The FX Trader: USD rally will need new drivers if it is to continue.

The latest

The follow-on USD rally from the FOMC meeting last Wednesday has continued apace, in a kind of “having its cake and eating it too” moment. The treasury market has supported on the one hand: yesterday’s modest dip in short US treasury yields aside, US short-end yields have largely held up as the market sticks to its guns in anticipating a September FOMC rate hike, with even the modest 33% odds for the July FOMC meeting holding up. Meanwhile, yields elsewhere continue to deflate, taking two-year yield spreads to multi-month lows in the case of Australia-US and Europe-US, for example. Early this week, ECB President Lagarde’s comments that there is no evidence of a forceful ECB response needed at this stage has capped ECB expectations for only one more rate hike – one that is being pushed further and further out this year (now only slightly more than 50/50 probability priced through September ECB meeting, for example.)

But now that the market has made this significant adjustment, can the US treasury market continue to further support a US dollar rally? Decisively stronger growth-related incoming data would be needed there, since now all inflation data will be discounted for a few months by the collapse in oil prices. Cue first-of-the month data rolling in next week as the first test, and let’s remember that new Fed Chair Warsh placed a big fat question mark around all US data and its quality. Aren’t we still flying a bit blind with this new Fed?

Elsewhere, part of the “having it too” angle for the US dollar is its traditional safe haven prowess on display this week as it rose on Tuesday’s chunky equity market sell-off (triggered chiefly by a mini-meltdown on Korean memory stocks as stories circulated of demands for a change.) When Korean tax policy can send shivers through global equity markets, it makes you wonder how frothy things might be and might get as two-way volatility in momentum stocks has become downright hair-raising. Last night’s strong Micron earnings have shored up confidence in the momentum/AI hardware space for the moment, but let’s see how that move survives the march into Friday’s option expiry.

Interesting to note the USDJPY “pause” here at the very top of the range since the post-1980’s (the 2024 high of 161.95) after the Ministry of Finance has been very quiet all the way up, save for tantalizing news of a Ministry of Finance Katayama call with US Treasury Secretary Bessent early this week. Coordinated comments on FX are vastly more impactful than any fresh MoF intervention potential, but the market has nothing to go on here. Meanwhile, ironically, the traditional support for the JPY, long US treasury yields, is doing all it can to throw further confusion into the mix. This latter indicator has been thrown out the window because of the perception that the Takaichi government is pursuing an inflate-our-way out nominal growth policy. Consider the Bloomberg article on Japan’s USD 2.3 investment plan.

 Sterling focus – structural upside potential?
It is always important to keep an eye on EURGBP more than GBPUSD for a cleaner read on sterling direction. And the combination of the EURGBP pair pressing hard on the bottom of the well-defined range this year when we have a potential new political revolution unfolding is worth considerable attention in coming weeks and months. If – and the emphasis very much on if – likely new Labour leader and Prime Minister Andy Burnham plays his cards “right” we could set up for the largest political revolution since Margaret Thatcher. And it’s not a straightforward question of left versus right but whether Burnham can rebalance the tax code to incentivize more work and fewer transfer payments as well as removing the harshest of the Net Zero measures and encouraging vast infrastructure investment through some echo of the US’ transition to an industrial policy regime, all without breaking the bank (fiscal stability). It’s probably a very narrow path, but the potential here is interesting, especially with how the timing lines up with the technical situation. Everyone loves to hate sterling (including this analyst for probably too long) and the currency is pushing at the edge of the envelope here. And it’s not just in EURGBP, but also in the bigger picture in GBPCHF, as discussed below.

Chart focus: GBPCHF
For this update, I will take a break from EURUSD coverage (with the break lower there, we now have a fat resistance zone stretches all the way to 1.1500), and take a look at something more structural, namely GBPCHF. I’ve talked up the sterling upside potential for sterling above. As for CHF: the Swiss franc has become egregiously overvalued in PPP terms in recent years and the SNB is leaning as hard as it can on the interest rate policy with its go-it-alone ZIRP policy and even intervention threats to keep the franc from further strengthening. Much of the franc’s strength in recent years has been built on “store of value” arguments, much like those that drove the gold rally. But look at gold these days (sub-4000 relative to 5,500+ highs) and consider how much the SNB holds of that precious metal. Thematically, then, markets don’t look like they are scrambling for stores of value at the moment, but for something else. That something else could be carry, in which case all the more reason for CHF to serve as a funding currency for carry trades and weaken, but there is also a possible investment flow angle, with Europe needing to transform its economy and drum up its industrial policy and the UK needing to do the same – and Switzerland’s prohibitively expensive currency is a barrier for inbound investment. Technically, the situation is rather tantalizing as we have teased to new highs for the year here ahead of Andy Burnham’s (nearly certain) impending takeover at Number 10 Downing Street. It’s rare that I pull out a monthly chart, but needed to do so in this case to get the Brexit price action from ten years ago (!) within the frame. Note the GBPCHF mid-range back then was way back up at 1.4000. More locally, the pair has recently pulled to new highs since early this year and is attempting to sustain a rally above 1.0650, something it hasn’t managed to do after two prior tries (this is near the major prior 2023 low of 1.0635.) If sterling sustains a bid through the early days of the PM Burnham transition, the next focus could be as high as 1.1500 and perhaps even more if this turns outright secular. One step at a time – sterling is in a key pivot zone versus both EUR and CHF.