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Dollar Correction may be One More Leg Away from Completion

Summary:
The US dollar had one of its best weeks in months.   It rose against nearly all the world's currencies. Many participants see scope for additional gains ahead of the quarter-end, which is ostensibly to require dollar-buying as corporates and asset-managers adjust hedges and re-balance.   After several months of dollar weakness, we see its recent strength has corrective in nature.   The question is, what move is being corrected.  It could be the entire move since the March lows, or it could be the move here in Q3.  We will be sensitive to both, especially where the retracements overlap.  The dollar's strong finish warns that it may still be too early to pick a top. In part, it is a question of positioning, with the currencies that had risen most recent hit the hardest, with some

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Dollar Correction may be One More Leg Away from Completion
The US dollar had one of its best weeks in months.   It rose against nearly all the world's currencies. Many participants see scope for additional gains ahead of the quarter-end, which is ostensibly to require dollar-buying as corporates and asset-managers adjust hedges and re-balance.  

After several months of dollar weakness, we see its recent strength has corrective in nature.   The question is, what move is being corrected.  It could be the entire move since the March lows, or it could be the move here in Q3.  We will be sensitive to both, especially where the retracements overlap.  The dollar's strong finish warns that it may still be too early to pick a top. In part, it is a question of positioning, with the currencies that had risen most recent hit the hardest, with some exceptions.  But with the elevated uncertainty about the US elections (and aftermath), downward revisions in Q3 GDP estimates, the correction will give an opportunity to sell the dollar again shortly.  The technical indicators suggest the correction is well advanced.     

Dollar Index:  New two-month highs a little above 94.60 were recorded before the weekend.  It is near the (50%) retracement of the Q3 decline, which is about 94.80.  The MACD and Slow Stochastic are stretched, but a move into the 95.50-96.00 area looks likely.  It houses the (61.8%) retracement of the Q3 move and the initial objective (38.2%) of the decline from the March highs.  A note of caution comes from the Bollinger Bands.  The Dollar Index has closed above the upper band for the past three consecutive sessions, which it has not done since the March peak.  

Euro:  The single currency fell for the second consecutive week, the first back-to-back loss in Q3.  The 1.7% decline was the largest in five months and made a marginal new low at the end of the week.  The momentum indicators are over-extended but could still allow one more push lower.  A break of $1.1600 would target a little below $1.15, which could exhaust the move.  The $1.1485 area corresponds to a (38.2%) retracement of the six-month rally and (61.8%) of the leg up that began in late June.   The euro finished the past four sessions below its lower Bollinger Band.  

Japanese Yen:  While Japanese markets were closed for a holiday at the start of last week, the dollar slumped to JPY104, a six-month low, before rebounding smartly and set a nine-day high ahead of the weekend near JPY105.75.  In fairness, the JPY104 low was fractionally below the low set at the end of July.  The price action reinforces the lower end of the two-month trading range that extends to JPY107.  There is scope within the range for the dollar to trade higher, and the momentum indicators suggest it is likely.  The next target is the JPY106.00-JPY106.30 area before the JPY107 is challenged.  

British Pound:  The brief attempt above $1.28, a three-day high was stymied in Europe ahead of the weekend, and the subsequent retreat took it a few ticks below the previous day's low (~$1.2690).  Still, it managed to recover and closed about the technically important $1.2725 area, which holds the 200-day moving average, the (38.2%) retracement of the year-to-date move, and the  (61.8%) retracement of the Q3 move.  The next target is near $1.2840 and then $1.2880.   On the downside, a  break of $1.2675 could signal a move toward $1.2450-$1.2500.

Canadian Dollar:  Neither back-to-back gains in US equities nor preliminary signs that Trudeau's minority government will survive by passing the 2021 budget (as early as next week) gave much help to the Canadian dollar.  The US dollar's recovery against the Canadian dollar extended for the third week. Yet the Loonie's roughly 1.5% decline was the second-best performer among the major currencies (behind the yen, which lost a little less than 1%).  The next immediate target is CAD1.3440, the (61.8%) retracement objective of the greenback's decline since late June.  The momentum indicators are stretched but have not begun turning, suggesting another leg up next week. Above there, the 200-day moving average is found near CAD1.3525.  The (38.2%) retracement of this year's decline is not until closer to CAD1.3660.   

Australian Dollar:   Ahead of the weekend, the Australian dollar, like sterling, traded on both sides of the previous day's range.  The market rejected the initial push higher, but unlike sterling, the Aussie was sold to new lows for the move.  The $0.7000 support area held, but the close was not inspiring.  It was below the (61.8%) retracement objective of the Q3 rally (~$0.7055).  A break of the $0.7000 could trigger a quick drop toward $0.6965, but there is little to grab on to until closer to $0.6800, and the 200-day moving average around $0.6775.  The Aussie takes a six-day losing streak into next week and closed below the lower Bollinger Band (~$0.7050) for the last four sessions.   

Mexican Peso:  The peso takes a "staircase higher and the elevator lower."  The dollar snapped a six-week decline with a more than 6% rally.  In one week, the dollar recouped more than two months of declines. At the end of July, the greenback settled around MXN22.2760.  It finished last week near MXN22.42.  The central bank delivered the 25 bp rate cut that was widely expected, and the source of the peso's weakness was the rebounding US greenback.  The pullback in US equities did not help it, but even when stocks traded higher, like before the weekend, the peso still was heavy.  The technical indicators warn of additional dollar gains.  Only a break below MXN22.00 would negate the constructive outlook.  The next target is around MXN22.73, a (38.2%) retracement of the greenback's losses since Apri.  While some resistance may be seen in front of MXN23.00, the next retracement objective (50%) is closer to MXN23.32. 

Chinese Yuan:   The dollar rose by 0.8% to end an eight-week drop.  It was only the second weekly increase since the end of June, but the biggest since March.  By some reckoning, officials may have signaled a desire to moderate the pace of the yuan's ascent through the setting of the reference rate around the middle of the week.  Its broad strength may allow the greenback to extend its recovery against the yuan toward CNY6.8550-CNY6.8750.  

Gold: The precious metal was about 4.6% less precious last week.  It fell and could not get up, remaining in the trough (~$1850-$1875) without showing much enthusiasm for the upside.  It seemed to sell off with US shares but did not begin to recover like they did.  Initial resistance is seen in the $1880-$1900 area.  The momentum indicators are extended but have not begun turning.  Another leg lower is favored.  The (38.2%) retracement of the rally since the March low (~$1455) is around $1837.  

Oil:   After rallying almost 10% the previous week, November WTI slid 2.8% to settle a little above $40.  Prices tumbled on Monday and remained in the range established for the rest of the week. That range, roughly $39.00-$41.50, is likely to continue to dominate the near-term price action.  It looks that resistance, which may extend to $42, where the 200-day moving average is found, looks stronger than support.  A retest of September's lows near $36.50 cannot be ruled out.  

US Interest Rates: The US 10-year yield barely moved last week.  It was stuck between about 64 bp and 69 bp.  The six-month average is 66 bp. MOVE, which tracks bond market volatility, fell to its lowest level in at least 20 years last week (~37.2%).  Recall that during the chaos in March, it spiked to over 160%.  The 2-10-year yield curve has averaged about 54 bp, and it finished last week near 53 bp.  The 10-year breakeven (the difference between the yield of conventional 10-year Treasury and the TIPS) has trended lower this month.  After poking above 1.80% at the start of the month, culminating a 5.5-month advance, the breakeven reached almost 1.56% ahead of the weekend, the lowest since August 4.  

S&P 500:  The S&P fell about 10.5% from its record high set earlier this month, and the NASDAQ's peak-to-trough was closer to 13%.  Bargain-hunting bottom-pickers have supported the market over the past two sessions.  It is possible the corrective low is in place, but the confidence may be weak until quarter-end passes.  A move above 3325 in the S&P 500 (~11050 in the NASDAQ) would bolster the case that the correction is over.  The strong close before the weekend may help lift Asia bourses at the start of the new week and set the stage for a possible gap higher opening in the US on Monday.  

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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