Can the dollar and bonds rally together for long?
After reversing lower despite a robust jobs report on July 2, the greenback saw limited follow-through selling at the start of last week and instead recovered fully. The major currencies that bore the brunt of the dollar's gain were those currencies that are understood to be ahead of the Fed in normalizing policy. The Norwegian krone and dollar-bloc currencies bore the bulk of the greenback's adjustment, while clear laggards, like the yen and Swiss franc, posted moderate gains (0.8% and 0.7%, respectively, last week). The dollar's recovery occurred alongside a slide in US yields. The 10-year note yield briefly traded below 1.25% for the first time in five months. The implied yield on the December 2022 Eurodollar futures, which we use to track expectations for Fed policy, fell from 55 bp on July 2 to 42 bp before consolidating ahead of the weekend. Equities traded mostly lower, and the MSCI Emerging Market Equity Index finished the week by extending its losing streak into the ninth consecutive session. There appear to be two main narratives. The first sees the price action as a short-covering rally in the dollar and Treasuries and some profit-taking at the start of the second half. The second emphasizes doubts about the "reflation trade" given the mutation, which appears to have reduced the prophylactic efficacy of the vaccines (while still preventing hospitalizations), the disappointing PMI readings from Asia, which led the global recovery. China, which had been removing stimulus, staged one of the biggest reversals and delivered a 50 bp cut in required reserves that is said to free up a trillion yuan ($155 bln) of liquidity. It was announced before the weekend and is effective on July 15, the day after the release of Q2 GDP. The move follows the soft PMI readings and some signs that producer prices may have peaked. The decline in yields and the rise in the dollar mean that there is little concession for the upcoming $120 bln of Treasury supply. We suspect something will have to give, and probably a combination of higher rates and a softer dollar. Dollar Index: The Dollar Index reached almost 92.85 in the middle of last week, its best level in nearly three months. Initial support is seen around 92.00, which corresponds to last week's low and the 20-day moving average. The Dollar Index has not traded below the 20-day moving average since June 11. The MACD and Slow Stochastic are rolling over. The initial downside target is the 91.40-91.60 area corresponding to the 200-day moving average and (38.2%) retracement objective of the rally since late May. Euro: After approaching the $1.19 area on July 6, the euro reversed low and fell below $1.18 for the first time since early April. Bids were found near $1.1780, from which the single currency bounced to $1.1880 ahead of the weekend. Still, it has fallen for five of the past six weeks, and we suspect it is poised to rebound. The $1.1900-$1.1920 area needs to be overcome to lift the tone. The momentum indicators are curling up, and the euro managed to eke out a minor gain for the week. It will begin the new week with a two-day gain in tow. Japanese Yen: The dollar had set a new high for the year in the hours before the jobs data on July 2 near JPY111.65. It reversed lower and trended lower for most of last week, reaching a low near JPY109.50 on July 8. The five-day moving average fell below the 20-day moving average for the first time since late May. The greenback's decline against the yen coincided with a sharp drop in US rates and equities. However, ahead of the weekend, the capital markets stabilized, US rates rose, and the dollar established a foothold above JPY110.00. Among the technical damage inflicted by the dollar's drop was the violation of the April-May-June uptrend line that begins the new week around 110.25. British Pound: Sterling has forged a base in the $1.3735-$1.3750 area, and despite a disappointing May GDP report, it popped higher ahead of the weekend to post its highest close in two weeks (~$1.3900)). Nearby resistance extends toward $1.3930, and a break would target the $1.4000-$1.4050 area. The MACD and Slow Stochastic have turned up and suggest that the correction since the June 1 multi-year high (~$1.4250) is over. Canadian Dollar: The US dollar has trended higher since setting a six-year low slightly above CAD1.20 on June 1. It reached almost $1.26 on June 8, its highest level since the hawkish outcome of the April 21 Bank of Canada meeting. The strong jobs growth (albeit the third consecutive monthly loss of full-time positions) and jump in the participation rate keep the Bank of Canada on track to continue its exit strategy and slow its bond-buying further as soon as the meeting on July 14. The recovery in commodity prices and the steady equity market performance supported the Canadian dollar at the end of last week. The MACD has not turned lower but looks poised to do so in the coming days. The Slow Stochastic has held below last month's peak, and its failure to confirm the new high in the exchange rate is a possible (dollar) bearish divergence. The first downside target is the 20-day moving average by CAD1.2360, corresponding to the (38.2%) retracement of the greenback's gains since June 1. Below there, support is seen around CAD1.2300, marked by previous congestion and the next (50%) retracement target. Australian Dollar: The Australian dollar fell to new lows for the year ahead of the weekend, slightly above $0.7400. It rebounded smartly to approach $0.7495. However, it was not sufficient to erase the entire week's decline, and it still settled about 0.5% lower. It is the fourth decline in the past five weeks. A move above $0.7500-$0.7525 would boost confidence that an important low is in place. The MACD has not turned up, but the Slow Stochastic has held above last month's low and is rising, a potential bullish divergence. Australia reports June employment data next week (July 14), and although May's 115k increase (97.5k full-time positions), another increase is expected despite the new social restrictions. Mexican Peso: The dollar rose by around 0.5% against the peso last week, its first rise in three weeks. However, it finished on a relatively soft tone, suggesting renewed dollar losses are likely at the start of the week ahead. The peso's loss was almost half of the decline posted by the JP Morgan Emerging Market Currency Index, and the peso fared better than most Latam currencies. The Brazilian real, which was the world's best performer in June, fell by 3.8%, and the Colombian peso dropped 2.4%, leading the EM-complex lower. The Chilean peso shed 1.8% though the central bank may hike rates next week. The greenback spiked a little above MXN20.16 on July 8 but had retreated below MXN19.87 the following day, ahead of the weekend. The momentum indicators have flatlined. Support is likely in the MXN19.70-MXN19.75 area. The market has nearly fully discounted a 25 rate hike at next month's Banxico meeting (August 12). Chinese Yuan: The dollar traded with a firmer bias against the yuan last week. It was evident in the higher lows that were recorded. The greenback rose to a marginal new high since late April by CNY6.4915 ahead of the weekend. However, counter-intuitively, the yuan strengthened after the PBOC expectedly cut the required reserve ratio by 50 bp to give more lending capacity. Against the offshore yuan, the dollar fell to new session lows slightly below CNH6.4820. We had suspected that the CNY6.49-CNY6.50 area was the upper end of the new range after the PBOC seemed to object to the price action through its daily fixings and its decision to increase the reserve requirement for foreign currency deposits at the start of June. If the PBOC was protesting a one-way market, it has simply moved to the other horn of the dilemma. The yuan had strengthened seven of eight weeks in April and May but has now weakened for six consecutive weeks.