Dollar: Trending Or Rangebound?

One of the most basic but important questions traders have to ask themselves is whether the market they are looking at is trending or moving sideways. The tactics and tools vary according to the answer.

The turn of the calendar—a new marking period begins—offers an opportunity to look afresh at the price action. What makes a review of the dollar difficult, however, is that we only know the dollar relative to other currencies and there is no one pattern that fits all.

The euro appreciated by 2.7% against the dollar in Q1. The rally was mostly a January story, and for the past two months, it has been trading broadly sideways. One way to illustrate the range-trading is that the five, 20 and 50-day moving averages have converged (~$1.2340-$1.2355).

In the larger picture, the euro's rally since last April when it became clear that the populists-nationalists were not going to win in the Netherlands or France, has brought it to an important technical area that is has stalled around. The $1.2520 area, for example, marks the 38.2% retracement of the euro's decline from the record seen in July 2008 near $1.6040. The $1.26 area houses a monthly downtrend line from then as well as the 61.8% retracement of the euro's decline since mid-2014 when it was last near $1.40.

While those levels give one a sense of likely inflection points on the upside, a break to the downside should not be ruled out. Market positioning and sentiment heavily favor further dollar losses, but the widening short-term interest rate differential (think Eurodollar and Euribor) makes it increasingly costly to be long dollars against the euro without the euro appreciating to offset the carry (interest rate differential). Currently, that interest rate differential translates into about five basis points a week.

The $1.2180-$1.2200 area offers chart support, but on March 1, the euro spiked down to $1.2155 before staging a key reversal. But before the euro can set up a test on those important supports, it must punch through the base in the second half of March near $1.2240. A break of the range would set up a test on the $1.1940-$1.2040 area initially.

The Japanese yen was the strongest of the major currencies in Q1, rising 6.1% against the US dollar. The highs were made late in the quarter, amid reports of aggressive exporter hedge-related dollar sales. The dollar fell to JPY104.55 on March 26, the lowest level since November 2016. It posted its own key reversal that day, and two days later, it tested JPY107.00.

The dollar-yen exchange rate strikes us to be often rangebound, and when it looks like it is trending it is moving from one range to another. Now, perhaps at the start of the new fiscal year, a new range is being established. For the last three quarters of 2017, the dollar largely traded in a JPY108-JPY115 range.

We do not know the new broad range yet, but there does appear to be a near-term range. The floor is had been JPY105, but now it JPY104.55. A break would suggest potential toward JPY100. On the upside, the JPY107 is the nearby cap, but JPY108 may be more significant. The upper end of the broad range may come in around JPY110.

Sterling has been trending higher since the so-called flash crash in October 2016. The uptrend, though, did not begin in earnest until March 2017. Sterling peaked in late January just below $1.4350. With a few exceptions since it has been confined to a $1.38-$1.42 range. The beginning of the next stage of Brexit negotiations, the recent string of economic data, and two dissents at the last MPC meeting, calling for an immediate hike helped bolster sterling. Half of Q1's 4% gain took place in March amid these favorable developments.

If there is a major central bank that can keep up with the Federal Reserve this year, the Bank of England is one of the few candidates. Talk of three more hikes this year in the US has quieted in the face of the return of the Q1 curse of disappointing GDP and little progress on wages. Meanwhile, the market is looking past the rate hike widely expected in May toward another hike before the end of the year (now about a 50% chance is priced into the OIS curve).

A break of the $1.3980 warns that the March run at new highs has faltered. While the immediate recognition could spur a move toward $1.3915, the $1.3700-$1.3750 area may hold the key to the medium-term technical outlook. On the upside, above the $1.4350 post-referendum high, the is $1.4520, which equates to the 50% retracement of the decline since the 2014 high near $1.72.

The US dollar recovered smartly against the Canadian dollar after sliding in January. The Canadian dollar's 2.4% loss made it the worst performing currency in Q1. The greenback really recovered in February and consolidated in March and finished only slightly higher.

A potential head and shoulders pattern may be being traced. The neckline is drawn near CAD1.28, and the left shoulder topped out near CAD1.30. The head was formed when the US dollar rose to CAD1.3125 just after the Ides of March. A break of the neckline would suggest a measuring objective near CAD1.2475. In addition to the recent highs, the US dollar may face more important resistance near the trendline drawn off the 2016 and 2017 highs. It is found near CAD1.3215 at the end of next week, falling almost 15 ticks a week.

The Australian dollar has been trending lower since peaking in late January near $0.8135. It recorded the low for the year on March 29 near $0.7645. The risk extends toward $0.7500, but the MACDs and Slow Stochastics suggest a low may be close. There have been a couple of two-three cent corrective bounces within the downtrend. A bounce of that magnitude would bring the Aussie toward the mid-March highs near $0.7920.

In a broader view, the Australian dollar has been tracing out a larger range since the end of Q2 17. That larger range also sees $0.7500 as the marker of the lower end. The upper end of the range is around $0.8125. The Aussie was turned back from there in late January. However, note that since then short-term US interest rates have risen above Australia, undermining one leg, while lower metals prices weaken another.

Light sweet crude for May delivery made a new high near $66.55 at the start of last week but shed in what appears to be corrective action. It snapped a three week 7.7% rally with a 1.4% decline. As long as the contract stays above the $63.35 area it may try again at the highs. However, the technical indicators are not very encouraging. On a long-term view, we note that the May contract has not closed below its 100-day moving average since last August. It is found now near $60.60.

Besides a bearish dollar conviction, the consensus also expected higher interest rates—rising policy rates, shrinking central bank balance sheet and a large dollop of fiscal stimulus on an economy growing above trend. The 10-year yields rose 33 bp in Q1, but it peaked shortly after the middle of the period near 2.95%. It finished the quarter a little below 2.75%. The market is fishing for the lower end of the range. It may not be far from it. The 2.70% area may offer the first window, and if not, scope exists toward 2.65%.

The June note futures contract celebrated the end of Q1 with its highest close since January 29. The technical indicators are stretched but have not turned down or showed divergences, warning that what seems to be a short-covering rally may continue. With the close above 121-00, the next important technical area is found near 122-00.

In February's swoon, the S&P 500 held the 200-day moving average. It has done so again in late March. That average is found 2590 to start Q2. The technical indicators suggest a low maybe being forged. A close above 2668 or a move above 2675 would be encouraging. Even then, we suspect sentiment may take longer to repair especially if there is some leadership rotation in the works. Some may want to see how the market's breadth evolves in any renewed gains. There is a gap from the lower opening on March 22 (~2696-2710) which also houses the 20-day moving average and retracement objectives, may try to draw prices.

The S&P 500 lost 1.2% in Q1. That made it the second-best performing G7 stock market behind Italy's FTSE Milan, which rose 2.5%. For many dollar-based investors, the underperformance of many major markets was not sufficient to offset the decline of the dollar. That includes the FTSE 100, DAX, and the Dow Jones Stoxx 600. However, one area of diversification that still paid was in emerging markets. The MSCI Emerging Markets Index rose nearly 1.3% in Q1, which was the fifth consecutive quarterly advance.