USD in the crosshairs

FX Update: Bits and pieces as we await EU inflation and US jobs data

Forex 5 minutes to read
Strats-Hardy-88x88
John Hardy

Head of FX Strategy

Summary:  The market spent all of last week unwinding the yen reaction to the FOMC meeting of the week before, while the US dollar went sideways as risk sentiment not only recovered its stride but showed that global markets are not fretting a more hawkish Fed. This week, the calendar focus turns to German and EU inflation data and a US jobs report on Friday, with focus on wages intensifying.


FX Trading focus: Bits and pieces for the week ahead.

Last week saw the energy seeping out of the market as the reaction to the prior week’s FOMC meeting failed to spark fresh follow through higher for the US dollar, and the neutralization of the treasury market rally saw the JPY rally in the crosses also effectively erased. With a full week of no follow-on momentum last week, it feels like we risk a summer in directionless doldrums, but we’ll give this week a chance to surprise us, with a number of bits and pieces on the agenda.

German and EU inflation. While US inflation has gotten the bulk of focus recently, we have important inflation data up from Germany tomorrow and the EU on Wednesday. The month-on-month readings for headline German inflation for the last six months are running at more than 7% annualized pace, a staggering figure, while the year-on-year headline inflation for the June flash headline reading from German tomorrow is expected at 2.4% vs. 2.5% in May and the month-on-month reading is expected to drop to 0.4% for June. The EU headline CPI hit a cycle high of 2.0% in May, but is expected to drop to 1.9% for June and the core reading is expected to drop to 0.9% from 1.0% in May. Upside surprises are of course the most interesting test for the market.

Swedish political “crisis” not harming SEK so far – to be sure, the now former political leadership in Sweden may feel that it is in a crisis after PM Löfven lost a confidence vote last week, but there is no sense of suspense in the currency, which has pushed back higher versus the Euro today despite the situation. Löfven is apparently scrambling to put together a new coalition without calling snap elections but will have to either allow the opposition to cobble together a coalition or proceed with snap elections before midnight tonight if he fails. The backdrop of strong risk sentiment and the uptick in EU yields is SEK-supportive, but the question is whether enough energy can build to take out the massive 10.00 area on the chart in the near term. Options positions (put spreads, etc.) are one way to express a downside view.

Quarter end and US treasury yields – we have noted the massive signs of excess liquidity in the US financial system as a possible driver that is obscuring any pricing signals from the US treasury market, as banks awash in liquidity from the stimulus checks, Fed QE and the US treasury winding down its general account at the Fed have forced the Fed to actually mop up the liquidity to the tune of $800 billion in its overnight reverse repo facility. With the US Treasury set to continue winding down its account at the Fed until August 1 and having well north of $200 billion to go to reach its target of less than $500 billion, this situation could draw out. But yields picked up on Friday, and we have the transition to a new quarter here on Thursday, with banks possibly set to reverse some of their treasury purchases after the end of the quarter (the largest US banks attempt to reduce their total balance sheet size at reporting snap-shots to avoid penalties linked to their size). In other words, bond market volatility might pick up by the end of the week, and not just on the important US jobs data discussed below.

US payrolls and earnings data – we’ll cover this as the week progresses, but the most important macro data on the calendar this week is the Friday US jobs report, including the official non-farm payrolls change and average hourly earnings. Wednesday sees the June ADP private payrolls data, an unreliable coincident indicator. Interest has spiked recently on the degree to which signs of huge demand for labor relative to the pace of hiring will result in a spike in wages (with the average hourly earnings series a misleading indicator until a few more months down the road). More interesting than the AHE, in April, the JOLTS “quit rate” tracking the number of workers who have quit their jobs rose to a new high in the history of the survey at 2.7%.

Chart: USDJPY vs. US-Japan CPI-based 10yr real yield spread
I created the chart below using the 10-year yield less the core CPI for the US and Japan and then creating a spread to indicate the degree to which US real yields have been sent steeply into the negative in relative terms. The indicator has roughly correlated with the USDJPY exchange rate over the last twenty years with notable episodes of divergence, but the current one is rather remarkable. If US fiscal policy continues to drive divergent inflation outcomes, won’t the market at some point pick up on this and have to course correct? The yen is likely driven more by Japanese domestic savers and their shifting of savings and investments and the current backdrop of extremely positive risk sentiment for global credit, especially in EM, is likely driving carry-trading and reach-for-yield behaviour by Japanese investors that is yen-negative, but there could be quite the snap-back in JPY on any eventual correction, given the divergence in real yields.

28_06_2021_JJH_Update_01
Source: Bloomberg

Table: FX Board of G10 and CNH trend evolution and strength
The trend readings in our FX board show how the trending energy is almost entirely lacking, with the USD “uptrend” only holding in there due to the scale of the reaction to the FOMC, as there was no follow-through higher for all of last week. The flip-side of the USD seems to be gold, where the market is reluctant to buy the “non-transitory” inflation story and was sufficiently impressed, apparently, by the Fed’s modestly hawkish turn at the FOMC meeting.

28_06_2021_JJH_Update_02
Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
Not much worth discussing in the individual pairs, although interesting to note the SEK pairs stirring in places and EURSEK is doing its best to get back on track to the downside with a flip to the negative today if the sell-off holds. The positive risk sentiment in Europe, together with higher inflation data, might help SEK further if the “worst political crisis in decades” continues to fail to raise any concerns for the currency.

28_06_2021_JJH_Update_03
Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1200 – Euro Zone ECB’s Weidmann to speak
  • 1300 – US Fed’s Williams (voter) speaks on BIS panel
  • 1600 – US Fed’s Barkin (voter) to speak on inflation risks
  • 1710 – US Fed’s Quarles (voter) to speak on digital currency
  • 2330 – Japan May Jobless Rate
  • 2350 – Japan May Retail Sales
  • 0410 – New Zealand RBNZ Governor Orr to Speak

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