FX Update: Coiling and coiling before Powell speech.
Head of FX Strategy
Summary: FX traders are clearly on the sidelines here as most USD pairs coil aimlessly in very tight ranges, most likely in anticipation of a pivotal speech from Fed Chair Powell tomorrow. Elsewhere, the ruble is under pressure on geopolitical concerns and even as a major hurricane strike threatens oil and gas production facilities and refineries along the Gulf Coast.
Trading focus in coming days:
USD status, please: we continue to await the status of the US dollar as the last several days have merely shown a constant coiling in the major USD pairs in a very tight range – rather clear that we are awaiting an outcome of the Powell speech tomorrow. I wrote at length on in this Monday’s extensive update and we also discussed on this morning’s Saxo Market Call podcast. The EURUSD focus is on which side of 1.1700 or 1.1900 we close tomorrow and/or Friday in the wake of the speech. As noted on the podcast, the message from the Fed may have been largely pre-flagged, and even without notable signals from Powell tomorrow, traders may simply view this speech as a hurdle to be cleared before putting risk capital to work. Interesting to note below, however, that pressure may be building in the bond markets first, with waves to be felt across all markets if the rise in yield continues. We’ll refresh our view of the USD on Friday.
Yields poking back higher ahead of Fed Powell speech – is move validated or rejected? – Likely related to the anticipation that the Fed is set to unleash a new Average Inflation Targeting (AIT) regime that would see a lax policy response to rising inflation, yields at the long end of the US yield curve have pulled back higher. This make eminent sense, as assuming the Fed is successful in its pursuit of inflation, a long bond with negative real yields would offer terrible returns. If we focus in on the US 10-year benchmark yield, it has approached the 75 bps area again, a notable local resistance zone ahead of the early June high above 95 bps (psychologically, 100 bps likely key test). European yields have also been dragged higher if in slower fashion.
Are rising US yields a USD bullish or bearish development? It doesn’t have to be either depending on the logic…it’s USD bearish assuming rising long yields represent an anticipation that the Fed will succeed in engineering the very negative real interest rates increasingly priced into the market in recent weeks. On that note, we have pointed out that, while it’s well and good for the Fed to declare AIT forward guidance, but would likely require significant and sustained further fiscal stimulus to make that policy relevant. And to spoil a note I am writing for later this week, the stimulus gravy train could prove more difficult to come by in the event a divided Congress after the election can’t agree on what and how much to stimulate as is the case currently ahead of the election. The other wild card is whether vaccine hopes are significantly delayed relative to the current expected timetable and/or impact on normalization. On the flip side, if higher US yields upset the persistent strong streak in risk sentiment of the last many weeks, the USD may prove stubbornly resilient regardless how the bond market absorbs whatever Powell has to say tomorrow.
Elsewhere, if this back-up in yields reverses course sharply, for whatever reason, but especially in combination with sudden weak risk sentiment on Powell’s speech, the JPY could make its present felt with a strong rally again – possibly interesting for crosses like EURJPY and AUDJPY.
Oil focus and CAD, NOK and RUB: With a hurricane rapidly strengthening in the Gulf of Mexico before making landfall near a refinery-rich area in the US in East Texas some time tomorrow morning in the US, oil-linked currencies are trading nervously. If the hurricane tracks to the east of Port Arthur in far East Texas we will likely see almost no impact on energy markets and in energy-sensitive CAD and NOK, but if it strays much to the west of the currently expected track as of this writing, and even worse, toward Galveston Bay (access to the US’ biggest port in Houston and hitting up to 30% of US refining capacity), the risk of a significant impact on energy markets is high. NOK looks ready to challenge cycle support below 10.50 if European risk sentiment can finally pull the major indices on the continent out of the range and oil sustains its bid here now that it has poked to a new high. A similar argument for CAD downside (though note the Bank of Canada is out today with a discussion of its own mandate!).
It’s not just USD pairs that are coiling and coiling, but also EURNOK, as the rallies have lost amplitude even as the key support zone below 10.50 has failed to give way. Also, while earlier, EURNOK had a hard time staying below the 200-day moving average, it has recently been unable to sustain a move above. The mood in energy markets and risk appetite broadly in the wake of US Fed Chair Powell’s speech will be among the key factors for the outlook for NOK (which prefers strong risk sentiment) but more specifically, whether European markets can pull higher through the range, joining the recent accelerations in US equity markets. If the ducks line up for EURNOK and we see a break of this 10.50 area again, we’ll look lower to 10.25-30.
The Russian ruble (RUB) is in a very different place, at a three-month low versus the US dollar (USDRUB almost touching 76 today) on the geopolitical uncertainty set loose by the Belarus election, as the Moscow-leaning Lukashenko is under heavy pressure from protestors claiming a rigged election. Aggravating the overall pressure on Russia are accusations that Russian opposition leader Navalny was poisoned. Further disorder in Belarus and especially Germany’s next steps in how it treats its relationship with Russia over the Navalny issue are pivotal for the ruble in addition to the direction in oil prices. The EU is a critical market for Russia’s energy exports of oil and gas.
USDRUB has cleared 75.00 even as the oil price has headed higher on the recent geopolitical concerns for Russia concerning Belarus political instability and the fate of Russian opposition leader Navalny, now in a coma in a German hospital after requiring emergency hospitalization in Russia, with German doctors claiming he was poisoned and Germany demanding answers from Russia’s political leadership.
Quarterly Outlook Q2 2022
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