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FX Update: Yields rebound, and so does the US dollar.

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John Hardy

Head of FX Strategy

Summary:  The US dollar found a local low this morning and rebounded ahead of an ECB meeting this afternoon and a Bank of Japan meeting up overnight, with neither likely to deliver much support for their respective currencies unless the “Fed pivot” narrative deepens in the coming week. The outlook for USD liquidity rules all in this cycle.

FX Trading focus: Dollar down, but may not stay down for long.

The US dollar has tumbled since yesterday, mostly on the drop in longer US treasury yields, with the move lower in yields and the US dollar persisting in today’s European session as yields continue to run lower. The US 10-year treasury yield benchmark is already back near the 4.00% level that was important on the way up. Key technical levels have fallen in most important USD pairs, including the parity level in EURUSD, the 1.1500 level in GBPUSD, and the 0.6400 area in AUDUSD. USDJPY is also under pressure, trading below 147.00 as of this writing, with the next important level up at 145.00, a level I have a hard time seeing falling unless US treasury yields drop well below that 4.00% mark.

The proximate trigger for the move yesterday, judging from its timing, was arguably the release of the August S&P CoreLogic Home price data, which showed the 20-city index dropping -1.32% MoM, far more than the -0.8% expected and with the July data revised some 25 bps lower to -0.69%. Given that 15 months ago, US mortgage rates were still only 10 basis points above record lows and then rose to more than 20-year highs by late September, we can expect a further brutal correction in housing prices. Less noticed was the ugly drop in the US October Consumer Confidence survey, where the present situation index fell sharply and to a new 18-month low. This survey correlates tightly with the jobs market.

As we discussed on this morning’s Saxo Market Call podcast, a few “events” and signals have encouraged a conspiracy theory that the Biden Administration is doing all it can to tilt the odds going into the US mid-term elections, with the Fed helping by wanting to avoid attention entirely. The most important for the US dollar and US yields in the near term would be the idea that the Fed doesn’t want to make any further waves for the moment and would prefer to fly under the radar at next Wednesday’s FOMC meeting. It probably would want to wax a bit less hawkish soon anyway, given that expectations for the Fed Funds rate had reached the psychologically significant 5.00% level recently. The WSJ article at the weekend from “Fed whisperer” Nick Timiraos added some fuel to this narrative. As well, US Treasury Secretary Yellen expressed interest earlier this week in carrying out treasury “buybacks”, supposedly to improve market liquidity after consulting with primary dealers. Such buybacks make some sense, given that the Treasury can reduce the nominal national debt burden by retiring low-coupon debt trading at a significant discount to par and then refinancing at higher rates. Then again, it’s just a shuffle beyond the very short term, as issuance would simply have to increase by the same amount down the road as committed to such buybacks now.

So – how long can the squeeze on USD longs stretch? Arguably, at current levels, the market has front-run a bit of a dovish shift in the Fed at next Wednesday’s FOMC meeting, so that will be the next key test, with the immediate test in tactical, price action terms around the levels noted above in key USD pairs that were taken out yesterday and this morning. The window of the next two weeks (through the tabulation of the mid-term results after the Tuesday, November 8 election) is an important test of the secular USD trend, to be sure.

EURUSD surged above the local resistance briefly already on Monday, but followed through with more force yesterday after the release of the latest house price data in the US, with the parity level falling this morning in European trading. That level was pivotal, as is easily visible on the chart, but ahead of it, the extremely well defined and persistent falling trend channel was already broken. If the move holds, the next obvious focus is on the pivot high near 1.0200, with an even more significant level up at 1.0350. Sentiment has brightened in Europe as the pressure on gas and power prices has eased tremendously in the wake of panic topping up of gas storage facilities just as fresh LNG ships have arrived with nowhere to put the gas in the face of extremely balmy weather across much of Europe. But forward prices know that Europe’s energy woes are far from solves. Also, let’s not forget we have an ECB meeting tomorrow, where the ECB may struggle to stay credibly hawkish beyond the expected 75 basis point hike, with longer term credibility issues around its QT plans and how it avoids “fragmentation” on weaker peripheral bond markets. But EURUSD bears would need a sharp reversal back through 0.9900 to suggest that this move has been a false dawn.

Source: Saxo Group

The market behavior in the wake of the Bank of Canada decision yesterday was a possible microcosm of how this market is likely to behave from here. The dovish 50-bp hike (market was leaning well above 50/50 for a 75-basis point move) and the statement fretting the eventual impact of the policy tightening already in the bag as well as the expectation of “close to zero” growth in the “next few quarters” has put the kibosh on any notion that the Bank of Canada will provide any leadership in this tightening cycle, as the Canadian 2-year rate plunged a chunky 25 basis points yesterday in the wake of the decision. CAD knee-jerked to the downside, as one would expect, but then nearly the entirety of that reaction versus the US dollar was erased late yesterday. Why? Likely because the Bank of Canada news enhances the narrative that the Fed is also set for a coming deceleration/pivot and the direction of Fed expectations is the dominant factor, not a secondary consideration like the actual spread. Of course, with US yields pulling back higher we have USDCAD recoiling back higher as well, with the 1.3500 area now the key trend support.

Table: FX Board of G10 and CNH trend evolution and strength.
The US dollar has slipped into a negative trend until proven otherwise, but we are barreling toward an important event risk for the greenback next Wednesday. The CNH downtrend is the most pronounced signal of late. Sterling getting overdone on the upside?

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
So many freshly minted USD trends will suddenly be facing an existential test if the USD rises much further here – AUDUSD around 0.6400 is pivotal, GBPUSD around 1.1500, EURUSD psychologically around parity, etc. It’s certainly been a wild ride for USDCNH, which correctly sharply yesterday all the way back below 7.20, only to see the move approximately cut in half today. Ahead of a possible Xi-Biden meeting at the G20 summit on November 15-16 in Indonesia, China’s leader was out overnight expressing the hope that the US and China can find ways to work together “to find the right way to get along with each other in the new ear on the basis of mutual respect, peaceful coexistence and win-win cooperation…” Putin will supposedly be in attendance at that meeting as well, with a US team scrambling to ensure there is no chance for the Russian leader and US President to even risk rubbing shoulders in hallways, much less meeting one another.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • 1215 – ECB Rate Announcement
  • 1230 – US Q3 GDP Estimate
  • 1230 – US Sep. Durable Goods Orders
  • 1230 – US Weekly Initial Jobless Claims
  • 1245 – ECB President Lagarde Press Conference
  • 1500 – US Oct. Kansas City Fed Manufacturing
  • 1530 – Bank of England’s Woods to speak
  • 1700 – US Treasury auctions 7-year notes
  • 2100 – New Zealand Oct. ANZ Consumer Confidence
  • 2330 – Japan Tokyo Oct. CPI 
  • 2330 – Japan Sep. Jobless Rate
  • 0030 – Australia Q3 PPI


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