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High Anxiety is Auto-Correlated

Summary:
The economic and financial reaction to the global pandemic has triggered a surge in the US dollar, which itself may amplify the disruption that is evident throughout the capital markets.  The macro analysis piece (The Economic Tsunami that has Begun and the Drive for Cash) focuses on the fundamental considerations behind the greenback's surge. This piece focuses specifically on the price action itself.   One way to conceive of the price action is that it is a reflection of psychology. Not the Freudian psychology of the id, ego, and superego, of course, but crowd psychology.  As an individual, we may learn, but crowd behavior seems repetitive, and hence patterns emerge. Also, technical studies can help quantify the risk and provide mile-marker-like levels.  In equity investing,

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High Anxiety is Auto-Correlated
The economic and financial reaction to the global pandemic has triggered a surge in the US dollar, which itself may amplify the disruption that is evident throughout the capital markets.  The macro analysis piece (The Economic Tsunami that has Begun and the Drive for Cash) focuses on the fundamental considerations behind the greenback's surge. This piece focuses specifically on the price action itself.  

One way to conceive of the price action is that it is a reflection of psychology. Not the Freudian psychology of the id, ego, and superego, of course, but crowd psychology.  As an individual, we may learn, but crowd behavior seems repetitive, and hence patterns emerge. Also, technical studies can help quantify the risk and provide mile-marker-like levels. 

In equity investing,  one can pay a downpayment of the purchase, as in buying on margin. In the over-the-counter markets, one does downpayment is not toward the purchase, but toward the future loss. How much can one lose before the position can be closed? This is a function of volatility. As volatility rises, participants are forced to trade smaller size or pony up more funds. Volatility often appears auto-correlated, which means the best guess for the next period volatility is the last period. High vol periods seem to come in clusters. That suggests that elevated volatility should be expected in the days ahead. In turn, that has implications for the placement of orders, slippage on execution, and the tolerance of violations of technical targets.  

Dollar Index: On March 9, the Dollar Index was sold to 94.65 its lowest level since September 2018. It has preceded to rally to 103.00, its best level since January 2017. The surge lifted the momentum indicators into over-extended territory, and they are not showing an imminent turn lower. The Dollar Index has closed above its upper Bollinger Band (~100.87) for the past two sessions. The next upside chart points come from the late 2016/early 2017 high in the 103.55-103.80 area. Above there is little until Aug-Sept highs in 2002 (~108.75-109.25). Initial support may be in the 101.00-101.50 area. A break of that area, without going much higher first, could be an early sign that the surge is over.  

Euro: The single currency fell by about 3.75% last week following a nearly 1.6% decline the previous week. It traded in a six-cent range last week (~$1.0635-$1.1235). The last time a month had such a range that big was in January 2018. One-week implied volatility rose above 20% last week for the first time in four years. One-month implied volatility finished last week, around 14.3%. It had been near 6% at the end of February. The technical indicators do not point to a near-term euro bottom yet, and the next support area is around $1.05. However, the volatility means a move below $1.00 cannot be mathematically discounted. A move above $1.08 now is needed to stabilize the tone. 

Japanese Yen: The dollar reached JPY111.50 ahead of the weekend as it nearly completes the round trip that began around JPY112.20 on February 20-21. It dropped like a rock to JPY101.20 on March 9. The technical indicators are not yet over-extended, and the upper Bollinger Band is near JPY112.25. The most acute shortage of dollars may not be from Japanese commercial banks, but other financial institutions and may not be addressed by the official dollar-swap lines. A move above the JPY112.50 area could target the JPY115 area. March 12 was the last session that the dollar took out the previous session's low. The pre-weekend low was about JPY109.35. Below there, support is seen in the JPY108.00-JPY108.35 area. 

British Pound: Sterling has been pounded for 11.3% since the nearly $1.3210 peak on March 9. It recorded a low a little above $1.14 ahead of the weekend, a level not seen since 1985. The low then was around $1.05. For the past three sessions, it has slipped below $1.15 intraday but has failed to close below it. The pre-weekend bounce fizzled near $1.1935, shy of the $1.20 psychological level and $1.21, the (38.2%) retracement of the sharp sell-off. The MACD and Slow Stochastic appear to be trying to bottom. One-week and one-month volatility reached nearly four-year highs of around 35.5% and 26.2%, respectively, last week. There have been ten-cent ranges in each of the past two weeks, and the softening of the implied volatility ahead of the weekend may be hinting that such ranges are unsustainable. 

Canadian Dollar: Since March 9, when the US dollar bottomed against most of the major currencies, the Canadian dollar has been the strongest, losing only 4.6% of its value. Its 1% rally before the weekend solidified its standing. Although the Bank of Canada has cut rates 100 bp this month, at 75 bp, the policy rate is still 50 bp above the next highest G7 countries, including the US. Between the drop in oil prices and commodity prices more broadly, and the economic and financial disruption is going to be significant. The US dollar reached almost CAD1.4670 on March 19 before dropping to nearly CAD1.4150 on March 20, helped by a surge in oil prices and a (brief) moment of stability in equities. The MACD looks to be about to level-off at extreme levels. The Slow Stochastic has been flatlining near its highs. After closing for three sessions about its upper Bollinger Band, the US dollar moved back under it (~CAD1.4525) at the end of the week. The US dollar approached the high from last 2016 near CAD1.4670.  If this is overtaken, there is appears to be nothing on the charts to prevent a test on CAD1.50. 

Australian Dollar: The Australian dollar recorded back-to-back weekly declines of more than 6.5% (nearly 8.5 cents). It took out the lows from the Great Financial Crisis near $0.6000 and fell to almost $0.5500, last seen in October 2002.The pre-weekend session was the first since March 9 that the Aussie rose above the previous session's high to reach about $0.5965. It needs to recapture the $0.6000-$0.6030 area to give up that collapse is over. The announcement that the Federal Reserve was granting Australia (along with several other central banks) dollar-swap lines seems to help the spot. Still, the three-month cross-currency basis swap finished the week at what appears to be a record extreme. The Slow Stochastic appears slightly ahead of the MACD in suggesting a potential easing of the selling pressure. Volatility soared to levels not seen since last 2008, as one-week vol jumped above 46%  and one-month role rose almost 38% (both were tenors were are 10% at the end of February).

Mexican Peso: Initially, the dollar strengthened against the peso as carry-trades that were drawn to Mexico's high real and nominal rates were unwound. The greenback gains accelerated as the peso was sold alongside other emerging markets currencies. Mexico depends on tourism, and worker remittances as sources of hard currency, and these streams are evaporating. The government also seems slow to respond to the Covid-19 threat by closing down airports and restaurants, for example. Banxico delivered a 50 bp rate cut ahead of the weekend, but at 6.5% it is overnight rate remains among the highest in the G20.  Mexico was struggling before the pandemic and seems ill-positioned to cope with the coming economic shock. The dollar is at record highs against the peso, reaching almost MXN24.65 before the weekend. The rise has been breath-taking: 11.4% last week after 9% the previous week. In the five-week advance, the greenback has risen from about MXN18.54 on February 24 to settle a little below MXN24.42 before the weekend, an almost 32% move (31.7%).  

Chinese Yuan: The dollar had been relatively stable against the Chinese yuan from the time the local markets re-opened from their extended Lunar New Year holiday on February 3. It was confined to a CNY6.91-CNY7.05 trading range. The broad dollar buying pressure was too great, and it gapped higher on March 19 to trade near CNY7.1250 and held the breakout on March 20. The dollar reached a high around CNY7.1850 last September, though the CNY7.15 area may prove a bit sticky first. The yuan lost about 1.2% against the dollar last week but gained against near every other currency in the world. This appreciation may have prompted officials to allow a weaker yuan in the previous couple of sessions. However, the fix has been stronger yuan than the bank models suggested in recent days.   

Gold: The price of gold has dropped 15% since March 9, high above $1700. Some gold sales were linked to the need to raise cash (in part to meet margin calls elsewhere). Other links include some participants borrowed dollars to buy gold, and as the structure was unwound, gold, which was treated like any other asset, was liquidated. There was an attempt to form a base near $1450 last week.  Both the MACD and Slow Stochastic have flattened out but have yet to turn higher. A close back above the 200-day moving average (~$1503) would help the tone. If a near-term bottom is in place, then the first corrective targets are seen near $1544 and $1575.

Oil:  May crude reached nearly $20 a barrel in the middle of last week, an 18-year low. At the end of 1998 is briefly traded below $10.50.  Although the MACD and Slow Stochastic are overextended and the $20 level was tested again ahead of the weekend, there is no compelling technical sign a low is in place.  The lower Bollinger Band is a little below $18.  Initial resistance is seen near $30 and then $36.35. Ahead of the weekend, Saudi Arabia and Iraq reduced discounts for shipments (which is tantamount to a price increase), and Aramco CEO warned that it may not be able to maintain maximum output beyond April.  Over the past two weeks, US crude inventories have risen about 9.5 mln barrels. Meanwhile, as the first step toward implementing Trump's call for the to top up the Strategic Petroleum Reserves (available capacity of another 77 mln barrels), the Department of Energy said it would buy 30 mln barrels by the end of June (~11.3 mln barrels of sweet crude and ~18.7 mln barrels of sour crude).  It will focus, according to official statements, on purchases from small and medium-sized producers (with less than 5k employees).

US Yields: The largest and most liquid and transparent bond market, US Treasuries, has been destabilized. Consider the ranges of the generic 10-year yield. In the first week of March, the range was a little more than 50 bp. In the second week of March, the range was 70 bp, and last week's range was 65 bp. The March 9 low was about 31 bp, and last week's high (March 19) was 1.27%. The yield pulled back to 84 bp ahead of the weekend. At 137-06, the June note futures retraced half of its losses since the March 9 high (140-24). The next (61.8%) retracement is near 138. The two-yield fell for the fifth consecutive week. On Valentine's Day, it closed just shy of 1.43% and finished last week a touch above 31 bp. The first fed funds futures contract that ended last week above 25 bp was July 2022, though illiquidity may distort. The June Eurodollar futures contract implies a three-month yield in three months of a little less than 55 bp. The next quarterly contract that implies a higher yield than that is December 2022.  

S&P 500: The benchmark has not strung together two consecutive gains in over a month. It finished last week below the initial (38.2%) retracement of the rally since the 2009 low that is found near 2352. The next retracement (50%) is seen near 2030. The Slow Stochastic is moving sideways in over-extended territory, while the MACD appears to be at record lows and still heading south. The VIX peaked in the middle of the week above 85, more than four-times the six-month average. It traded below 60 ahead of the weekend before rebounding to close above 66. The higher vol is translated into wider Bollinger Bands, which are set at two standard deviations from the 20-day moving average.  The S&P 500 finished the week above the lower Bollinger Band (~2230).  

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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