Dollar Losses Set Stage For Recovery

The US dollar lost ground against nearly all the major currencies last week. The sole exceptions were the Australian dollar, where pressure ahead of the weekend following Moody's decision to cut the outlook for five Australian banks wiped out the previous small gain, and the Norwegian krone, which was really flat with less than a 0.1% loss.  

The euro, Swiss franc, yen and sterling gained around 1% against the dollar last week.The magnitude of the move may have been exaggerated by the seeming lack of participation, but the direction seems to be the largely a function of technical factors and the market's wrestling with the outlook for the Federal Reserve.  

The dominant technical force in the Dollar Index is the retracement of the rally from early May.  The 61.8% retracement is just below 94.10.  It was tested to the tick on August 18, and it held. It also corresponded with a trendline drawn off the May and June lows and the lower Bollinger Band. The RSI and fast Stochastics have turned higher, though the slower moving indicators like the MACDs and slow Stochastics have not. The first objective is 95.00, but there may be potential toward 95.60-95.80. 

The euro is the biggest constituent in the Dollar Index, but it is not nearly as constructive.  The euro has recouped more than 61.8% of its decline since early-May (~$1.1325). It has risen in eight of the past ten sessions.  Despite the pullback before the weekend, it did not break the previous session's low once last week.  Moreover, it remains above the breakout from the downtrend line from early-May.  That trendline is found near $1.1230 at the start of the new week and $1.1210 at the end of the week.  Although it is bumping against the upper Bollinger Band, the technical risk may extend toward pre-Brexit high (~$1.1400-$1.1430).  

The dollar slipped through the psychologically and technically significant JPY100 level. Although it traded below there in three of the past four sessions, the break has not yet been convincing.  It has popped back above there and has not yet spent an entire session below JPY100. We suggest that a convincing break could confirm a rare but not unprecedented continuation head and shoulders pattern.  The measuring objective of the pattern would project dollar losses toward JPY92.50.  

The dollar's upside is initially blocked by the JPY100.50 area, and a break it could see JPY101.20-JPY101.50.  This is especially true if our hypothesis of the break of JPY100 being spurred not by Fed views (according to Bloomberg probability calculation the odds have increased over the course of this past week from 16.0%, 17.5% and 36.0% for the September, November, and December Fed funds futures contracts respectively on August 12 to 24.0%, 28.5% and 41.4% on August 19) but by activity in the Treasury market.   

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