Head of FX Strategy
Summary: The US dollar has made a modest show of turning stronger in the wake of a strong US ISM Manufacturing index, which saw US treasury yields jump higher. But yields are rising elsewhere even more quickly, suggesting that the US dollar may have a hard time impressing unless financial conditions come under pressure after the recent easing. The next couple of sessions through Friday’s US jobs report and ISM services are important for establishing the lay of the land.
FX Trading focus: Yield rises elsewhere outpace US yield
While US treasury yields are an important coincident indicator for US dollar direction, the impact of a rise in yields like the one we saw yesterday may continue to prove rather modest as long as financial conditions aren’t likewise tightening. And over the last couple of weeks, financial stress measures have generally eased, whether its market volatility itself or in an important indicator like credit spreads. So the ability of the US dollar to post a turn back to the strong side is an open question through the key data for the remainder of this week: the May NFP change and earnings data and May ISM Services data points tomorrow.
Further holding the USD in check is a string of more hawkish developments from other central banks, for example from the Bank of Canada yesterday (more below). These have yields at the short end and even at the long end of the yield curve for many currencies outpacing the rise in US yields. German Bund yields are posting a new high for the cycle today, while the US 10-year benchmark is still a full 30+ basis points below its cycle high. The same for the UK 10-year Gilt yield, which hit a new cycle high above 208 bps already yesterday and is following through higher today. In other words, when the impulse for new cycle highs in yields is driven by the Fed and market conditions tighten notably, the USD leads, when conditions are maintaining an even keel and other CB’s are leading the charge, the USD performance is likely to prove more mixed or even weak.
The JPY, naturally, is suffering strong fresh downside pressure on the general rise in yields, with USDJPY touching above 130.00 this morning. But given the new highs in Bund yields, for example, could be interesting to watch whether some of the other JPY crosses like EURJPY will outperform and reach new cycle highs first – watching 140.00+ in EURJPY.
Chart: USDCAD after Bank of Canada
USDCAD broke down further in the wake of the Bank of Canada meeting, which delivered the expected 50 basis point hike to take the policy rate to 1.50%, but offered up quite hawkish guidance in the final sentence of its policy statement yesterday, that the bank is “prepared to act more forcefully if needed to meet its commitment to achieve the 2% inflation target.” Between the lines, this means the willingness to hike by greater than 50 basis points. In response, Canadian short yields surged further and USDCAD punched down to new local lows well below the 200-day moving average before the modest USD comeback post-ISM Manufacturing release kept the action choppy. This 1.2600-60 looks the last gasp area for the pair to find any support – otherwise a capitulation toward the range lows to 1.2400 looks may lie ahead. Impressive that CAD has brushed off the oil market correction this week.
ECB hawkish talk intensifying. While the timing of the first hike for July seems too thoroughly flagged to expect a June 9 move, we have had the ECB’s Holzmann out yesterday calling for a 50 basis point hike to avoid inflation expectations spiraling out of control. And today the Bank of France’s Villeroy said that inflation is “too high and too broad” and this calls for a “normalization” of monetary, which he oddly tried to differentiate from “tightening”. ECB expectations are back to the highs for the cycle and some analysts are calling for the ECB to hike by 50 basis points at one of the meetings this year. The December ECB meeting is now priced for more than 100 basis points of rate hikes in total, meaning rising odds that one meeting will see a larger than 25-bp rate hike, assuming no June lift-off.
Table: FX Board of G10 and CNH trend evolution and strength.
The US dollar looks in danger of a larger scaled capitulation and even full reversal in places if it can’t stick a more impressive rally through the end of this week. But the JPY will likely continue to lead the charge lower as long as yields continue higher.
Table: FX Board Trend Scoreboard for individual pairs.
Most pairs threatening a trend cross are of little consequence, but EURSEK is an interesting one as a downside break of the range is also potentially in play here if it continues lower and also would fit with the solid easing in financial conditions we have seen recently.
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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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