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FX Update: Unease in Chinese markets sees modest contagion

Forex 4 minutes to read
Picture of John Hardy
John Hardy

Head of FX Strategy

Summary:  The US dollar has bobbed back higher from a slight weakening yesterday ahead of the event risk of the week for the US, the FOMC meeting tomorrow, however little anticipation the market has drummed up for the latest thoughts from Powell and company. Elsewhere, turbulent Chinese markets are the development most worth studying for knock-on effects, whether limited to the region or more broadly.

FX Trading focus: Unease in Chinese markets drives modest contagion

While we await a not-so-anticipated FOMC meeting (and the accompanying irony that the lack of anticipation means that it would take very little to surprise the market), the development most worth noting is the significant meltdown in Chinese equity markets as regulators there move against a variety of companies based on imperatives for the country’s leadership that are rather well described in a Bloomberg article. Hard to tell where this situation can take us, but a further stampede by foreign investors out of Chinese equities or second guessing of formerly passive allocations to the Chinese market could drive a widening contagion into regional FX to start, but even globally at the extreme. Within G10 FX, one obvious focus is on the JPY, which has backed up higher in rather modest fashion on the two-day blood-letting in Chinese equities, as the Japanese equity market bounce from recent lows has proved far more modest than elsewhere. In addition, the Aussie and kiwi are important to watch, with the latter likely far more vulnerable on a significant further spike in regional unease, given the huge shift higher in NZ short rates that could partially unwind, all while short AUD rates have remained pegged at low levels, unable to respond to the rise in rates elsewhere, as the RBA’s dovish guidance has weighed.  As well, we have seen a huge jump in copper prices which could revive interest in Aussie from the commodity resurgence angle.

US markets are in a world of their own recently, particularly the mega-caps, with the largest of these set to report today and in the days ahead. At the same time, yesterday saw US real yields marking their lowest level ever as a measure of the 10-year real rate dropped below -110 bps, suggesting that investors are struggling to find investments (besides incumbent mega-cap stocks) that will bring a positive real return as inflation is expected to persist. In fact, while nominal rates have traded sideways over the last few days, breakeven rates have surged, driving the deepening drop in real yields.

NZD could be one of the more vulnerable currencies in G10 FX to any significant widening of regional contagion in Asia on the back of the turbulence in Chinese markets that may have global portfolio managers second guessing allocations as well as to the general growth outlook of the region. While NZD rates are so far unfazed, the “beta risk” is greater on a general change of mood on the global forward outlook than perhaps any other G10 currencies. Among regional comparisons, AUDNZD is also interesting to watch for the same reason as noted above. Technically, the downside risk was corralled after the pair broke lower, but with no follow through higher, so the next steps here are an open question. A failure through 0.6900 could set up a challenge toward the pivotal area near 0.6800 and even the 200-week moving average near 0.6760.

Source: Saxo Group

Data watching for the rest of today

US Jul. Consumer Confidence will be an interesting release to watch today after the preliminary July University of Michigan sentiment reading showed a significant dip and registered a five-month low. This has been somewhat out of synch with the Consumer Confidence data series, which has risen every month since January and is back in the pre-pandemic range. A soft survey here could suggest something is souring in the consumer outlook, whether in the jobs market or due to concerns of rising costs or a (hopefully) one-off like the delta variant outbreak. A recent poll suggested a large recent drop in sentiment on the general direction of the country.

The Australia Q2 CPI is up tonight and expected to show the highest reading since 2008 on the headline (anything above 3.5% year-on-year will do the trick) but with considerable focus likely on the core CPI measures like the “trimmed mean” which is only expected to come in at 1.6% year-on-year, hardly unsettling stuff, although a significant printer higher than the 0.5% QoQ reading expected could move the needle. Potentially in play, therefore, is the RBA’s confidence in its own policy guidance, as hot inflation readings put the central bank in the hot seat, together with the US Fed in a high stakes prediction that inflation will prove transitory.

Table: FX Board of G10 and CNH trend evolution and strength
Trend readings across G10 FX are generally fading fast and note that the Chinese market turbulence weighing extra-hard on the CNH over the last couple of days. Interesting that these new lows in US real yields haven’t sparked more interest in gold – is the crypto space stealing the precious metal’s thunder?

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
Hard to hang our hat on any new developments over the last couple of sessions and ahead of the FOMC meeting tomorrow. Watching NZDUSD for a potential new downtrend if the USD catches a bid post-FOMC as noted above.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1230 – US Jun. Durable Goods Orders
  • 1300 – US May S&P CoreLogic Home Price Index
  • 1400 – US Jul. Consumer Confidence
  • 0130 – Australia Q2 CPI


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