Long Dollar Positions Highest In 6 Years

According to the latest report from the CFTC, speculators hold the largest amount of long-dollar, short-yen positions in 6 years. While this data was as of Tuesday November 19, we bet that long USD/JPY positions have only increased since then because USD/JPY did not break 100.50 until 2 days later and the breakout most likely enticed new buyers. The fact that traders are adding to their long USD/JPY positions is supporting the move higher but as the currency pair continues to rise, the risk of a correction increases as well. From a fundamental perspective USD/JPY deserves be to trading closer to 105 but with no major U.S. economic reports scheduled for release next week and U.S. yields backing off on Friday, we would not be surprised if USD/JPY dropped back below 101 on Monday or Tuesday.

We've seen a significant amount of divergence in the dollar's performance and the Thanksgiving holiday in the U.S. means this could continue. The only economic reports expected from the U.S. are housing market related, consumer confidence and Chicago PMI. Though important none of these releases are expected to alter the bias of FOMC voters. The notion that higher U.S. rates will lead to a stronger dollar will bring relief for a lot of currencies but some central banks such as the RBA can't afford to wait. The lack of clarity from the Federal Reserve on when asset purchases will be tapered has prevented the dollar from rising as quickly as other central banks would hope to see. However it is not in the U.S.' best interest to sound overly eager about reducing stimulus because of the upside risk that it poses to U.S. yields. In fact, Fed Chairman Ben Bernanke told us with very little ambiguity this week that the decision to taper next month hinges largely on where U.S. rates are at the time. If 10-year Treasury yields are at 3% or higher come December U.S. policymakers will be reluctant to reduce stimulus prematurely and risk an even larger rise in yields. If rates are 2.7% or lower, pre Christmas tapering remains on the table. When the FOMC minutes were released we said investors overreacted but at the end of the day, the dollar is still headed higher.

Stronger IFO Helps EUR End Week Above 1.35
Between all of the euro zone economic reports and the FOMC minutes, it was an active week for the euro. However unlike many other major currencies that embarked on a new trend, EUR/USD ended the week not far from where it started as Germany is once again carrying the growth for the region. According to the German IFO report, businesses grew more optimistic in the month of November. This improvement in sentiment is consistent with the uptick in service and manufacturing activity and masks the deeper problems in Europe's economy. As our colleague Boris Schlossberg noted in his morning piece "Germany continues to diverge from the rest of Europe as its economy is vastly outperforming the other member nations especially France which is teetering on the edge of recession. This contrast in growth is sure to create conflict in the union as periphery nations will no doubt press for more monetary easing in order to stimulate growth. However, for now Germany continues to hold the line on any further policy with Mr. Draghi dismissing any talk of negative interest rates. Such hawkishness, along with continued positive surprises out of Germany have helped to maintain a floor underneath the EUR/USD and Friday's pop above the 1.3500 level indicates that currency traders continue to find the unit attractive. However, unless the periphery begins to see a pick up in demand the disparity between German growth and the rest of the EZ sluggishness could create major tension in the region and put a cap on the current rally. Ultimately the clear difference in intent between the hawkish leaning Fed and the still very dovish ECB is likely to tilt the balance of buying in favor of the dollar."

GBP: Soars To Fresh Highs vs. JPY And AUD
With no U.K. economic reports released Friday, it was quiet trading for the British pound. Sterling extended its gains against the U.S. dollar and Japanese Yen but retreated versus the euro. While the GBP/USD is poised for a test of this year's high of 1.6260, there's not much in the way of economic data to support a significant move beyond those levels. Most of next week's U.S. economic reports are second tier and from the U.K., revisions to Q3 GDP, consumer credit and mortgage approvals are the only noteworthy pieces of data on the calendar. The Bank of England is no rush to ease monetary policy or raise interest rates and this steady outlook for monetary policy has helped drive the currency to fresh highs against the JPY, AUD and EUR. The central bank previously said that their first move to tighten will be to raise interest rates but according to BoE minutes released this week, achieving the 7% unemployment rate target does not automatically mean that rates will be increased. "There could be a case for not raising the bank rate immediately when the 7% unemployment threshold is reached." Instead the BoE said at the time, the committee will "reassess what it had learned about the nature of the recovery." In doing so, the central abnk is subtly backing away its forward guidance and letting investors know that 7% is a soft and not hard target. However even though the central bank is trying to manage down the market's expectations, as long as the unemployment rate continues to fall, investors will be attracted to the British pound.

USD/CAD: Will It Fail At 1.06 Again?
This has been a terrible week for the commodity currencies. The Canadian, Australian and New Zealand dollars were hit hard by weaker economic data, U.S. dollar strength and in some cases, talk of FX intervention. Throughout the week, the focus has been on the more than 2.5% slide in the Aussie and Kiwi vs. the greenback. Most traders have ignored the moves in the Canadian dollar because USD/CAD is up only 0.6%. However the more moderate sell-off in the CAD does not make the breakout in USD/CAD any less significant. In fact, USD/CAD rose to a 4-month high Friday whereas the AUD/USD and NZD/USD are only trading at 2-month lows. Thursday was also the first time in 2 months that USD/CAD managed to break above 1.05 in a meaningful way and with this key resistance level broken, many traders are wondering if the recent rally will turn into a new uptrend in USD/CAD or if the currency pair will fail at 1.06 once again. To address this question we look at the fundamental and technical outlook for USD/CAD. This morning, Canada released 2 key economic reports - retail sales and consumer prices. Like many parts of the world, inflation in Canada is too low. Consumer prices dropped 0.2% in the month of October, driving the year over year rate down to a 5-month low of 0.7% from 1.1%. Excluding the declines in the cost of food and energy, consumer prices rose 0.2% but on an annualized basis CPI still slowed to 1.2% from 1.3%. Retail sales on the other hand were very strong, rising a whopping 1% in September compared to 0.1% the previous month. This would have singlehandedly reversed the rise in USD/CAD if not for the flat growth in retail sales ex autos. Excluding the largest rise in automobile sales in 4 years, consumer spending stagnated. So while confidence has reached a 2.5 year high in Canada, consumers are reluctant to spend and with low price pressures, the Bank of Canada will maintain its neutral monetary policy stance. Yesterday BoC Governor Poloz said he wanted to see inflation higher than where it is right now and this confirms they are in no rush to raise rates. Therefore rising U.S. rates should support a stronger rally in USD/CAD. Unfortunately 1.06 is a very stiff resistance level that the currency pair has struggled with for the past 3 years due in part to the 61.8% Fibonacci retracement of the 2007 to 2008 run up. Since 2010 every attempt to break above this level flamed out. Even if USD/CAD manages to break above this level, it will resistance at 1.0650 and 1.07 but nonetheless based on the price action seen in the monthly chart, the currency pair is prime for an upside breakout that should clear 1.06.

JPY: What Does The BoJ Think About The Yen?
As USD/JPY extended its rise, a number of Japanese Yen also crosses hit fresh multiyear highs and the rally in U.S. stocks supported the move. Next week will be a busy one for Japan with a number of important economic reports scheduled for release. This includes retail sales, industrial production, small business confidence, consumer prices and manufacturing PMI. While manufacturing activity is expected to improve, economists believe that retail sales growth slowed. For the most part, the economy is performing as the Bank of Japan expects. In their monthly report, they maintained their assessment that "Japan's economy has been recovering moderately." Exports are expected to increase on the back of improving overseas economies with industrial production expected to remain on an uptrend in the October to December quarter. However the price of corporate goods could rise at a slower pace, reflecting softer commodity prices. BoJ Governor Kuroda said they have no plans to adjust monetary policy but won't hesitate to make changes to ensure that their 2% inflation target is reached. The BoJ head does not feel that the yen is abnormally low which suggests that they are perfectly comfortable with a further sell-off in the Yen crosses. Who can blame them for wanting a weaker currency when it helps to boost inflation and growth.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.