Equities: New extremes and a challenging opportunity set
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Head of FX Strategy
Summary: Outside of solid AUD volatility, this has proven a boring week in FX, assuming today’s US PCE inflation print doesn’t move the needle for the US dollar. Next week should be a different affair, with the next batch of important US data and three important central bank meetings, including the FOMC meeting on Wednesday and the Bank of England and ECB meetings up the following day. The market feels dangerously complacent.
FX Trading focus: Market extremely complacent ahead of important macro risk calendar next week. More potential for ECB and BoE to impact expectations for next six months than the Fed.
Yesterday saw a modest pick-up in US treasury yields on yet another drop in the weekly claims (to 186k, the lowest since last April) and a slightly firmer Q4 US GDP estimate than expected. This helped keep the USD from losing further ground, but it feels as though USD traders see little need to trade here, with a string of important US macro risks coming into view next week, including the FOMC meeting on Wednesday, the same day as the ISM manufacturing survey, and then Friday’s jobs and earnings data and ISM Services (recall the oddly large swoon for the December ISM Services survey).
The chief driver of USD weakness of late has been the powerful easing of financial conditions. As we have noted on the podcast of late, one major measure of financial conditions suggests that financial conditions in the US are now easier than when the Fed began hiking rates early last year. Some of that is on USD liquidity coming from the US treasury as it winds down its account with the Fed, and there is a further $300 billion or so of further fuel if the treasury takes the account close to zero in coming months, which it will do as long as the US debt ceiling situation remains unresolved. Elsewhere, the Bank of Japan’s operations have added enormous global liquidity as well, the latest being its huge 5-year loans for bonds operations. Endless irony in the BoJ driving enormous liquidity easing as a part of its supposed roadmap for exiting from hyper-easy policy – that has been the flip-side of JPY strength.
Cable could prove one of the more vulnerable USD pairs next week to USD strength if we see a combination of market complacency yielding to a bit more uncertainty (bad US data could prove bad news for risky assets on the impact on corporate earnings, and supportive of the USD, while stronger than expected US data could support the USD on repricing the forward Fed expectations back higher). Only a very gentle soft-landing scenario would seem able to keep the USD bears in business here. As well, we could see the Bank of England allowing itself to indulge in less hawkish guidance (to reduce their role in adding to the severity of the oncoming recession) after the recent sterling strength and decelerating inflation data. There is certainly plenty of room for a consolidation lower to 1.2200 and perhaps even 1.2100 without triggering a major reversal, while a move challenging to 1.2000 would begin to more thoroughly neutralize the bullish case encouraged by the recent test and strong rejection of the break below the 1.2000 area and 200-day moving average.
The ECB will have to be a bit clearer on its policy guidance at next Thursday’s meeting, with the hawks touting multiple 50 basis points moves, while the doves seem more in favour of not guiding beyond the presumed 50 basis point hike next week. The ECB is priced to do more tightening than any other G10 central bank over the next several months, with some 140+ basis points of hikes priced in through the July meeting (50 basis points next Thursday, with 90 bps to follow). Will be hard for the ECB to surprise on the hawkish side and with the 2yr2yr EU-US yield spread approaching parity recently, the relative rate expectations will likely have a hard time rising more in the euro’s favour. With the EURUSD rally losing momentum, it would seem the side of least resistance for the pair is lower, with enormous room for a solid consolidation with necessarily reversing the up-trend (a retreat to 1.0500 in the coming couple of weeks.)
Finally, it’s been a very quiet market for some time, but do note the oil price here at the top of the range – a big move higher in oil prices would not sit well with this complacent backdrop.
Table: FX Board of G10 and CNH trend evolution and strength.
The weak volatility in FX is quite visible in trend readings with an absolute value of less than one for the majority of . The only truly big move this week was AUD on Australia’s CPI release and in anticipation of China reopening. That move looks a bit stretched in a broad sense.
Table: FX Board Trend Scoreboard for individual pairs.
Most moves this week outside of AUD pairs have been uninspiring, but interesting to note the significant rejection of the EURSEK downside attempt this week. The gold move higher may be tiring as well as this week draws to a close, in momentum terms suggesting reversal potential (more likely on a resilient data/strong USD scenario next week, one would think).
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