 48.7 in September, a four-year low, from 60.6 in August. Previous resistance around CAD1.3300 and the 200-day moving average may offer support. Caution is suggested by the proximity of the upper Bollinger Band (~CAD1.3350), recovering equities, and the possible stabilization in oil prices.
Australian Dollar: The Australian dollar's downside momentum eased after it reached 10-year lows near $0.6670 in the first couple days of the quarter. Short-covering helped lift it to the nearby ceiling in the $0.6775-$0.6780 area and it finished the week just off its highs. Nearby resistance above there is in the $0.6800-$0.6810 band, but $0.6900 is more significant. If the corrective forces are to continue, the Aussie should hold above $0.6725.
Mexican Peso: The US dollar's five-day rally ended in the middle of last week with a push to almost MXN19.87, just shy of the MXN19.90 objective, which was the (61.8%) retracement of the greenback's drop from the year's high set in late August. The dollar will begin next week with a three-day downdraft in tow. The dollar finished below its 20-day moving average (~MXN19.5450). The prospect of lower US rates helped the JP Morgan Emerging Market Currency Index in the second half of last week, but Mexico, which has become the single largest US trading partner, maybe more sensitive to why rates are coming down, namely risks to the growth prospects. The MXN19.40 area provides the next important support area.
Chinese Yuan: The dollar slipped about 0.4% against the offshore yuan (CNH) since the mainland markets closed for their national holiday. The dollar finished the week near its 20-day moving average (~CNH7.11). The 20-day moving average against the onshore yuan (CNY) is found near CNY7.12. The dollar closed a little below CNY7.15 at the end of September. The MSCI Emerging Markets equity index fell about 1% last week, and Chinese shares may play a catch-up. A further postponement of the set of US tariffs that were to be originally implemented on October 1 and now slated for October 15, could weigh on the dollar against the yuan.
Oil: November crude oil ended an eight-session slide ahead of the weekend with a 0.7% gain. It still lost 5.5% to trade at two-month lows. It had spiked to around $64 when Saudi Arabia was attacked and on October 3 reached $51. A hammer candlestick may be in place, which would mark a near-term low. The technical indicators are stretched and a recovery into the $53.85$54.50 area appears likely.
US Rates: Over the past three weeks (15 sessions), the US 10-year yield closed higher twice and the two-year yield has risen three times. In this span, the 10-year yield has fallen by about 40 bp. Recall the yield rose by 50 bp in the first half of September. While it is about 10 bp above last month's low, the two-year yield fell to new two-year lows near 1.35%. The 2-10-year yield curve that was inverted in late August and early September was the steepest last week in a little more than two months. It approached 15 bp, which may not sound impressive but it matches the 200-day moving average. The December 10-year note futures contract had a large outside up day on October 1. It reversed higher after hitting 129-20 and closed the week just below 132-00. The contract high was set on September 3 near 132-16. The technical indicators look supportive but are getting stretched and the contract closed above the upper Bollinger Band.
S&P 500: The sell-off accelerated through October 3. when the S&P 500 reached 2855. It had peaked on September 19 (~3022), failing to takeout July's record high near 3028. The S&P 500 reversed higher on October 3 and gapped higher on October 4, after the employment data. It had gapped lower on Wednesday, October 2, so the gap ahead of the weekend created a bullish two-day island bottom. A move above 2960 suggests the recent decline was corrective in nature and another run that the highs is likely. The technical indicators are constructive, but the market may be cautious as the formal start of Q3 earnings is a week away.