FX Update: How high can the USD go after big break?
Head of FX Strategy
Summary: Yesterday saw a big US dollar move higher as key support gave way in EURUSD and other currencies likewise came under pressure against the big US dollar. This time, the move was its own phenomenon, not requiring sympathetic weakness in risk sentiment or higher yields. The timing is worth noting as today is the last day of Q3 and end-of-quarter effects may be in play, but the momentum is impressive and would take considerable force to reverse.
FX Trading focus: The USD has broken higher – how far can it extend?
As I argue in the Saxo Q4 Outlook, set for release early next week but penned more than a week ago, the fourth quarter could prove a difficult test for USD bears. And that is already proving the case before Q4 even gets under way tomorrow as key USD resistance fell away yesterday with a bang – with EURUSD below 1.1665 and even below the late 2020 low of 1.1603 while other currencies also dropped like flies against the surging greenback. As noted in the excerpt, the most interesting aspect of yesterday’s move was that it unfolded in isolation from other factors like risk sentiment (mostly stable if leaning slightly lower yesterday but actually recovering today) or US treasury yields (consolidating). One factor besides critical resistance giving way, which likely triggered both stop-outs and new positioning, is the end-of-month and end-of-quarter today, so we still need to see how this move holds in the days to come, but in the meantime must take it at face value and ask both what is driving it and how far the move can extend.
The key driver for the stronger US dollar in the background is likely the anticipation that the Fed is finally set for policy normalization while the chief surplus economies like the EU and Japan are still stuck in perma QE, which is so large there and rates so negative there that surplus savings end up recycled back to the US. Two factors have added a bit of energy of late on that account: the weak result for the center-left in the German election and fading anticipation that a massive EU fiscal programme is on the way. Likewise, the “steady” choice in Japan’s leadership could keep Japan’s fiscal outlook less interesting. On the capital flow front, the huge shift in Chinee policy in recent months has meant a huge reallocation away from China in global portfolios, with the US far and away the largest market for capital hunting a new destination.
The US dollar is pressing higher across the board, having cleared 12-month+ lows in EURUSD and taking aim at 1.1500 or lower to the downside there, while elsewhere, the strong greenback has yet to clear major pivot levels established on its previous run higher – for example in AUDUSD, where the 0.7106 level pivot has yet to fall. Note how the recent rally and retreat has created a kind of right “shoulder” after a giant “head” formed from the US election-era timeframe lows to the highs near the beginning of the year. Using the sloped neckline of that head-and-shoulders formation, the key level break level is coming into view ahead of that 0.7106 level. Looking lower, the 0.7000 area was an obviously critical level both pre- and post-pandemic breakout as shown. Then there are the projections lower if 0.7000 falls – anything from the 0.6805 area show (sample EW target) to 0.6550 to even the 0.6210 area (which is the classic approximate head-and-shoulders target area as well as the 161.8% extension of the last sell-off wave from the 0.7478 retracement). One factor that could support the Aussie before the more extreme sell-off extensions is the already crowded short positioning. For now, let’s see if 0.7106 falls.
As to how far the USD move can extend, I suspect it can continue for a while, but will rapidly become self-limiting as USD strength becomes so destructive at anything approaching the current momentum. We are already within about two percent of the levels that triggered Yellen’s abrupt slowing of rate normalization plans back in early 2016, although to be fair, that was after a sustained rally of some 20% from the mid-2014 time frame. Levels of note would include the higher of the sub-0.7000 targets for AUDUSD mentioned above, the 1.1300 area for EURUSD and the 115.00 level in USDJPY. Anything significantly higher than these dramatically accelerates Fed or coordinated central bank action as the USD would be suffocating the global economy. Otherwise, fundamental factors that could help the USD lose speed would be:
- US economic loss of speed (watching current fiscal argument closely on that front, but higher energy prices are a recovery risk as well if these head higher still) forcing a rethink of the degree to which the Fed can ever extract itself from QE. Longer term, the Fed can’t, but that remains for the all of us to discover over time.
- German coalition forms quickly and the EU shows signs of getting its act together in responding to the current energy crisis with massive new fiscal stimulus – importantly geared towards supply-side on energy rather than as income replacement to keep demand elevated – the current global supply side can’t even cope with current demand levels. Ditto for Japan…
Elsewhere, on the US fiscal front, today is critical for the outlook as the House is meant to vote on the infrastructure bill passed by the US Senate. Will the progressive Democrats hold true to their word and nix the bill in protest as the larger social- and climate spending bill has been de-linked from this bill? If so, the fiscal cliff next year for the US looms that much larger, requiring massive consumer dis-saving if the US economy is to continue to expand. The immediate threat of a US government shutdown/default has been averted for now by a stop-gap spending measure that delays that issue until at least December 3.
Table: FX Board of G10 and CNH trend evolution and strength
With China off for Golden Week starting tomorrow and through next Thursday, interesting to see if CNH continues to track a follow-through move higher in the US dollar over that time frame. Elsewhere, note the severe loss of altitude in NOK despite the ongoing Natural Gas spike and kiwi and sterling in a race to the bottom).
Table: FX Board Trend Scoreboard for individual pairs
NZDJPY is the latest JPY cross to roll back over, while EURGBP has flipped higher, but really needs to follow through out of the 0.8600+ range and through the 200-day moving average to suggest a new up-trend is unfolding here. USDCAD has flipped back higher, but the range there extends all the way to 1.2950.
Upcoming Economic Calendar Highlights (all times GMT)
1200 – Poland Central Bank meeting minutes
1200 – Germany Sep. Flash CPI
1230 – Czech Central Bank Repurchase Rate
1230 – US Weekly Initial Jobless Claims and Continuing Claims
1345 – US Sep. Chicago PMI
1400 – US Fed Chair Powell and Treasury Secretary Yellen before House panel
1400 - US Fed’s Williams (voter) to speak
1430 – DOE’s Weekly Natural Gas Storage Change
1500 – US Fed’s Bostic (voter) to speak
1530 – US Fed’s Harker (non-voter) to speak
1600 – USDA’s Grains Quarterly Stock Report & Wheat production
1630 – US Fed’s Evans (voter) to speak
1800 – Mexico Central Bank Rate Decision
2100 – New Zealand Sep. ANZ Consumer Confidence
2350 – Japan Q3 Tankan Survey