Dollar Consolidation may Continue until Jobs Data

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4 Jul 2016

The US dollar turned in a mixed performance in the week after the UK decision to leave the EU. There was an acute market reaction for a couple of days, but the disruption to the financial system was not major. Officials and investors feared worse. The initial line of defense, central bank swap lines were barely used. The Bank of Japan was the only central bank to draw on the Fed's lines, and even then, the amount was inconsequential ($2 million).

Outside of sterling, which lost nearly 3% on the week, the Swiss franc (-0.3%) and the yen (-0.5%) were the worst performers as so-called safe haven buying was reversed. The dollar-bloc and the Swedish krona did best as risk appetites seemed to return. Consistent with this was the 4% rally in the MSCI Emerging Market equity index. This was the largest weekly rise since early-March. It finished the week at its highest level since June 9.

Both the Dollar Index and euro appear to be carving out a flag pattern. Flag patterns are usually continuation patterns. If valid, it would suggest that from a technical point of view, addition dollar gains are likely. It is not clear at what level the pattern is no longer valid in the Dollar Index.  Ideally, it would hold above 95.30, a retracement level that corresponds with the 20-day moving average (~95.25), but even if it eases to 94.40 (200-day moving average is near 94.65), it may still be valid.  Flags fly at half-mast, and depending on how the pattern unfolds; it could project toward 97.50-98.00.

The euro held the $1.1170 retracement level ahead of the weekend. Above there is the $1.1230 retracement target, which coincides with the 20- and 100-day moving averages. Support is seen in the $1.1000-$1.1030 band. If its flag is also at half-mast, it could project a move below $1.08.

The dollar was turned back from the week high near JPY103.40 before the weekend, and it was pushed to the lower end of its narrow consolidative range (JPY102.40). The RSI is low and flat, but the MACDs are about to turn higher. The slow stochastics are also constructive. We suspect that the blowout move to JPY99 satiated many of the yen bulls, and are more inclined to buy dollars on further weakness, in anticipation of a recovery in US job growth, and new stimulus in Japan after the July 10 upper house election.

After the historic drop, sterling spent most of the past week consolidating in a triangle pattern, which is also often a continuation formation. The top of the triangle is formed connecting Monday, Wednesday, and Thursday's highs. It is near $1.3490 now and falls a cent by the end of next week. The bottom of the pattern connects Monday's and Thursday's lows. It is found by $1.3215 now and $1.3340 on July 8.

One of the implications of this pattern is that sterling made the highs for the week on Monday. If the move below JPY100 exhausted the yen bulls, it may take a push through $1.30 to satisfy the sterling bears. It seems that the down moves were more impulsive than the upticks. Moreover, sterling remained under pressure against the euro and recorded fresh two-year lows ahead of the weekend (euro pushed briefly above GBP0.8400). We look for the euro to rise into the GBP0.8500-GBP0.8600 area in the coming weeks.