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Will Divergence give the Dollar another Leg Up?

Summary:
The "correction within the correction" that we dubbed the pullback in the dollar that began with the January job report looks to have been completed last week. Some of our targets, JPY104.40 and .2150 in the euro, worked well, and sterling made new highs since May 2018. The Canadian and Australian dollars overshot our objectives.   The dollar-supportive divergence-meme is coming back to the fore.  The stimulus bill is working its way through the reconciliation process, which has been utilized by the last four administrations.  The size of the fiscal shock (0 bln in December and probably something close to .5 trillion now) is head and shoulders above what most other high-income countries will do.  Consider that the ballyhooed European Recovery Fund.  It is roughly the equivalent

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Will Divergence give the Dollar another Leg Up?

The "correction within the correction" that we dubbed the pullback in the dollar that began with the January job report looks to have been completed last week. Some of our targets, JPY104.40 and $1.2150 in the euro, worked well, and sterling made new highs since May 2018. The Canadian and Australian dollars overshot our objectives.   

The dollar-supportive divergence-meme is coming back to the fore.  The stimulus bill is working its way through the reconciliation process, which has been utilized by the last four administrations.  The size of the fiscal shock ($900 bln in December and probably something close to $1.5 trillion now) is head and shoulders above what most other high-income countries will do.  Consider that the ballyhooed European Recovery Fund.  It is roughly the equivalent size of the US December package. The application process is underway, and the first funds are unlikely to be distributed much before midyear. 

In the first instance, this fiscal shock positive boost US economic activity and lift returns on investment. We expect it to allow the dollar to continue to recover.  However, that will be followed by the impact of the fiscal stimulus in Europe and concerns that can be bucketed as the twin-deficits.  Holding all else constant, the magnitude of the US's fiscal shock will generate growth differentials that suck in imports and cause a deterioration in the current account.   Short-term up, medium-term down. 

Dollar Index:  The sell-off seen before last weekend continued in the past week. The (61,8%) retracement of the bounce that began in early January is near 90.10.  The index carved a shelf in the 90.25-90.40 area.  A move above 91.00 would lend credence to our view.  We anticipate gains toward 92.75-93.00.  The momentum indicators are still trending lower, and a break below 89.75 would sour our outlook. 

Euro:   The single currency reached almost $1.2150 the halfway mark of the decline saw it slide from $1.2350 to $1.1950.  The euro fell to nearly $1.2080 ahead weekend before a sharp short squeeze ahead of the European close stalled near $1.2135.  The $1.2025-$1.2050 band offers support, and a break would signal a return to the lows. A break of  $1.1950 signals a move to the  $1.1885 area, the (61.8%) retracement of the November-December rally.  Deeper still, the possible head and shoulders topping pattern's measuring objective are closer to $1.1750, which now is a little above the 200-day moving average ($1.1735).  The technical indicators appear more bullish, however.  The MACD and Slow Stochastic are still trending higher.  The 5-day moving average is crossing back above the 20-day moving average for the first time since January 12.  

Japanese Yen:  In the first half of last week, the dollar trended lower and neared the bottom of the support band we identified (JPY104.40-JPY104.60). However, it found better footing and ahead of the weekend and approached the (61.8%) retracement target (~JPY105.25) of the losses suffered since seeing JPY105.75 before the US job data. The momentum indicators are trending lower. The rising US 10-year yield, which finished the week near 1.18%, may offer dollar support from Japanese accounts.  Maybe the dollar will chop around the JPY104.50-JPY105.50 range in the coming days. 

British Pound: Sterling continues to be bought on pullbacks.  After rallying the first three sessions of last week, reaching roughly $1.3865, it retreated to $1.3775, ahead of the weekend. It was snapped up and rallied to a new session high, a little below the week's high. There is not much on the charts ahead of $1.40.  A break of the $1.3750 may be necessary to weaken the bulls' grip on the downside.  The MACD is trending gently higher, while the Slow Stochastic is over-extended, it is still trending higher. 

Canadian Dollar: After falling from nearly CAD1.2785 to start the week, the greenback carved out a low ahead of CAD1.2660 on Wednesday and Thursday last week.  In both sessions, the US dollar bounced smartly and closed near session highs.  The downside blocked, it made sense ahead of the weekend to probe higher, and the market did.  The greenback traded to almost CAD1.2765 but then reversed sharply lower, forming a possible shooting star candlestick.  The momentum indicators are falling quickly.  After a soft start before the weekend, the strong recovery in oil and equities supports the Canadian dollar.  

Australian Dollar:  The Aussie has been fairly resilient as well. It has advanced in five of the last six sessions, and its nearly 1.1% advance last week was the most among the majors. It rose by more than twice the old dollar-bloc currencies.  What is being dubbed a "commodity super-cycle" may help explain the interest.   It has forged a shelf in the $0.7000-$0.7020 area.  The close ahead of the weekend (~$0.7750) was the highest since November.  While there is a band of congestion between around $0.7780 to $0.7800, the high since March 2018 was recorded in early January near $0.7720. The MACD and Slow Stochastic indicator are moving higher, and the upper Bollinger Band is near $0.7800.  

Mexican Peso:  The greenback takes a four-day loss into next week, and it has fallen in five of the past six sessions. This leaves the dollar slightly higher on the year (~0.2%). Similarly, the JP Morgan Emerging Market Currency Index has risen by about 0.25% this year, though these past two week increases are the first in 2021.  The momentum indicators are still falling, but the pressure on the dollar appears to be abating. It is straddling the (61.8%) retracement objective of the gains in late January (from ~MXN19.55 to MXN20.60) found around MXN19.95.  A break of MXN19.90 would encourage the dollar bears to push for a retest on the lows. 

Chinese Yuan: China's domestic markets will reopen on Thursday, February 18. Since mainland markets closed on February 10, the offshore yuan has strengthened slightly (~0.15%). Fund managers seem universally bullish. They are attracted to the relatively high-yielding rates and a constructive outlook for the currency. The is a structural element to many arguments.  The idea is that it will gain market share from the dollar.  Halfway through Q2 21, and the dollar has spent it mostly confined to the ranges seen in the first two trading sessions of the year: ~CNY6.4300-CNY6.5150.  Year-to-date, the yuan has risen 1% against the dollar, making it the stronger currency in the Asia Pacific region, and all but the Norwegian krone and British pound (~1.35%) among the majors.  


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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