Friday, May 11, 2018

FX: "Dollar Momentum Sapped, Near-Term Pullback Likely"

From Marc to Market:
The US dollar pulled back following yesterday's slightly softer than expected CPI report and this likely marks the beginning of a new phase, with the dollar moving lower. Investors have learned over the past two weeks that neither wages nor consumer prices are accelerating. There is little reason in the recent string of data or official comments to suggest a more hawkish path for monetary policy (e.g., four rate hikes this year).

Technical indicators have become stretched for the dollar, and we have on the lookout for signs of a near-term correction. With the loss of momentum over the last few days, the technical indicators are turning, and we will update our corrective targets in our weekly note. Not to get too far ahead of ourselves here, the initial targets are another cent to the upside for the euro and sterling. A break of JPY108.65, the neckline of a potential double top, could JPY107.30. The Australian dollar appears to have scope for a cent advance, while the greenback is recording a big outside down week against the Canadian dollar, suggesting losses back into the CAD1.24-CAD1.25 area.

For today's price action, note that there are some very large euro options expiring. There are 2.4 bln euros struck at $1.1900 and another 624 mln euros at $1.1925. At $1.1950 there are another 774 mln euros struck. There are also large expiring options in dollar-yen: There are $821 mln struck at JPY119.50, and $360-$472 mln options struck half a yen away as well. On Monday, there are quite large expires at JPY108.50 ($1.3 bln), JPY108.65 ($1.1 bln), and JPY110 ($1.3 bln). Lastly, there is an option struck at $1.3550 for GBP679 mln that also expires today.

Market expectations for Fed policy did not change for June meeting or the odds of a fourth hike this year. The effective Fed funds rate has traded on the firmer side of the Fed's target range (1.50%-1.75%) recently. Fed funds change hands at 1.70% on a volume-weighted average basis. A 25 bp rate hike in June would put fair value of the July Fed funds futures contract 1.95% and it is at 1.945%. Assuming a follow-hike in September (lifts the average effective rate to around 2.20%) and a December hike would put the effective Fed funds rate around 2.45%. The January 2019 contract is unchanged, implying a rate of 2.285%.

Among the accomplishments at the Bank of Canada, Mark Carney made important contributions to central bank thinking about forward guidance. Ironically, his strength has turned into a weakness, and he was pressed hard by members of parliament about his communication. Of course, there had been a string of disappointing data, including inflation, that also encouraged investors to scale back tightening expectations. But this was not the first time that Carney seems to have reversed himself in a short period of time, leaving investors scratching their heads. The market has pushed the hike out into Q4....