The Dollar: Was it the ECB and BOJ or the Bounce in Equities?

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Marc Chandler
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After extending its recent gains, the dollar fell sharply at the end of last week. Many factors could have sparked the pullback, including the stronger expressions of concern by Japanese officials with an implicit threat of intervention and perceptions of an increased likelihood that the ECB will deliver another 75 bp hike next month. We had anticipated that the dollar bulls would turn cautious after the ECB meeting and before the September 13 US CPI report. 

Headline CPI may have fallen last month for the first time since May 2020. It follows a flat reading in July and could reinforce expectations that US inflation has peaked. This may see some participants reconsider a 75 bp hike at the September 20-21 FOMC meeting. However, given that price pressures remain elevated, the core may even tick higher, the strength of the labor market and the messaging for Chair Powell point to another large move. With the Fed standing accused of being late to recognize the persistence of inflation, officials appear to want to drive home their commitment to bring inflation down, which means erring on the side of another big hike.  

Still, broadly speaking, the dollar's momentum indicators were stretched, and a correction was arguably overdue. We are not convinced that it was triggered by the ECB's 75 bp rate hike, as many suggest. First, it would seem more likely that the euro's rally would have taken place on Thursday if that were the case. Second, while the euro rallied before the weekend, it was among the weakest of the major currencies, losing ground against sterling, the Swiss franc, and the Antipodeans. Nor are we persuaded that there has been a change in the underlying drivers and dynamics.  

The yen bounced back after stopping a whisker away from JPY145.00. Japanese officials threatened unspecified action, but most participants remain dubious. The odds that unilateral intervention that does not signal a policy change would be successful are slim. The 10-year Treasury rose for the sixth consecutive week. Over this run, the yield has risen from 2.65% to 3.35%. The US 2-year note yield rose to a new multiyear high (~3.57%) at the end of last week. Speculators in the currency futures market had covered short yen exposure from mid-May to mid-August and have grown since then. However, at about 58.2k contracts, it is a little more than half the April peak (each contract is for JPY12.5 mln or ~$87.5k).  

We suspect the currency move reflected a near-term change in risk appetites. The S&P 500 and NASDAQ bottomed after the US returned from the Labor Day holiday on September 6. The low was around the (61.8%) retracement objective of the June-August bear market rally. The greenback topped the day against most of the major currencies. The dollar's setback ahead of the weekend coincided with the gap higher opening of the S&P and NASDAQ. The strong close suggests there may be follow-through next week. At the same time, the dollar could remain offered ahead of the CPI report.  

The momentum indicators on most of the currency pairs we look at below give the dollar room to correct lower. However, past the US CPI data, real sector data may support the idea that consumption (retail sales) and production (industrial output) point to an expanding economy. As a result, the dollar may find better traction ahead of the FOMC meeting and the Italian election (September 25).  

Technical analysis can help identify and quantify the risks. So, let's turn to the price action.  

Dollar Index: If the dollar is correcting lower, what is the move that is being corrected? Our working hypothesis is that it is the move that began from around 104.65 (Aug 10-11).   It peaked at slightly below 110.80 in the middle of last week. The three-day decline, the longest in a month, in the second half of last week met the (38.2%) retracement objective near 108.45 (the pre-weekend low was almost 108.35). The next retracement level (50%) is about 107.70. Provided the 107.00 (61.8%) area holds, the plain vanilla correction story appears validated, and the Dollar Index can return to the highs. However, the momentum indicators warn that the corrective forces may have just begun. The MACD is turning down from below the highs seen in mid-July, suggesting a possible bearish divergence. The Slow Stochastic is also turning down but from over-extended levels.  

Euro: After recording new 20-year lows (~$0.9865) in the middle of last week, the euro reached almost $1.0115 ahead of the weekend before consolidating in around $1.0050 for most of the North American session. This met the (50%) retracement of the euro's losses since the August 10 high, a little shy of $1.0370. The next retracement (61.8%) is $1.0175.  If the euro has forged a double bottom, it could project back to the August 10 high. The MACD has turned up from the middle of its range, never taking out the low from mid-July, when the euro initially dipped below parity. The Slow Stochastic has been gently rising since the third week in August. Ahead of the weekend, the euro settled above its 20-day moving average (~$1.0015) for the first time since August 14. Indeed, the five-day moving average looks poised to cross back above the 20-day for the first time in three weeks.  

Japanese Yen: The dollar approached JPY145 for the first time in nearly a quarter of a century in the middle of last week. It spurred stronger warnings from Japanese officials, who expressed more concern about the volatility than the level or the direction. Three-month implied vol rose from a little below 10% in mid-August to over 13% last Wednesday. Recall it peaked in mid-June at 14%. On the other hand, three-month actual volatility (historic) is about 12.1%, a little above the June peak and the highest since the pandemic first struck. While intervention may seem tempting, it is fraught with risks. Perhaps, the only thing worse than no intervention would be failed intervention. Amid the broad dollar pullback ahead of the weekend, the greenback fell to about JPY141.50 and closed above JPY142.60. The MACD looks poised to turn lower from levels not seen since April. The Slow Stochastic has already turned down but only barely and is still over-extended. If JPY145 is the top of the near-term range, then JPY140 may be at the lower end.  

British Pound:  Sterling briefly traded at its lowest level since 1985 last week, near $1.1405. It closed above $1.15 that day, seeming to reject the lows. The bullish hammer candlestick pattern pointed to further gains, and sterling reached almost $1.1650 before the weekend. The MACD and the Slow Stochastic are curling up. The last leg lower began with an outside down day on August 26, when it traded on both sides of the previous day's range and settled below the low. It peaked at $1.16. Before the weekend, sterling met the (50%) retracement of that leg lower. The next retracement (61.8%) is around $1.1710, and the 20-day moving average is a little higher, slightly above $1.1730. The (38.2%) retracement of the large move from the August 10 high (~$1.2275) comes in around $1.1740. Even though sterling has traded below $1.15 every session this month, it has not closed below it once. 

Canadian Dollar:  The disappointing Canadian jobs data was unable to offset the positive impulses from risk-on of rising stocks, and the Canadian dollar set new highs for the month ahead of the weekend. The greenback pushed above CAD1.32 in the middle of the week and reversed lower. It sunk nearly CAD1.2980 at the end of the week. The momentum indicators have recently turned lower. Canada lost 113.5k jobs in June-August, and almost 85% were full-time posts. The increase in the participation rate to 64.8% does not account for the jump in the unemployment rate to 5.4% from 4.9%. The data reinforces our sense that the outperformance of the Canadian economy is behind it. Not coincidentally, the S&P 500 rose for the past three sessions, and its roughly 3.4% gain was the best since June. The US dollar closed below the near-term trend line drawn off the mid- and late August lows (~CAD1.3080 on September 12). The US dollar approached the halfway mark of the rally since August 10 (~CAD1.2730), which is found near CAD1.2970. The next retracement (61.8%) is around CAD1.2910, where the US dollar bottomed in late August.  

Australian Dollar: The Aussie met a minimum technical objective in the middle of last week at $0.6700. It recovered smartly before the weekend to peak near $0.6875. The 20-day moving average is there too. The (38.2%) retracement objective of the leg lower that began from the roughly $0.7135 high on August 11 came in near $0.6865. The next retracement target (68.2%) is found about $0.6920. The MACD is turning up from the lower part of its range, while the Slow Stochastic has turned higher but is still over-extended. Australia reports August jobs data on September 15. Australia lost almost 87k full-time jobs in July. The re-opening of the border has seen a surge in migration and could be distorting the labor market. Part-time positions rose by 46k. Wage pressure remains modest, with a 0.7% increase in Q2 and a 2.6% year-over-year increase. After four half-point increases, the market sees only about a 1-in-10 chance of a fifth one, suspecting the central bank will dial back to a quarter-point move at the next meeting on October 4.  

Mexican Peso: For about a month, the US dollar has been chopping against the Mexican peso between roughly MXN19.82 and MXN20.26. It rose to almost MXN20.19 on September 7 and was turned back and fell to about MXN19.87 at the end of the week. The MACD is flat this month. The Slow Stochastic has turned down from the upper half of its range. Mexico has a light economic calendar in the week ahead, leaving the peso at the mercy of external developments and the broader risk environment. Net-net, the peso was virtually flat last week, as was the JP Morgan Emerging Market Currency Index. Brazil was among the earliest and most aggressive in the rate hikes, and it may be among the first to be done. Inflation (IPCA measure) has trended since peaking near 12.1% in April. Before the weekend, it reported that CPI stood at 8.7% in August. The dollar has traded choppily against the Brazilian real. Net-net, it has been nearly flat over the past four weeks.  

Chinese Yuan:  The US dollar rose for the fourth consecutive week against the Chinese yuan. The PBOC has been setting the dollar's reference rate below where the market (Bloomberg, median forecast) projects it. This is aimed at slowing the dollar's rise/yuan's decline as the dollar can only rise 2% from the fix, though it rarely moves half of that. The PBOC also cut the required reserves on foreign currency deposits by 200 bp, twice as much reduction earlier this year. The dollar gapped higher on Monday, as it has done the previous two Mondays. The greenback's retreat before the weekend saw a new low for the week, but the open gap was not closed. It extends to about CNY6.9095. With inflation decelerating and PPI now below CPI, officials ostensibly have scope to cut the benchmark one-year medium-term lending rate in the coming days. But it shaved 10 bp off it last month, making a cut now seem unlikely. August retail sales and industrial production may show the economy stabilizing at a lower level of activity while property investment continues to fall.