The aggressiveness that the market now sees in Fed tightening underpinned the dollar, while the 2-:10-year yield curve flattened to levels last seen in November 2020. The market has about a one-in-five chance that the initial move in March is 50 bp. The swaps market has about 135 bp of tightening discounted for this year.
With a Fed move in March as much of a done deal as these things get, the US employment report may lose some of its market-moving ability. The same can be said of Canada. Weakness will be attributed to the virus. The focus turns to the Reserve Bank of Australia, the Bank of England, and the ECB. The RBA's dovishness may be curbed, but a decline in the eurozone's January CPI, as the German VAT increase drops out of the year-over-year comparison, will keep the ECB on the sidelines. The BOE can be aggressive, with a rate hike, and first G7 central bank to allow its balance sheet to shrink.
The greenback punched through some key technical levels, and after the false breaks earlier this month in the yen and euro, some short-term players and momentum traders may be trying to pick a top. Several of the pairs that we discuss below are beyond their Bollinger® Bands (two standard deviations around the 20-day moving average). However, for medium-term participants, we expect the US dollar to rise further.
Dollar Index: Since bottoming on January 14 (~94.60), the Dollar Index has jumped nearly 3% and took out last year's highs. In the consolidation ahead of the weekend the 97.00 area offer support. The upper Bollinger Band begins the new week near 97.15. The MACD is moving higher but the Slow Stochastic is on the verge of becoming stretched. Still, the last time the Slow Stochastic entered over extended territory, the Dollar Index rose by almost another 200 points before peaking. The next technical objective is the 97.70 area, which is the (61.8%) retracement of the decline since the March 2020 high (~103.00). A break of the 96.35-96.50 area would warn of a false break.
Euro: The euro recovered from the initial pre-weekend push to a new low around $1.1120. The minor gain snapped a four-day drop. The upticks were not sufficient to lift the single currency much above the lower Bollinger Band, which finished the week slightly above $1.1165. The week's decline of around 1.6% was the largest loss since last June and pushed the Slow Stochastic into oversold territory. The MACD is falling at near the middle of its range. There appears to be little meaningful chart support until closer to the $1.1000-$1.1050 area. We suspect that some of the fuel of the euro's recent drop was late longs that played the upside break earlier this month were forced to liquidate. While there may be scope for some near-term consolidation, the divergence between the ECB and the Fed may be underscored by what will likely be a decline in January EMU CPI and Lagarde’s patience.
Japanese Yen: The yen is torn between rising US yields and falling equities. After briefly dipping below JPY113.50 at the start of last week, the dollar rose to almost JPY115.70 before the weekend. However, equity market volatility seemed to have deterred new dollar buying. The momentum indicators have turned higher, and the five-day moving average looks poised to cross above the 20-day moving average in the coming days. We peg initial support for the dollar in the JPY114.85-JPY115.00 band. The dollar rose to its highest level in five years at the start of the month (~JPY116.35). It can be retested in the coming days if equities steady.
British Pound: Sterling's 1% loss last week made it the second strongest major performer against the dollar after the Norwegian krone. Political uncertainty continues to hang over 10 Downing Street, even though what appears to have happened in broad terms does not appear out of character for the Prime Minister. The Bank of England is expected to deliver its second hike in the cycle and reach the threshold (50 bp) to begin allowing a passive reduction of its balance sheet. The market has four hikes discounted and 75% chance of a fifth hike. With the recent decline, sterling has met the (61.8%) retracement objective (~$1.3395) of the rally that began a little before Xmas near $1.3175 and peaked on January 13 at almost $1.3750. It closed below the lower Bollinger Band on last Thursday but closed above it (~$1.3385) ahead of the weekend. The MACD is trending lower and the Slow Stochastic is about to enter oversold territory. The $1.3470-$1.3500 area offers a nearby cap. Separately, but related, the euro has been sold to almost GBP0.8300. The low from the February 2020 is near GBP0.8280. It was slightly lower in December 2019, this is the weaker end of where the euro has been since the June 2016 referendum.
Canadian Dollar: Despite the Bank of Canada also signaling what Governor Macklem repeatedly call a "significant" shift in policy, the Canadian dollar suffered in the wake of the greenback's surge. In fact, the market sees the Bank of Canada as the most aggressive of the G7 central banks this year. The swaps market has nearly 160 bp of tightening discounted. The Bank of Canada's balance sheet will also likely begin falling this year. The greenback's gains negated the head and shoulders pattern we've been monitoring. It bottomed near CAD1.2450, well above the CAD1.2250 measuring objective. The dollar's assault stopped shy of CAD1.28 ahead of the weekend. It met the (61.8%) retracement objective of the recent decline (from ~CAD1.2965 on December 20 to CAD1.2450 on January 19), which came in near CAD1.2770. The upper Bollinger Band begins the news week near CAD1.2810. Neither momentum indicator is stretched, and both are moving higher. The CAD1.2900 area becomes the immediate target when CAD1.28 is paid. The CAD1.2950-CAD1.2965 area capped the greenback last year.
Australian Dollar: The Aussie's 2.5% decline last week was the biggest since last August. The conjoined risk-off and Fed hawkishness proved too much. Before the weekend, it was sold below $0.6970 for the first time since July 2020. The greenback's ascent slowed broadly in North America, but the Australian dollar still struggled to regain a foothold above $0.7000, a key technical area. Given the nearly three-cent slide in two weeks, the momentum indicators are moving lower and the Slow Stochastic is more advanced in the move than the MACD. There are two relevant caveats. First, the Australian dollar settled the last two sessions below the lower Bollinger Band. The last time this happened, it marked the end of a down move and a nearly four-cent rally in two-and-a-half weeks. Second, the speculators in the futures market have been all over this, with having amassed the largest net short position on record in the middle of January.
Mexican Peso: The dollar rose against the peso every session last week. Its 2% gain was the most in a couple of months. The peso's weakness was partly a function of the risk-off shift. It delivered a 1% loss to the JP Morgan Emerging Market Currency Index, which snapped a three-week advance, large enough to offset nearly the full gain of the past two weeks. Part of the peso's weakness may also be a result of shifting short-term funds. Brazil has become a favored destination and the real was the only currency in the region to appreciate last week. Other central banks are raising rates more aggressively than Banxico, and Brazil is going to deliver 150 bp rate hike on February 2. However, last week, the only Latam currency that did worse than the Mexican peso was the Chilean peso, even though the Chilean central bank delivered a larger than expected rate hike. The momentum indicators are constructive, suggesting the greenback has potential to run further against the Mexican peso. The MXN21.00 area is the next obvious technical level. Above there, potential extends into the MXN21.20-MXN21.45 range.
Chinese Yuan: The dollar fell to almost four-year lows against the Chinese yuan in the middle of last week to hold barely above CNY6.32. It rebounded by 0.75% on January 27, the largest single day advance in six months to approach CNY6.37. The greenback consolidated ahead of the week-long holiday in China. It appears that Chinese bonds and stocks are less attractive now for many international asset managers and it looks like Brazil may have replaced it as a favored overweight. The dollar is trading a little stronger against the offshore yuan (CNH) and settled a little above CNH6.36. Like the yen and euro, the yuan's apparent breakout may not be sustained. The CNY/CNH6.40 area is the top of the recent range.
