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Dollar Drop Continues, but be Careful of a Third Gap Higher in the S&P 500

Summary:
The US dollar fell against most of the world's currencies last week and looks poised to move lower in days ahead.  When the presidential tweets seemed to dash lingering hope for more fiscal support on October 6, the dollar bounced, and stocks slumped.  Despite the technical signals, follow-through dollar buying was minimal, and the equity market quickly recouped all the lost ground plus some. Some participants expect the increase in long-term rates to be supportive of the dollar, but most are bearish the greenback, and the consensus forecasts reflect this attitude.  Listening to investors, participating in panel discussions, reading widely,  it appears a new meme is emerging that frames the bearish outlook in terms of the twin deficits:  The US reported its largest monthly trade deficit

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Dollar Drop Continues, but be Careful of a Third Gap Higher in the S&P 500

The US dollar fell against most of the world's currencies last week and looks poised to move lower in days ahead.  When the presidential tweets seemed to dash lingering hope for more fiscal support on October 6, the dollar bounced, and stocks slumped.  Despite the technical signals, follow-through dollar buying was minimal, and the equity market quickly recouped all the lost ground plus some. 

Some participants expect the increase in long-term rates to be supportive of the dollar, but most are bearish the greenback, and the consensus forecasts reflect this attitude.  Listening to investors, participating in panel discussions, reading widely,  it appears a new meme is emerging that frames the bearish outlook in terms of the twin deficits:  The US reported its largest monthly trade deficit in a dozen years, and it appears poised to set a record in the coming months.  Whether delivered ahead of the election, shortly after the election, or early next year, more fiscal support will be delivered.  Next year, the US budget deficit is penciled at around 10% of GDP, well above the other G7 countries. 

Dollar Index:  The Dollar Index was turned back from near 94.00 on October 7 and was trading near three-week lows (~93.00) before the weekend.  It fulfilled the (50%) retracement objective of the bounce from September 1 (~93.35).  The next retracement (61.8%) is a little below 92.90, but the low from the second half of September, around 92.75, beckons.  Beyond that,  there is little in the way of 92.00. The momentum indicators are trending lower. A move above 94.00 would improve the technical tone.  

Euro:  Ahead of the weekend, the euro punched above the $1.1810 area, which is the halfway point of the retreat from the September 1 brief push slightly beyond $1.20.  The next immediate target is $1.1860, the next retracement objective (61.8%).  The momentum indicators are trending higher, and the five-day moving average crossed back above the 20-day moving average.  The upper Bollinger Band begins the new week a little below $1.19. Given the barrage of official rhetoric, the immediate risk-reward may shift above there, possibly slowing the ascent a bit.  

Japanese Yen:  The dollar's rally from the dip below JPY105 on October 2 faltered a little above JPY106, which it probed in the second half of last week.  However, the greenback's broad weakness eclipsed other considerations, and it finished near its lows before the weekend.  Although the momentum indicators are still moving higher, they are lagging in an important way now.  There is scope to return to the JPY105.00-JPY105.30 band in the coming days.  A break of JPY104.80 would weaken the technical tone.   

British Pound:  Sterling disappointed early last week.  It could not establish a foothold above $1.30, the neckline of a potential head and shoulder bottom, and retreated to almost $1.2845 before finding support. The bulls were undaunted and lifted it to $1.3045 ahead of the weekend.  The minimum measuring objective of the head and shoulders pattern projects a move to $1.33.  The MACD is trending higher, but the Slow Stochastic has leveled off.  The five-day moving average remains above the 20-day.  The EU Summit is at the end of next week, and Prime Minister Johnson has an ambiguous threat about abandoning the trade talks. The risk may deter some aggressiveness by sterling bulls and deflect some speculative attention to other currencies to express dollar negativity.  The euro is in a range of roughly GBP0.9050 to GBP0.9150.  It drifted closer to the lower end of the range as sterling played a little catch-up before the weekend.  

Canadian Dollar:  The Canadian dollar rose about 1.5% against the US dollar last week, the most in three months.  The greenback's break and close below CAD1.3155, the (61.8%) retracement of the rally from the September 1 low suggests a resumption of its downtrend.   The momentum indicators are trending lower, and a return to CAD1.30 looks likely.  The CAD1.3245 area now may offer resistance.  The median forecast in the Bloomberg survey sees the US dollar at CAD1.32 at year-end.  Look lower.

Australian Dollar:  It struggled near $0.7210 at the start of the week, the (50%) retracement objective of the decline from the September 1 high a little above $0.7400.  However, after it backed off and found support around $0.7100, it had a running start to approach $0.7245 ahead of the weekend.  The next retracement objective (61.8%) is nearer $0.7260.   The MACD has turned up from the oversold territory.  The Slow Stochastic appears to be turning up after moving sideways a little.  We anticipate a retest on the $0.7400 before the end of the month.  

Mexican Peso:   The peso was the third strongest currency in the world last week, rising about 2.25% against the US dollar (~MXN21.1180). On a weekly basis, the greenback has risen only twice against the peso since mid-July. The next target is last month's low near MXN20.8450.  At the start of last week, the dollar's strength was greeted with new selling as it approached the 200-day moving average (now ~MXN21.8350). The momentum indicators are still moving lower. 

Chinese Yuan:  The Golden Week holiday ended, and the PBOC set a reference rate for the dollar on its return that was weaker than the bank models suggested.  The magnitude of the gap drew notice, and the yuan surged by a little more than 1.4%, the most since the peg was abandoned 15 years ago. China is the only G20 country that is expected to grow this year.  Last year's low was near CNY6.67, and a stronger base is seen near CNY6.60.  It is difficult to decipher Beijing's intent, but it does appear that it is willing to accept a stronger yuan against the dollar.  It is not clear the extent of the move officials will tolerate.  Over the weekend, the PBOC announced banks would no longer have to hold 20% reserves against forwards sold to customers.  This can be understood in two ways.  First, it is consistent with other moves that facilitate foreign portfolio inflows, making it easier or more efficient to hedge.  Second, it may be an attempt to moderate the yuan's increase.  For example, when the PBOC last did this, in September 2017, the yuan fell around 2.5% in the following few weeks.  A similar move now would bring the dollar toward CNY6.8650 from the pre-weekend close around CNY6.6950.  China has improved market access, offers attractive yields, and its economic rebound appears underway, even if the data is taken with the proverbial grain of salt.    While worried about the sustainability of China's debt, many critics want it to pursue more aggressive fiscal easing, amid claims it is not doing "its part."  

Gold: The precious metal became about $30 an ounce (1.6%) more precious last week.  It might be a safe haven, but now it is moving with the risk.  Specifically, the 30-day correlation between (the percentage change of) gold and the S&P 500 is near a five-month high near 0.45%. While gold is likely headed back to the record high set in August (~$2075), a few weeks before stocks sold-off and the dollar bounced, there is more wood to chop first.  A move above $1935 would target the $1960-$1990 band. The momentum indicators are favorably positioned. 

Oil:   A shutdown of almost all the oil platforms in the Gulf of Mexico helped lift the price of the November WTI futures contract last week by over 10.5%, the most in five months, but the sell-off right before the weekend on news that Norwegian oil workers strike was called off.  Prices fall by around 1.2%, and the November contract finished up 9.3%.  It had flirted with the 200-day moving average found a little above $41 a barrel.  The momentum indicators are mildly constructive and the high from the second half of September, around $41.70, is the next important chart point.  The weak close, however, warns of the risk that support near $39.00 may be tested first.  

US Rates:  The US 10 and 30-year Treasury yields rose around seven and eight basis points to around 0.77% and 1.57%, respectively, to approach their highest level in three months.  The re-opening Treasury offerings showed the 10-year note had a better bid-to-cover than the last auction and indirect participants took down more than previously.  The 30-year bond auction was less well-received, the bid-cover slipped, and the indirect bidders bought less.    The 2-10-year yield curve steepened by about five basis points to around 62 bp.  It has not been this steep since the hiccup in May.  No coupons are sold by Treasury next week. The December 10-year futures note looks heavy, but it is approaching support near 138-16.

S&P 500:  The benchmark rose by 3.8% last week, the best in three months.  It reached its best level (~3482.3) since September 3.  Although media talks about a blue wave, meaning a Democrat sweep of both legislative branches and the White House, investors are still pricing in volatility.  The difference between the October and November VIX futures remain near the highs for the year.  The S&P 500 gapped higher both Thursday and Friday.  It finished near its highs before the weekend.  A gap higher opening on Monday is possible, but in gap theory, such a sequence is seen as a bearish development on the grounds the market is overbought.  The gaps are found between around 3426.25-3428.15 and 3447.30-3458.10.  The other note of caution is that the S&P 500 finished above the upper Bollinger Band (~3476.5).  Once again, dip-buying, whether it was the sell-off in September or the reaction this past week to Trump's tweets, has been rewarded.  New record highs seem likely.  



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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