Stock Market Rally Drives Profit Taking in Dollar

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The consolidative price action in the forex market this morning provides currency traders with a taste of what they can expect for the next 2 weeks. The holidays are upon us and they are typically characterized by low volatility, thin trading volumes and narrow ranges. Occasionally there are breakout moves driven by year-end position adjustments and today’s price action in currencies is indicative of profit taking.

According to the CFTC’s IMM report released on Friday, speculators were very short JPY, CAD and AUD the day before the Fed reduced asset purchases. We suspect those long USD/JPY, USD/CAD, and short AUD/USD positions only increased further after Bernanke suggested that the central bank will start reducing monthly bond buys by $10 billion at every upcoming meeting, which would bring asset purchases to zero by the end of 2014. When positions are at extreme levels, currencies are particularly vulnerable to profit taking and in this case, unwinding into year end but if this occurs, we expect the retracements to be limited because the gains in the dollar is supported by fundamentals.

With only a minor uptick in U.S. yields today and new record highs in stocks, the U.S. dollar is trading lower against all of the major currencies. USD/JPY is struggling to rise back above 104 while the EUR/USD has found support near 1.37. This is an extremely quiet week for economic data. In fact, aside from today’s releases and tomorrow’s U.S. numbers, there’s not much in the way of market moving data from any of the G10 economies. According to the Bureau of Economic Analysis, personal spending and income growth accelerated in the month of November with the former rising by 0.5% and the latter by 0.2%. The increase in spending was the largest in 5 months and validates the Federal Reserve’s decision to taper last week. Incomes rose at a slower pace than spending but this reflects drop in earnings in the agriculture sector. The savings rate also dropped to a 9 month low of 4.2%, a sign that spending is being funded by a combination of wages and savings. The PCE deflator, which is one of the Federal Reserve’s favorite measures of inflation growth was flat. Yellen believes that price pressures are not a problem and if there is no pickup in the PCE, she could reduce asset purchases more slowly next year. No revisions were made to the University of Michigan’s consumer sentiment index.

Meanwhile the best performing currency and the biggest mover today is the Canadian dollar. Of course, it doesn’t mean much when the move is less than 0.5%. Canada maintained a steady pace of growth of 0.3% in the month of October but on a year over year basis, the economy expanded by 2.7%, up from 2.4%. Not only was this significantly faster than the previous month but also the strongest pace of growth since May 2012. 1.07 has proven to be a significant resistance level in USD/CAD and we expect the currency pair to continue to reject this level, aiming for a move to the December low of 1.0560.

Kathy Lien
Managing Director

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