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Treasuries Call the Tune in FX

Summary:
The higher than expected US CPI spurred a jump in rates and the greenback, but it proved to be little more than a bull trap.  The dollar's upside momentum faded even before the large miss on retail sales ahead of the weekend.  Yes, if one averages some recent data and squint in just the right way, the reports don't look so bad,  but the point is not so much about fine-tuning Q2 GDP estimates, which are easing from still strong levels.  Rather, the key questions are whether it moves the Fed's needle or encourages the market to do the Fed's heavy lifting.  And both are being answered in the negative.  Without higher US rates, both relative to other countries and in absolute terms, it is difficult in this context to see the dollar mounting a strong and sustained bounce.  Moreover, the miss

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Treasuries Call the Tune in FX

The higher than expected US CPI spurred a jump in rates and the greenback, but it proved to be little more than a bull trap.  The dollar's upside momentum faded even before the large miss on retail sales ahead of the weekend.  Yes, if one averages some recent data and squint in just the right way, the reports don't look so bad,  but the point is not so much about fine-tuning Q2 GDP estimates, which are easing from still strong levels.  

Rather, the key questions are whether it moves the Fed's needle or encourages the market to do the Fed's heavy lifting.  And both are being answered in the negative.  Without higher US rates, both relative to other countries and in absolute terms, it is difficult in this context to see the dollar mounting a strong and sustained bounce.  Moreover, the miss on both jobs and consumption suggests that Chair Powell's consensus is not likely to unravel at next month's meeting.  More will come around to the view that the Jackson Hole Fed confab and the September FOMC meeting are the next windows of opportunity for a policy adjustment.  

Ironically if high-frequency data are not likely to sway the Fed for another quarter, and if the bond vigilantes adhere to the maxim about not fighting the Fed, technical factors may have greater sway in the foreign exchange market. It is with that in mind that we turn to our weekly look at the price action.    

Dollar Index:  The CPI-higher rates sparked a rally in the Dollar Index that stalled at the (61.8%) retracement objective (~90.90) of the decline from the high seen in the middle of the previous week, which is also where the 20-day moving average is found.   The Dollar Index has not closed above its 20-day moving average in over a month.  A break of 90.00, near where the lower Bollinger Band starts the news week, signals a test on the February low near 89.65.   Beyond that is the low for the year set in early January by 89.20, a three-year low.  The momentum indicators seem somewhat supportive, but the weak close ahead of the weekend means that they may play catch-up. 

Euro:   The euro rose last week to its highest level since the end of February, just above $1.2180.  The pullback brought it to almost $1.2050, where the March and April lows trendline intersected.  It ended the week with strong momentum, and a test on the $1.2180-$1.2200 resistance area looks likely.  Above there, the late February high was close to $1.2245.  The MACD and Slow Stochastic are not generating strong signals and understandably so given that the single currency has been in a two-cent trading range (~$1,1980-$1.2180) for a month.  

Japanese Yen:  The dollar's movement against the yen closely tracked the US 10-year yield.  When the yield was near 1.70%, the greenback rose to around JPY109.80, its best level since mid-April.  As rates pulled back, the dollar slipped to JPY109.20 ahead of the weekend.  A break could signal a return to the JPY108.35-JPY108.65 area. However, the momentum indicators give little reason to expect a break of the JPY108-JPY110 trading range.  While some chartists may draw attention to a possible head and shoulders topping pattern, with a neckline near, we are suspicious because of the downsloping neckline and the position of the momentum indicators.

British Pound:  Sterling stalled last week near $1.4160, ahead of the late February high near $1.4235. However, the five-day moving average is at a new three-year high, a little below $1.4100.  The momentum indicators look constructive, but the upper Bollinger Band comes in near $1.4135 to start the new week.  Although sterling closed above the band in the first part of last week, it was not sustained.  If some of sterling's strength has derived from ideas of the rapid economic recovery that BOE Governor Bailey talked about that was predicated on the rapid re-opening of the UK economy, some pushback is possible if the new Indian variant of Covid pushes out the planned economy-wide re-opening n June 21. Initial support is seen near $1.3960 if $1.40 gives way.  Trendline support off the mid-April and early May lows is a little below $1.3900 at the start of next week. 

Canadian Dollar:  The Canadian dollar was the only other major currency besides sterling that rose against the US dollar last week. The weaker than expected April employment data did not generate the consternation that the US miss did. Bank of Canada's Macklem comments about not wanting the strength of the Canadian dollar to adversely impact exports spurred a little more than a one-day wobble.  The central bank has begun tapering and says the economic slack will be absorbed in the second half of next week.  The June 2021 BA futures yield is about 44 bp.  The implied yield of the December 2022 BA futures is above 1.0%.  This is arguably a more significant consideration than Macklem's comments.  That said, the Canadian dollar has risen for the past six weeks, and the momentum indicators over-extended. The Slow Stochastic looks poised to turn higher.  Yet last week's back-to-back declining sessions, the first in a month, were seen as a new buying opportunity ahead of the weekend after the US April retail sales disappointed.   Canada's economic highlights next week include April CPI and March retail sales.  

Australian Dollar:  The Aussie was the poorest performer among the major currencies last week, falling almost 1% against the US dollar, and that is after it bounced back around 0.5% before the weekend.  The Australian dollar reversed lower at the start of the week after reaching its best level since late February, near $0.7900. It dipped below $0.7690 before finding a good bid and finishing the week by $0.7770.  Resistance is seen in the $0.7790-$0.7815.The recovery came despite the setback in commodity prices, including iron ore, following Beijing's concerns about the rapid increase. The momentum indicators are not impressed and still are headed lower. A break of $0.7675 signals a retest of $0.7600.  

Mexican Peso:  Before the weekend, the dollar fell to its lowest level  (~MXN19.7540) against the Mexican peso since late January. It has fallen for seven of the past 10 weeks. The exchange rate seems particularly sensitive to US rates.  The correlation between the dollar-peso exchange rate and US 10-year yields (60 days, percent change) is nearly 0.45, a four-year high.  Banxico, while recognizing upside risk to inflation, still anticipates convergence with its target by the middle of next year. However, the market is moving in the other direction.  The one-year cetes yield 4.9%, compared with the current cash target of 4%. It has risen by more than 30 bp since the end of April. The MACD and Slow Stochastic are falling. A break of the MXN19.73 area signals a test on the year's low (~MXN19.55).  The greenback's high last week was around MXN20.2135, which seems far away.  The MXN19.90-MXN20.00 offers a nearby cap.  Mexico reports March retail sales next week.  A flat January was followed by a 1.6% gain in February.  Bloomberg survey's median forecast is for a similar rise in March.  

Chinese Yuan:  Others shared our observation that the gap between the PBOC's daily dollar fixing and the expectations was a subtle signal of possible PBOC displeasure with the yuan's gains that had lifted it to new highs for the year on May 10 (~CNY6.4380). However, the broadly heavier dollar appeared to neutralize the signal, and the yuan finished higher in the last two sessions.   Nevertheless, the die was cast, and the yuan ended a five-week advance. The yuan has been tracking other emerging market currencies.  The correlation (30-day, on levels) between CNY and the JP Morgan Emerging Market Currency Index is 0.95.  The CNY6.40 area is the next important chart area. We have suggested potential toward CNY6.20 this year.  China reports April retail sales, industrial production, fixed-asset investment in the coming days.  The data is expected to be strong even if not accelerating.  Beijing's expression of concern about the rise of commodity prices spurred dramatic losses in the last three sessions.  These developments will continue to command attention.  Other factors also contributed to the retreat in the CRB Index, which snapped a five-week rally with a roughly 1.75% pullback.  


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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