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Speculators made several significant position adjustments in the CFTC reporting period ending 19 July. The euro bears added to their gross short position for the fourth consecutive week and for the ninth week in the past ten. The 16.2k contract increase lifted the gross short position to 211.5k contracts, the largest since the first week of the year.
The US dollar gained against all the major currencies over the past week. It also rose against many emerging market currencies. A notable exception was the Chinese yuan. The yuan rose before the weekend, extended its advancing streak to four consecutive sessions, and in so doing, it snapped a six-week slide.
The New York Times reported that the US is preparing to seize $1 bln in assets tied to 1MDB, S&P downgraded Turkey a notch to BB with a negative outlook, citing political uncertainty, Turkish President Erdogan declared a three-month state of emergency, The Nigerian Naira weakened above 300 per dollar for the first time, and Brazil’s central bank signaled a longer wait until it cuts rates
As the week draws to a close, there are three main developments in the capital markets. First, the profit taking seen in US equities yesterday has continued in Asia and Europe today. The MSCI Asia Pacific Index and the Dow Jones Stoxx 600 in Europe are both off around 0.5%.
The weighted average of the Fed funds rate has edged higher. Following the Fed hike in December 2015, the Fed funds average around 36 bp in January before moving into a 37-38 bp range. However, since the UK referendum it has been trading consistently around 40 bp.
The Fed fund futures contract settles at the average effective Fed funds rate for a given month, not at the policy rate. Ahead of next week's FOMC meeting where practically no one expects a change in policy, implied yield of the July Fed funds futures contract is 40.25 bp.
Draghi said nothing that surprised the market. He acknowledged the resilience of the markets in the aftermath of the UK referendum. He also noted that with new staff forecasts, next September, and the upcoming data, the ECB would be in a better position to assess the macroeconomic situation. The risks to growth remain tilted to the downside.
Monetary policy is said to have lost its impact on the foreign exchange market, as investors scratch their heads at the resilience of currencies with negative interest rates. Yet the price action in the action cannot be understood without recognizing the ongoing importance of monetary policy expectations.
The Australian dollar recorded a key downside reversal last Friday (July 15) and had seen follow through selling this week. It is off 1.25% over the past three sessions, which makes it the worst performing major currency behind the Japanese yen.
As this Great Graphic, composed on Bloomberg shows, the recent losses have pushed to Australian dollar close to the uptrend line drawn off the late-May low near $0.7150 and the spike low from Brexit (~$0.7300). The trendline is found near $0.7450 today.
It is a bizarre turn of events. Just as the Game of Throne's Westeros is a map of the UK put on top of an inverted Ireland, so too do UK events seem to be a strange permutation of the pre-referendum views.
Although sterling and interest rates have not fully recovered from the Brexit decision, equity markets have, and fear of contagion has died down. Indeed, it appears the UK may not be in the back of the queue from trade deals after all, and the IMF's more pessimistic scenario about the contagious impact has been significantly revised away.
Our underlying constructive outlook for the US dollar remains intact. It is broadly based on the divergence between the US and most other major economies. The US acted early and aggressively to counter the Great Financial Crisis. Unorthodox policies, such as quantitative easing, were adopted years before the ECB and BOJ. This has produced different outcomes. US economic growth may not be impressive by pre-crisis standards, but it does not seem particularly fragile.
The European Court of Justice upheld the principle of making creditors bear the burden for investment in banks that sour before government funds could be used. Italian banks are particularly sensitive to the ruling, which cannot be appealed because the European Banking Authority and European Central Bank stress tests on July 29 are expected to show that some Italian banks are under-capitalized.
The US dollar is sporting a firmer profile today, but it is not the driver. Heightened speculation that Australia and New Zealand may cut interest rates next month is pushing those respective currencies more than 1% lower today. The Canadian dollar is being dragged lower (~).5%0 in what looks to be primarily sympathy, but it had seemed vulnerable to us in any event.