Two steps forward, one step back

The US had a difficult week, falling against nearly all the major currencies, recording new lows for the month against the euro, Swiss franc, and sterling among the major currencies. Indeed, the euro and sterling gains were sufficient to erase the earlier losses to post an advance for July.

It is difficult to find a common theme through the capital markets. There is much talk about new interest in the reflation trade, but the decline in rates and second consecutive weekly decline in the MSCI Emerging Market Equity Index do not line up well, even though the US S&P 500 and NASDAQ and Europe's Dow Jones Stoxx 600 set new record highs last week.

Nor did the currency markets give unequivocal support for the reflation thesis. The weakest two major currencies were the Australian and New Zealand dollars, which would have been expected to have a better relative performance if the reflation theme was the key driver. Moreover, the Swiss franc's 1.5% advance was among the best, only outpaced by sterling (~1.6%).

Although the Federal Reserve was more confident that progress was being made toward its objectives, there was little new for investors. When everything was said and done, the 10-year Treasury yield remained within the range set on Monday to start the week (~1.22%-1.29%), which was within the range set in the previous week (~1.12%-1.31%). That said, the 10-year yield has fallen for five consecutive weeks and 10 of the past 11 weeks.

We have been using the December 2022 Eurodollar futures contract to track US rate expectations. On July 2, the implied rose to a three-month high near 56 bp. It has fallen and finished last week at the lower end of the month's range near 40 bp. Given that three-month LIBOR is near 13 bp, a quarter-point hike at the end of next year remains fully discounted.

We now turn to the technical outlook for a few major currencies and the Mexican peso and Chinese yuan. Generally speaking, the technical condition of the foreign currencies has improved, and we expect it to carry over into August activity. In addition, a strong US jobs report is anticipated, and it will support speculation that at the Jackson Hole conference at the end of August, Chair Powell will provide more guidance about the pace and composition of the Fed's bond purchases.

Dollar Index: The Dollar Index threatened to decline in all five sessions last week, but after extending its losses ahead of the weekend, news that the US was suspending Chinese IPOs seemed to help stabilize it. However, the losses allowed it to meet the initial (38.2%) retracement of the rally (near 91.80) that began in late May near 89.55. The next retracement objective (50%) is found near 91.35, which is also around where the 200-day moving average begins the new month. The momentum indicators are falling, and the five-day moving average has pushed below the 20-day moving average for the first time since the first week in June. The 92.25 area offers initial resistance, with a more important cap by 92.55.

Euro: The euro carved a trough in the $1.1750-$1.1760 area and briefly traded above $1.19, a new high for the month ahead of the weekend. The high was recorded before the eurozone reported stronger than expected Q2 GDP (2.0 vs. 1.5% expected) and strong price pressures (2.2% in July vs. 2.0% expected), and a larger than expected decline in June unemployment (to 7.7% from a revised 8.0% in May). The single currency reversed lower in the waning hours of July's activity. Initial support is seen in the $1.1840-$1.1850 area, but a break of the $1.1820 could signal a retest of the trough. Above the $1.1910 area, formidable resistance is seen in the $1.1950-$1.2000 band.

Japanese Yen: Over the last few weeks, the dollar has traded in a clear range of JPY109.00 to JPY110.70. The dollar recovered after initially slipping to eight-day lows (~JPY109.35) ahead of the weekend but spent the last two sessions below JPY110. The momentum indicators are not generating a clear signal. The MACD is at new lows in over-sold territory, while the Slow Stochastic appears to be turning lower after recovering toward the middle of the range. The exchange rate remains sensitive to US yields, and ahead of what is expected to be a strong employment report on August 6, the downside appears limited.

British Pound: Sterling's sharp recovery faltered ahead of $1.40 before the weekend. It had been sold to its lowest level since early February on July 20 near $1.3570. The important retracement objective (61.8%) of sterling's retreat since the multiyear high was recorded on June 1 near $1.4250 was found slightly below $1.40, which is also near the upper Bollinger Band, which is moving higher. A convincing move above it would bring the focus back to the highs. The MACD is trending higher and is in the middle of the range, while the Slow Stochastic is getting stretched. Despite the minor loss ahead of the weekend that snapped a four-day advance, the weekly gain of around 1.3% was the biggest of the year.

Canadian Dollar: The Canadian dollar gained about 1.1% against the US dollar last week. It was the first back-to-back weekly gain since late May. The US dollar recovered from six-year lows (~CAD1.20) on June 1 and peaked on July 19, a little above CAD1.28. However, it took two weeks for it to give up half of those gains, and the greenback approached CAD1.2425 ahead of the weekend, its lowest level since July 6. The momentum indicators are trending lower, and the five-day moving average (~CAD1.2510) has moved below the 20-day moving average (~CAD1.2530) for the first time since early June. The next retracement target (61.8%) is near CAD1.2315.

Australian Dollar: The Australian dollar disappointed. Despite poking above $0.7400 for the first time in two weeks, the Aussie finished the week lower to extend its losing streak for a fifth consecutive week. It was the only major currency that fell against the US dollar last week. The New Zealand dollar was the next weakest. It was unchanged after falling for the previous four weeks. The lockdown in Sydney has been extended until the end of August, and the Reserve Bank of Australia will likely abort plans to reduce its bond-buying. Instead, it will likely provide more support, probably via increased bond purchases. The momentum indicators are not particularly helpful presently and are still rising. Initial support is seen in around $0.7335 before the low for the year set July 21 (before posting a key upside reversal) near $0.7290.

Mexican Peso: The US dollar has ground lower against the peso for seven consecutive sessions and tested the MXN19.80 level ahead of the weekend, its lowest level since July 6. A late recovery by the greenback prevented the decline from extending for an eighth session. The MACD is hovering near zero, and the Slow Stochastic is trending lower. The late June and early July lows form a band of congestion in the MXN19.70-MXN19.75. The JP Morgan, Emerging Market Currency Index ended a four-week slide with a 0.60% gain to close out the month. The benchmark fell a little more than 0.90% in July, while the peso appreciated by about 0.35%. Political risks weighed on the Peruvian sol that got tagged for 3.5% last week and 5% in July.

Chinese Yuan: The yuan's sharp recovery after falling to three-month lows was sufficient to lift it on the week to snap an eight-week slide. We have been tracking a range since late June between CNY6.45 and CNY6.4950. The sell-off in Chinese bonds and stocks saw the dollar rise to CNY6.5125 on July 27, just shy of the 200-day moving average (~CNY6.5170). Efforts by Chinese officials to restore calm and a broader retreat in the US dollar saw the greenback return to almost CNY6.45 ahead of the weekend. It was an unusually wide range for the dollar last week, and the historical (actual) volatility last week reached almost 7.5%, its highest this year. To re-attract global capital flows, Chinese officials may want to boost the attractiveness by signaling tolerance of a stronger yuan. A break of the CNY6.45 area would target the CNY6.4000-CNY6.4200 area.