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Is the Dollar’s Decline since the Election set to Correct?

Summary:
The US election in early November was an inflection point.  Stocks have rallied.  The dollar has been sold. The rise in US yields has dragged up the yields in many other countries, especially in the dollar-bloc.  European bonds have held in better, and peripheral European bonds have shined.  Italy's 10-year benchmark yield fell to a new record-low ahead of the weekend.  Before the political drama in Washington last week, we had the market had largely discounted the adverse developments.  The move seemed to be getting stretched technically, and the sharp backing up of US rates in the past week may have also reached a near-term inflection point.While our medium-term expectation for the dollar to resume its decline remains intact, we anticipate a near-term correction.  We look at the charts

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Is the Dollar's Decline since the Election set to Correct?

The US election in early November was an inflection point.  Stocks have rallied.  The dollar has been sold. The rise in US yields has dragged up the yields in many other countries, especially in the dollar-bloc.  European bonds have held in better, and peripheral European bonds have shined.  Italy's 10-year benchmark yield fell to a new record-low ahead of the weekend.  

Before the political drama in Washington last week, we had the market had largely discounted the adverse developments.  The move seemed to be getting stretched technically, and the sharp backing up of US rates in the past week may have also reached a near-term inflection point.

While our medium-term expectation for the dollar to resume its decline remains intact, we anticipate a near-term correction.  We look at the charts and momentum indicators to help quantify some price targets.  

Dollar Index:  The lowest level since the spring of 2018 was recorded in the middle of last week (~89.20). The dollar recovered even though the data was disappointing; particularly, the contraction in the ISM services and the outright loss of 140k jobs last month. It tested the 20-day moving average (~90.15) after the employment report.  The moving average has capped counter-trend rallies for nearly two months.  The momentum indicators did not confirm the new lows.  The 90.65 is a reasonable initial target, but the 91.10 area is the real hurdle, and it is roughly the halfway mark of the leg lower since the election.  On the downside, a break of 89.00 would give scope for another 1% decline. 

Euro:  The euro peaked near $1.2350 amid the turmoil in Washington and recorded the low for the week just below $1.2215 ahead of the weekend.  It briefly traded below the 20-day moving average (~$1.2230) for the first time in nearly two months.  The MACD and Slow Stochastic peaked before Christmas.  Initial support is in the $1.2170-$1.2200 band.  A break of that area could signal another cent or so near-term decline.  The US-German 10-year spread was near 205 bp in late 2019 was halved in April 2020.  Last week it rose to almost 165 bp, with the (61.8%) retracement just below 170 bp, which in this fractal world is also the (38.2%) retracement of the larger decline from November 2018 (~280 bp).   It is the widest since March 2020.  The rise in US yields likely reflects both supply and inflation premium.  

Japanese Yen: Rising US yields and cautionary words by the Ministry of Finance arguably may have lifted the greenback from its lowest level since last March (~JPY102.60) to above JPY104 for the first time since mid-December.  The dollar's technical tone looks strong, and the five-day moving average is poised to cross above the 20-day next week.  The MACD and Slow Stochastic have turned up.  The greenback takes a three-day rally into next week. A convincing move above JPY104.00 would target last month's high near JPY104.75, and then JPY105.  Support is likely found around JPY103.40.

British Pound:  Sterling peaked at the start of last week a little above $1.37, and not much came of the key reversal that was recorded.   In the middle of the week, it was still around $1.3670.  A shelf has been carved in the $1.3530-$1.3540 area, with the 20-day moving average in the middle of it.   The momentum indicators have turned lower.  There may be additional support around $1.3500, but a break of $1.3440 is needed to suggest something more than broad consolidation.   Last week was only the second week since the US election that sterling fell (~0.70%).  

Canadian Dollar:   The US dollar fell to about CAD1.2630 in the middle of last week.  That is the lowest level since April 2018.  The greenback consolidated in a narrow range above the trough in the second half of the week. The downside momentum was not reinvigorated ahead of the weekend despite the employment report that showed an increase in full-time jobs last month. The greenback closed firmly and looks poised to re-challenge the CAD1.2800 area next week.  The MACD appears to be turning higher from the middle of its range, and the Slow Stochastics is poised to cross higher.  

Australian Dollar:  After briefly trading below $0.7000 around the closing of the US polls in early November, the Australian dollar reached $0.7820 last week for the first time since early Q2 18.  The momentum that had carried it above the upper Bollinger Band on a closing basis for two consecutive sessions stalled. A consolidative tone has emerged in the past couple of sessions.  There may be near-term potential for it to return into a $0.7640-$0.7680 band.  The MACD is rolling over, and the Slow Stochastic did not confirm the new highs but remains overextended.  As part of the reflation theme, we have noted, the Australian dollar has fallen in only one week since the end of October and the US election, and that was the week of Christmas. The more than 10% move seems excessive.  

Mexican Peso: The dollar rose against the Mexican peso for the second consecutive week for the first time since mid-July.  Rising US Treasury yields, the pandemic, run-of-the-mill profit-taking on year-end moves all could have weighed on emerging markets currencies in general and the Mexican peso in particular.  It was the third consecutive week that the JP Morgan Emerging Market Currency Index fell, the longest losing streak since the end of H1 20.  The MACD has been trending higher since early December, and Slow Stochastic is turning up.  A move above MXN20.15 could spur a recovery toward MXN20.50.  

Chinese Yuan: The dollar fell for the second consecutive week against the Chinese yuan and traded at levels not seen since the middle of 2018.  It spiked down to almost CNY6.43 and quickly recovered.  A combination of daily reference rate settings and talk that large mainland banks were dollar buyers (for the PBOC?) was seen as a sign that the dollar's downside risks were smaller.   During this consolidative or corrective phase, we anticipate, the dollar can rise toward CNY6.50-CNY6.52.  The 20-day moving average is found at the upper end of that range, and the dollar has not closed above it since late last September, and it has been violated on an intraday basis only a handful of times since.  



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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