The dollar’s inflection point
On Friday, the Dollar Index traded to the highest level since Jan. 11 and came within five ticks of its 200-day moving average. This is significant because Jan. 11 was when the European Central Bank Minutes showed the bank their plan to change its policy message early this year to tighten sooner than later; this set a bullish tone for the euro and a bearish tone for the dollar.
Additionally, the Dollar Index has not tested the 200-day moving average since closing below it on May 12 last year. The Dollar Index has lost as much as 15% from its high in the first week of 2017 to its low this February. When a trend lasts as long as this one has, the herd follows creating a crowded trade and increasing the possibility of an adverse move as the herd exits. Our belief is that this recent rally in the Dollar and selloff in the Euro is exactly that; the herd exiting. The Dollar Index is weighted 57.6% by the Euro. The Euro regularly trades about twice as much volume as the yen or the British pound and nearly ten times that of the Dollar Index. The Euro’s open interest is three times that of the Yen or Pound and more than ten times that of the Dollar Index.
For this reason, we will look most closely at the April 24 Commitment of Traders report of the euro. We prefer to look at the Leveraged position on the Commitment of Trader; this way we can most easily see the "emotional herd." Since the December FOMC Meeting that sparked the next leg lower in the dollar, the Euro has averaged about a 4:3 Leveraged net-long ratio and reached a high of 5:2 while also reaching a record long position that had 77,000 more longs than shorts. As of this last Tuesday, the ratio was at 1.17:1 with only 8,000 more longs than shorts. Most importantly, the open interest in the Euro is now at the lowest level since that December FOMC Meeting. Furthermore, the euro lost another 1.5% to Friday’s low since Tuesday’s close; this signals that the 1.17:1 net-long ratio could now easily be 1:1 or even net-short!
While the dollar tested and rejected its 200-day moving average on Friday, closing 0.48% from there. The euro traded below its 200-day at 1.2136, reaching a low of 1.20975 but finished 0.55% from the low and settled back above the 200-day at 1.2164. Additionally, Thursday and Friday were the most volume in the euro since mid-March
Another potential factor for the recent rise in the dollar is that it is tailing the rise in U.S. Treasury yields. With the 10-year hitting 3% and the highest since 2014, it was all the noise this last week. As it rose, the spread between the U.S. Ten-year Notes and those from Europe or Japan widened. When this happens, it shifts money into the currency of the more attractive yield. However, we took note of comments from famed investor Jeff Gundlach; that it is wrong to believe U.S bonds are more attractive than those from Europe and Japan because of currency risk. Our bias agrees with his and if this is true, this signals that the recent currency move is nothing more than the aforementioned herd exiting.
What does this all mean? That we might have seen a capitulatory move in Dollar and Euro trade. However, this market remains just as fundamentally driven as it does technically and this week is about as big as it gets. In other words, this week will either confirm and reinvigorate the downtrend in the dollar or close above the 200-day moving average at 91.85, creating a much more complicated trade in everything; currencies and commodities.
The most important single event this week is a tie between Wednesday’s FOMC and Friday’s Nonfarm Payroll report. The Federal Reserve is not expected to adjust rates after their two-day meeting concludes on Wednesday at 1:00 p.m. Central. However, we will be watching closely for any changes in the statement and message on inflation, as well as the dot plot, after Chairman Powell’s second meeting at the helm. On Friday, the most important factor in the Nonfarm Payroll report has been and still is wage growth. Average Hourly Earnings is expected to increase 0.2% MoM. If wage growth gains more traction than expected on Friday, than the Fed’s message will be interpreted more hawkishly as this will be seen as confirming three hikes and potentially giving the nod to a fourth.
Monday is no slouch in getting the week started as German Retail Sales is due at 1:00 a.m. Central and Italian and then German CPI at 5:00 a.m. and 7:00 a.m. CT. The most crucial though is the U.S. Core PCE Index due at 7:30 am CT. This is the Federal Reserve’s preferred inflation indicator and though the data point has seen little volatility in recent months, it will surely set a tone for expectations on Wednesday’s statement. Also, China Manufacturing is Sunday night. The RBA meets early Tuesday morning. British Manufacturing and ISM Manufacturing are both due on Tuesday. German Manufacturing, Eurozone Manufacturing and Eurozone GDP are Wednesday morning. A critical Eurozone CPI read is on Thursday and will be followed by ISM Non-Manufacturing later in the morning.