Head of FX Strategy
Summary: The USD sell-off yesterday just beyond the edge of support in places held poorly into late trading yesterday, with some further reversal in trading today, if with insufficient conviction to suggest a decisive outcome. This keeps the burning question of USD direction alive ahead of the important EU council meeting tomorrow and as we watch and wait for additional US fiscal measures.
Note that this is my last FX Update until at least Monday the 27th of June.
In yesterday’s FX Update, I outlined the long-term bearish case for the US dollar, but take the opportunity today to discuss the possible difficult path to that outcome. The most straightforward hurdle to a weaker US dollar is a double whammy of this COVID-19 resurgence creating a W-shaped recovery coupled with any failure by the US treasury/Trump administration and/or US Congress to bring fresh stimulus measures. As well, the spike in delinquencies risks a shutdown in credit creation, all of which spell the risk of a tightening in the US dollar.
The most obvious counternarrative to these concerns is that the Fed is clearly on the dovish path again after Deputy Governor Lael Brainard’s speech this week, and that the Treasury has its $1.6 trillion war chest at the ready for bringing a hefty chunk of liquidity back into the market, not to mention the prospect for additional new stimulus as the election approaches in just over three months’ time, in the form of new stimulus checks, unemployment benefits and other stimulus.
Nonetheless, it is still possible for the US government to “get it wrong”, with President Trump perhaps uninspired to promote forceful new stimulus and other measures as his hopes for re-election fade. In just two weeks, the $600 per week in federal unemployment benefits will run out, a huge headwind for consumption if it is not renewed at all and signals from stakeholders are that if it is extended, it will be slashed significantly. For now, we’ll track those stories closely, together with the technical situation, which as we argue below, is perched at pivotal levels for the EUR and the USD.
The ECB headline decision brought no changes to the ECB’s asset purchase programme, with mere guidance on the minimum forecasts timeframe for its PEPP and other programmes, which we all know would be adjusted in the event conditions worsened. There was hardly any reaction to the initial announcement and the press conference is ongoing as we write this with hardly any reactivity in the euro to Lagarde’s statement and the initial portion of the Q&A. An expansion of the PEPP programme is likely at the next ECB meeting once the size of the EU recovery package is known.
Chart: EURUSD
Maximum limbo for EURUSD traders ahead of a weekend that will see the important EU Council meeting extending into Saturday. How will the market treat the news that an agreement has been hammered out on the EUR 750 billion recovery package and that the objections of the “frugal four” (Denmark, Sweden, Netherlands and Austria) have been overcome? On the one hand, a more clear path to mutualization and funding via new direct EU taxes suggests a path to mutualization that is encouraging for Euro bulls, while on the other, the overall size of the package is not terribly impressive and would lead to a sub-2% of GDP per year impact on the economy in the near future – so optimistic assumptions about this programme will have to be that it is merely a first step toward additional stimulus further down the road. Technically, yesterday’s session was a minor setback for bulls as much of the day’s gains into the key pivot zone higher were erased in late trading. We continue to watch this 1.1400-1.1500 zone (the spike high during the dire March trading conditions was 1.1495) for whether EURUSD can clear the hurdle to the upside.
The G-10 rundown
USD – we noted a break in the slavish, minute-by-minute negative correlation between risk appetite and the US dollar in recent sessions, though this seems to be reasserting a bit here. We continue to watch the combination of 1.1500 in EURUSD, 106.00 in USDJPY and perhaps 0.7050 in AUDUSD as the set of levels that will need to fall to indicate the USD is triggering for a run lower.
EUR – the recent bid is compelling, but let’s see where we are Monday morning after the key EU Council meeting stretching into the weekend. Easier to argue for a euro rally higher versus USD and JPY if the mood and economic outlook continue to brighten.
JPY – the lean lower yesterday quickly erased and frustrating once again the least attempt to establish a direction. More than a bit surprised that today’s shaky markets haven’t managed to inspire any notable bid into JPY.
GBP – yesterday’s surge in GBPUSD largely erased today as the sterling technical outlook is finely balanced (a move and close above 1.2700 needed to excite upside interest in GBPUSD.
CHF – we have to take note of the EURCHF rally handily clearing the 200-day moving average around 1.0740 – is this a short squeeze similar to the one inspired by huge shift in Merkel’s position on Germany’s responsibility to help fund the recovery or a more promising sign of a euro resurgence on new EU solidarity – we will know more next week after the market digests the EU council meeting. Note that the 1.0800 area in EURCHF rather important chart level we have neared today.
AUD – some headwinds for the Aussie at the moment on wobbly risk appetite and especially on the sharp consolidation in key metals prices that have provided a supportive backdrop, but the trading ranges in AUD so miniscule and the tactical reaction to developments is painfully lacking
CAD – the Bank of Canada provided little of note yesterday and USDCAD once again tested the 1.3500 area 200-day moving average without breaking. CAD looks passive here to risk appetite and oil prices, with that 1.3500 the key downside level.
NZD – AUDNZD not getting further support as key metals prices have slumped in recent sessions (less AUD supportive) and NZ Q2 CPI was a bit higher than expected.
SEK – the most important EURSEK pair hovering at these cycle lows, but will want a positive tone from the EU Council meeting and likely also a stronger euro to see EURSEK lower (SEK prefer a positive outlook for its export markets)..
NOK – the big barrier for further NOK upside is that 200-day moving average in EURNOK around 10.55 currently, and we likely need a steady risk rally to extend, together with Brent crude taking out the key resistance zone of late near 44.00/bbl to get more NOK upside/EURNOK downside.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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