FX Update: A blast from the risk-off past for FX. More to come?

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  An ugly reversal in global risk sentiment, together with a solid rally in treasuries, had the USD and JPY on the bid across the board in what used to be the typical pattern for risk-off developments across markets, in stark contrast to the patterns brought about in the recent past by rising yields. The G10 smalls were hit the hardest on this development, which could extend if volatility is set to rise further.


FX Trading focus: A classic risk off wave – any more and things start breaking again

In yesterday’s FX Update, I outlined what could go wrong for USD bears after the recent, rather sharp sell-off in the greenback, and chief among them was the simple notion that any pronounced weakening in risk sentiment could suddenly extend the big dollar a helping hand after its recent bout of weakness. And that is indeed what we got yesterday, in the form of a “classic” risk-off wave of equity selling while treasuries rallied (a throwback to prior market regimes before the situation earlier this year in which concerns centered on the spike in treasury yields). The classic twist of treasuries rallying while equities sold off meant that not only the USD backed up, but the JPY did so as well, with some interesting implications for JPY crosses, as noted in EURJPY, but also potentially in AUDJPY as discussed in this morning’s Saxo Market Call podcast. Japan also got a jolt overnight as officials there are considering whether Tokyo and Osaka will require a Covid-related declaration of emergency and an ex-minister said it was time to consider cancelling or delaying the Olympics, which apparently don’t enjoy popular support, with 70% against.

I find the attribution in the headlines to the sudden setback in risk sentiment to “new Covid concerns” a bit silly, given the massive new wave was rising quickly as much as a few weeks ago, and this doesn’t feel like a market where one can get a sense of rising risk, given the suppression of price discovery in bonds, whether sovereign or corporate. Our Steen Jakobsen’s article yesterday does point to some of the remarkable statistical and sentiment extremes the market has reached, and we recently pointed to MSCI World index valuations as historically stretched. So if this is the beginning of a partial bubble unwind at worst, or merely a chunky consolidation/setback, there could be plenty more USD and JPY strength in the near term. I like trading this via short AUD and CAD – USDCAD long already now it if stays above 1.2550 for a possible extension to 1.3000 (watch out for BoC today, though don’t see them making waves), while AUDJPY downside optionality looks reasonably priced, EURJPY downside is tradable by spot, and short AUDUSD can be added on a close south of 0.7650, which begins to point toward a more profound breakdown (the one that didn’t unfold as it threatened to on the prior break lower).

Elsewhere, EURUSD is teasing 1.2000 and I have a hard time seeing that hanging on, although there are a number of retracement supports worth noting after the recent strong surge off the 1.1700 area lows – far too early to call for significant downside risk there – will watch 1.1925-50 (200-day moving average and first retracement) and then the 1.1850 area as the major 61.8% Fibo retracement area and last gasp support ahead of the 1.1700 cycle low.

Chart: EURJPY
A key day reversal yesterday for EURJPY, as the risk-off and punchy rally in sovereign bonds was a whiplash-inducing contrast with the prior day’s surge in EU yields and recent, more positive spin on Europe’s post-pandemic prospects. The reversal certainly sets up a hook for bears to get involved with stops above the highs after yesterday’s shooting star candlestick, as long as yields remain tame here and risk sentiment corrects further. The level toward 128.00 looks important on the Ichimoku chart and is just below the sub-128.50 pivot low highlighted in the chart below. The market feels poorly positioned for JPY strength. AUDJPY is another pair worth noting – especially the 82.50-25 area.

Source: Saxo Group

Odds and ends

Shock German political poll shows Greens in the lead – a new poll from Forsa shows the CDU/CSU only polling at 21% relative to 28%. This is the first poll just after the announcement this week that Annalena Baerbock will seek the Chancellorship this September and that the CDU has thrown their support behind the unpopular Armin Laschet. I am surprised that the CDU is doubling down on their candidate Laschet over the more dynamic Söder, but I am no German political analyst. This polls is a huge shift from a series of recent polls and could have something to do with the freshness of the news and merely a shallow popularity poll of these two personalities. Regardless, German polls will bear close watching until the late September election, as the key point is that a Green German government would be a political revolution not just for Germany, but also for the EU, ending the decades of cautious “debt brake” and “Schwarzer null” fiscal principles in favour of vastly opening spending for climate initiatives and a tighter union in the EU.

Less urgency for ECB message at meeting after yesterday?  If EU yields stay generally tamed through today’s Bund auction, the ECB’s task tomorrow becomes a bit easier, though I never understood why the central bank ever got as exercised as it did on the rise in bond yields earlier this year (and any “vigilance” expressed tomorrow against rising yields isn’t particularly relevant if yields remain tame to lower elsewhere). From here through the German election, the focus has to be more acute on the future of EU politics, as noted above with the huge shifts in German politics.

Table: FX Board of G-10+CNH trend evolution and strength
We have a strong new direction change (JPY and USD bounce) and a trend measurer should be slow to pick up on that by design, with a change in momentum the first thing to notice. On that front, the JPY has shown a solid positive shift over the last week, while the US dollar has not because the latter faces an awkward shift in underlying drivers (from finding weakness because yields stopped rising to finding strength because the yield drop is coinciding with risk-off, while the JPY is more of a single-issue currency – with yields the chief coincident indicator). Elsewhere, note the gold pick-up.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
Among the individual pairs I note the AUDJPY threatening to cross to negative on the close today and USDCAD having crossed to a positive trend yesterday.

Source: Bloomberg and Saxo Group

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