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Positioning and Momentum Trump Interest Rate Considerations

Summary:
The US 10-year yield fell last week to its lowest level in three months, and the weekly decline was one of the largest in the past year.  The implied yield of the December 2022 Eurodollar futures contract slipped to almost 33 bp, the lowest level in nearly four months.  The yield has drifted lower for the fourth consecutive week.  It has risen in only two weeks since the end of March.  Three-month LIBOR fell to a new record low. Yet, the dollar proved fairly resilient to these latest interest rate developments. It rose against nearly all the major currencies, helped by a bout of short-covering ahead of the weekend.  Part of the decoupling may be traced to speculation that the Federal Reserve could signal its intention to begin to talk about tapering.  In addition, key chart levels, like

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Positioning and Momentum Trump Interest Rate Considerations

The US 10-year yield fell last week to its lowest level in three months, and the weekly decline was one of the largest in the past year.  The implied yield of the December 2022 Eurodollar futures contract slipped to almost 33 bp, the lowest level in nearly four months.  The yield has drifted lower for the fourth consecutive week.  It has risen in only two weeks since the end of March.  Three-month LIBOR fell to a new record low. 

Yet, the dollar proved fairly resilient to these latest interest rate developments. It rose against nearly all the major currencies, helped by a bout of short-covering ahead of the weekend.  Part of the decoupling may be traced to speculation that the Federal Reserve could signal its intention to begin to talk about tapering.  In addition, key chart levels, like $1.22 in the euro, $1.42 in sterling, $0.7800 for the Australian dollar, and the JPY110 and CAD1.20 levels largely held, which may have encouraged some momentum traders to move to the sideline.  Lastly, we have been tracking the deterioration of the foreign currencies' technical tone, even while recognizing that the heaviness of US interest rates may deny it much upside traction.  The broad sideways movement is alleviating the over-extended technical readings after the greenback trended lower in April and May.  

Dollar Index:  The Dollar Index set new highs for the week ahead of the weekend near 90.40, near the upper Bollinger Band (set two standard deviations above the 20-day moving average.  The last time the Dollar Index traded above the upper Bollinger Band was on March 31, when it peaked at around 93.45.  The high before the employment data was a little above 90.60.  The Dollar Index has been confined to around 100 points (~89.60-90.60).  The MACD continues to trend higher, while the Slow Stochastic has leveled out in the middle of its range.  The five-day moving average crossed above the 20-day moving average at the start of last week for the first time since April 9, which also illustrates the easing of the dollar's downside momentum.   While the 90.60 area offers resistance, additional gains toward 91.00 would still be consistent with the consolidative phase. 

Euro: After falling to sustain the move above $1.22 in the middle of the week, the euro was sold back toward $1.2100 that it had approached before the recent US jobs data.  A break of $1.21 opens the door to a test on $1.2050, the (38.2%) retracement of the rally since the end of March.  Below is the $1.1985-$1.2000 area that offers a combination of psychological support, the 200-day moving average, and the 50% retracement objective.   The five-day moving average is below the 20-day moving average for the first time since early April.  The momentum indicators are pointing lower.   Ahead of the weekend, the euro slipped through the lower Bollinger Band (~$1.2025) for the first time in Q2.  

Japanese Yen:  Even as US yields fell, the greenback found support in the JPY109.20-JPY109.30 area, just above the trendline off the April and May lows. The dollar closed firmly and looks poised to re-challenge this month's highs in the JPY110.30-JPY110.35 area.  That appears to be the main obstacle to a return to JPY111, which had been approached in late March.  The momentum indicators not confirming this favorable outlook for the dollar.  The MACD has flatlined, and the Slow Stochastic is still moving lower.  The BOJ meets next week.  While no policy change is expected, it will update its economic projections.  The inoculation efforts have increased, and confidence in the H2 recovery may be strengthening.   

British Pound: Sterling spent most of last week with the range set on June 4 when the US reported May job data (~$1.4085-$1.4200).  As the market came around to the idea that the UK economy-wide re-opening slated for June 21 was probably going to be delayed by a couple of weeks, sterling briefly traded as low as $1.4075, which corresponds to the (38.2%) retracement objective of the rally since the end of April.  After rising for the previous four weeks, sterling has now posted back-to-back weekly declines for the first time since the end of March.  The momentum indicators appear to warn of the additional downside risks, though the five-day moving average is whipsawing around the 20-day average and not convincingly breaking down.  The lower Bollinger Band begins the new week near $1.41.  The next retracement objective (50%) is around $1.4025.  Sterling has not traded below $1.40 in a little more than a month, and a break could spur another round of stop-loss sales. 

Canadian Dollar:  The US dollar finished last week, flirting with the best level against the Canadian dollar in over a month.  A move above CAD1.2145 targets CAD1.2200.  The greenback repeatedly tested the CAD1.2000 level, which we identified as critical technical support, but it proved solid.  The five-day moving average crossed above the 20-day moving average for the first time since mid-April. The momentum indicators continued to trend higher, though the US dollar closed above its upper Bollinger Band (~CAD1.2145) for the first time since late January.  Given the positioning and momentum, the risk is that the CAD1.2200 yields.  Above there, the next resistance is in the CAD1.2220-CAD1.2250 area and then CAD1.2330-CAD1.2350.

Australian Dollar:  After setting new two-and-a-half week highs, the Australian dollar reversed made a new low for the week ahead of the weekend.  The outside down day is a bearish omen. However, the fourth weekly decline in the past five weeks suggests that what we see as a correction is well advanced.  The momentum indicators are not particularly helpful here, with the MACD flatlining near the trough and the Slow Stochastic trending sharply higher.  The Aussie approached the lower Bollinger Band, which will start the new week near $0.7685.  The low from early this month is around $0.7645. The $0.7600 appears to offer formidable support.  

Mexican Peso:  The US dollar rose around 1.3% against the peso ahead of the weekend, recouping the cumulative losses seen in the week up until then and a little bit more.  The greenback approached MXN20.00, still well shy of the upper-end of the 4-5 week trading range near MXN20.21.  The momentum indicators are not very helpful now. The upper Bollinger Band will start the new week at MXN20.10.  All of the Latin American currencies fell last week.  The Mexican peso and the Colombian peso fared the best, seeing minor losses.  The Brazilian real lost the most in the region, falling almost 1.7% after rising around 6% in the previous two weeks.  The Turkish lira was the strongest emerging market currency, rallying about 3.5% against the US dollar.  It snapped a two-week 3% decline.  Turkey's central bank meets next week and is widely expected to keep its one-week repo rate at 19%.  We suspect a small rate cut will be delivered in Q3. 

Chinese Yuan:  The dollar edged higher against the yuan for the second consecutive week. It was the first back-to-back gain since a five-week rally ended in early April. The greenback firmed in four of last week's five sessions, but the cumulative gain was negligible at less than 0.1%.  The dollar's short-covering squeeze after the close of mainland markets will do Chinese officials who signaled displeasure with the market's persistent bid for the yuan a little favor and perhaps achieving more than managed to do.  At the start of last week, the dollar's peaked near CNY6.4025, where the 20-day moving average can now be found.  Assuming this area is overcome, we see the risk extending toward CNY6.4120 and then CNY6.4180.  Our working hypothesis is that the PBOC wants to avoid a one-way market and is not defending a particular level (e.g., CNY6.35).


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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