USD: Technical readings stretched and a correction is in the offing - BBH

Analysts at Brown Brothers Harriman suggest that while few will be trading in the week between Christmas and New Years, they thought it might be helpful to review the dollar's technical condition.  

Key Quotes

“We make two overall points.  

First, although the dollar's rally strengthened and extended after the November US election, this leg up of the dollar's longer-term rally began at the end of Q3.  The anticipation of new policies by the Trump Administration, part of the story, but other forces that were also impacting, such as the divergence of monetary policy.  The US economy was approaching the Fed's targets, and the December hike was telegraphed in earnest starting in September (when we had thought a hike was likely).

The Eurozone economy is expanding near trend, but the low price pressures meant that it was premature to expect the ECB to abandon its asset purchase operations.  It is more difficult to assess BOJ monetary policy, which shifted toward targeting the 10-year yield.  The BOJ appears to be buying fewer JGBs, so its balance sheet growth has slowed.   Perhaps the significance will be better appreciated if the rise in US rates continues to exert a pull on Japanese bond yields.

Second, the technical readings are getting stretched and the technical indicators suggest a correction is in the offing.  Thus far, where they have occurred, the dollar pullbacks have been shallow, and mostly shy of technical retracement targets.  The dollar's rally has truly climbed a wall of worry.  As they have for several weeks, many remain concerned that the market is getting ahead of itself.  Trump, they say, will be unable to deliver the kind of fiscal stimulus the market expects.   Also, they argue that the market is gone a long distance toward pricing in three Fed hikes next year.   Investors who put much stock in the dot plots could be disappointed (again).

Nevertheless, the value of appreciating the technical condition of the market is that allows the quantification of the risk.  It is far from perfect, to be sure, and admittedly, it is more an art than a science (though some would say the same about macroeconomics), but it can assist in risk (money) management.”