Head of FX Strategy
Summary: Most major currencies are caught in recent ranges, although the JPY weakness has tried to find a new leg and the CNH is making waves in showing rare isolated strength of sufficient magnitude to warrant a pushback from Chinese authorities overnight, a sign that the move will have a hard time extending from here. Elsewhere, we await a follow up on further taper talk from the Fed and wonder how the market will absorb it.
FX Trading focus: USD traders need to prepare for more taper talk
I was away from the office for the last two days of last week, luckily witnessing the transition to more summer-like temperatures in what has been an unseasonably cool May here in Denmark. My last update on Wednesday of last week had the subtitle: “USD is rather weak, but look at the backdrop!”, in which I argued that while the USD might be weak, the backdrop suggested that the support for USD bears has been turned up to 11, as the Fed’s excessive QE has created all manner of distortions, from record lows in Goldman Sachs’ financial conditions measure that we pointed out in this morning’s Saxo Market Call podcast to incredibly compressed credit spreads and spreads on mortgage securities to the ballooning Fed reverse repo facility.
On the very day of my comments last Wednesday, Fed Vice Chair Clarida was out teasing the need for eventual taper talk, the first recognition from the core of the Fed (as opposed to the odd regional Fed president) that the Fed can see that it is overdoing things. Clarida said “There will come a time in upcoming meetings, we’ll be at the point where we can begin to discuss scaling back the pace of asset purchases.”. Then on Friday we got the April US PCE inflation numbers that echoed the crazy spike in the CPI survey, as year-on-year core PCE inflation vaulted to the highest level since the early 1990’s and more impressively the month-on-month core number was the highest since the early 1980’s (save for a one-off odd spike recovery from a downward spike in Sep-Oct of 2001) at a rounded up 0.7%. Has this put the June 16 FOMC meeting in play for rolling out a more specific message on tapering? The most obvious starting point would be a timetable for eliminating the $40 billion in MBS purchases, which are not necessary when the market is at its hottest since the housing bubble, but let’s see. For now, it supports the greenback at the margin and may keep it from tumbling over the edge.
Chart: USDJPY
I have seen a number of other analysts bringing to my attention that this May was one of the least volatile calendar months ever for USDJPY, with a high of 110.20 and a low of 108.34, so a range of well under 2%. I didn’t even notice, given that USDJPY has been trading in a tight range since early 2017 and was unbearably boring for most of the last half of last year. But fundamentally, a significant real-yields gap has opened up between the US and Japan in the wake of this latest inflation data: one that favours the stable real-yields of the yen versus the now wildly negative yielding US dollar. The market is not picking up on this, but let’s keep an eye on status of the increasingly stale USDJPY rally after the strong move off the lows in March that peaked on the last day of Japan’s financial year on March 31. With last week’s rally to 110+, this area needs to hold to keep the focus higher, while a close back below perhaps 109.50-25 suggests we remain in range-trading limbo for now.
RBA up tonight – most likely a wait-and-see exercise. Little is expected from this meeting as the RBA has set up the July meeting as the key decision point for whether to re-extend the horizon of its yield-curve-control policy (I.e., whether to keep the April 2024 Australian Government Bond yield capped at 0.1% or to shift that yield cap policy to the November 2024 bond), but we have seen sharp market reactions to recent central bank moves, from the RBNZ guidance shift last week and the Bank of Canada’s taper move in late April, so any indication that the RBA is leaning more decisively for the more hawkish option in July could see a sharp reaction in the AUD. Iron ore prices have rebounded, but the RBA is also likely eyeing the Melbourne virus outbreak with some concern. Worth noting that both Australia (8.3%) and New Zealand (5.7%), while having been very successful in preventing the spread of Covid, have been very slow to vaccinate their citizens.
Table: FX Board of G-10+CNH trend evolution and strength
Here we note the ongoing JPY weakness (even if we continue to question how long this can sustain without signs that real rates are moving against Japan’s favour), but also the isolated CNH strength, an unusual development in recent market history and one that brought comments from Chinese officialdom overnight, pushing back against the pace of the recent move. In relative terms, would expect that CNH strength has peaked for now, given this warning and that the official CNY basket is trading up against the top of the range since 2018. Elsewhere, the recent gold move is trying to maintain altitude, while most of G10 FX is languishing without much conviction, although interesting to note NOK weakness despite Brent crude trading up against the highs of the range. RBA up tonight, but may not do much for AUD as the July meeting is the one seen in play as mentioned above.
Table: FX Board Trend Scoreboard for individual pairs
Here, the most interesting thing to point out may be the EURCNH trend moving negative a few days ago, while also noting the strongest reading on the board: the nosebleed CNHJPY trend strength of 7.9 – that looks excessive even if the trend remains positive.
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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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