Yesterday was an ugly session all around for global equity markets, with the major US indices suffering their worst single day sell-off in months and China following up with further downside overnight that has the major index there flirting with bear market status. The reaction function in currencies to the histrionics in equity markets was muted, perhaps in part as yield fluctuations were minimal during the episode, but perhaps also because China seems a source of growing concern, both on its exchange rate policy and on the outlook for its economy.
The CNY has devalued sharply versus the US dollar over the last couple of weeks, and more significantly, the CNY basket has also taken a large hit, suggesting a change of attitude from China.
The purported spark for the sell-off yesterday was the story that the Trump administration is laying groundwork to bar China from investing in US industries considered key for national security, from aerospace to robotics. Explicit denial of this story from Trump administration officials, from Secretary of the Treasury Mnuchin (more focused on denying that it was specifically focused on China) to trade adviser Navarro threw the market a lifeline.
USDJPY was the most reactive to the rise and fall of the market’s temperature yesterday, but we wake up this morning at unchanged levels while US equities are still down a couple of percentage points. A look over at US yields, where volatility was far more muted than in equities (telling?), suggests that the JPY will take its lead from yields more than risk appetite here.
The EURUSD reaction to the dovish European Central Bank has entirely failed to follow up with further downside after the enormous capitulation on the day of the meeting itself and has now crept back to the last arguable local resistance levels subsequent to that move. One more surge higher and the sell-off looks fully broken and bulls may come out of hiding for a look higher – for now the 61.8% Fibo retracement was the exact high for the cycle this morning.
We argue in our upcoming Quarterly Outlook that the trade war theme is a powerful driver of a weaker US dollar. Still, there is considerable wood to chop here to get the chart pointed back higher, starting with the blasting out of the local range and then an eventual move above the 1.2000 level. Given the low energy of this market, barring some major development (for example, along EU existential lines), the risk is that we settle into a summer range.