FX Update: Rising dollar an eventual wrecking ball

Forex 4 minutes to read
John Hardy

Head of FX Strategy

Summary:  The market is trying to put a brave face on after the treasury market trauma of late last week send shockwaves across asset classes. The hopeful narrative is one that yield-curve control to backstop asset markets is imminent. Already, the ECB is practicing rhetorical pushback against rising yields, and the Australian RBA stepped up long bonds purchases overnight. Surely the US is set to follow? Eventually, yes, but what will it take to get to eventually?


FX Trading focus: Rising USD an eventual wrecking ball

On Friday, I penned a longer piece discussing the path to Fed yield curve control – with the general conclusion that the Fed doesn’t want to take this drastic step at this time unless its arm is twisted forcefully by the market – either via a market crash or due to a real rate rise that is perilously steep (and persistent) and has the Fed fearing an impact on the economic and labour market outlook. The bar for the latter is rather high, given the twin factors of a vaccine roll-out progressing rapidly and allowing the economy to increasingly open up and the fresh $1.9 trillion additional stimulus that is incoming soon (most likely without a minimum wage hike, it appears) . Regardless, the veritable parade of Fed officials out speaking this week will bear close watching for whether last week’s treasury market volatility was sufficiently violent to trigger any consistent pattern that Fed members’ concern levels are rising.

Why the continued USD resilience and even strength?
The way this week (and this month) has bolted out of the gates, the market may simply be extending its celebration of the solid bid coming back into the US Treasury market on Friday and to a degree overnight, reversing much of the last Thursday’s eruption in yields. In fact, for 2-year treasuries, Thursday’s move was entirely erased on Friday, while for five and seven-year treasuries, the move was only about cut in half. But if the US yield move was largely erased at both the short end of the curve and for the very long end, why didn’t the US dollar also reverse back lower?

The possible answer is a shift in the awareness of other central bank moves relative to the seemingly nonchalant Fed: the ECB’s Schnabel out late last week warning on the rise in Euro Zone bond yields and the RBA overnight announced that it will double the pace of its longer-maturity bond purchases. These announcements leave the impression that other central banks’ puts are already incoming at these levels, and could be behind the USD resilience – i.e., that these moves remind us that the Fed doesn’t operate in a vacuum. The RBA’s move was likely motivated in part by not only rising yields, but also a steeply rising exchange rate, with AUDCNY posting new cycle highs since early 2018 last week before the hefty correction. The RBA meets tonight – its guidance will likely focus on both concern that longer rates rose too quickly as well as recent exchange rate moves.

But the key takeaway from yesterday’s close for FX traders is that the USD bears suffered a major setback last week, one that looks tactically decisive and even ominous in the likes of AUDUSD on a weekly candlestick basis (more below). Further damage will be done to the broader USD bearish case if EURUSD follows through lower through 1.2000 and sets that pair back into the 1.16-1.19 range again, which could mean a bit of a walk in the desert for USD bears of a few weeks or more until either negative real rate fears resurface down the road for the US (from excessive fiscal stimulus and spiking inflation levels) or the Fed hints at yield curve control, though my suspicion is that “eventual” yield  curve control will be something we have to wait a fairly long time for and will only be provoked by a market accident.

In the meantime, USD strength is eventually toxic for global market prices if it backs up more than a couple of percent.

Chart: AUDUSD weekly
An almost cataclysmic reversal in AUDUSD on Thursday and Friday created a rather profoundly engulfing bearish weekly candlestick, with most of the selling taking place on Friday. The only hope for bulls here would be that the move was exaggerated by end-of-month flows after a strong month for the Aussie, and stop-loss driven selling ahead of tonight’s RBA meeting. A quick rally and close well above 0.7900 would be needed to quickly neutralize the downside risk. Until then, this looks like a reversal that could follow through toward the 0.7565 prior range lows and even toward the prior major top around 0.7415 (note that this number almost coincides with the key support of the 61.8% Fibo of the last large rally wave at 0.7380. Note China’s slowing numbers overnight, with the official Manufacturing PMI out at 50.6 matched the post-pandemic nadir low of 50.6, as was the case for the Non-manufacturing PMI at 51.4.

Source: Saxo Group

Upcoming Economic Calendar Highlight (all times GMT)

  • 1300 – Germany Feb. Flash CPI
  • 1400 – US Fed’s Williams (Voter) to Speak
  • 1405 – US Fed’s Brainard (Voter) to Speak
  • 1430 – Canada Feb. Manufacturing PMI
  • 1500 – US Feb. ISM Manufacturing
  • 1520 – ECB officials Guindos and others speaking
  • 0030 – Australia RBA Cash Target, 3-year Yield Target
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