Head of FX Strategy
Summary: The US dollar has traded weaker still this morning after the earthquake of last Thursday’s October US CPI release, but the USD selling looks a bit steep here without fresh drivers in the form of incoming data that further lowers Fed expectations. We also have to zoom out and recall how far the USD bull market took us before this latest correction, as it would take considerable further USD selling to cement a major reversal of the secular trend. Elsewhere, the next two days have a strong sterling focus on UK CPI and the budget statement.
FX Trading focus: USD continues to struggle, but zooming out important. UK focus next two sessions.
The US dollar continues to stumble, with EURUSD trading above 1.0400 this morning and strong new highs in AUDUSD as discussed in the AUDUSD chart caption below. The latest driver was another strong blast of risk-on overnight in Asia, as markets there celebrated the friendly tone in statements from both sides after the Xi-Biden summit and the warning against any power threatening the use of nuclear weapons. Headlines touted “dovish” talk from Fed Vice Chair Lael Brainard yesterday, although her comments were quite measured and merely confirm what the market is pricing anyway, namely a step down to a hike of 50 basis points in December. At the same time, Brainard included the comment that “I think what’s really important to emphasize, we’ve done a lot, but we have additional work to do.” At the moment, the USD is lower chiefly on the melt-up in sentiment rather than any new lowering of Fed expectations. If we go out to the June 2023 3-month EuroDollar STIR future, it is trading five basis points below last Thursday’s close.
Stronger fundamental headwinds for the US dollar would likely require a poke from incoming data. That includes today’s PPI, not normally a market mover, though a significant shocker in either direction could get more attention than usual, given how far this market has traveled in recent days. The October US Retail Sales report tomorrow will carry a bit more weight, but incoming data watching takes considerable time to accumulate evidence. Eventually, weaker data has to mean traditional end of cycle phenomena like credit stress and weaker asset markets, but the market only has eyes for China opening hopes and US yields. We will need some kind of market that suggests a shift before pushing back too hard against this backdrop. Also, if we zoom out on something like the EURUSD chart, it is still rather remarkable how little damage has been done to the massive downtrend from late last year. The 38.2% retracement of that entire move doesn’t come in until just above 1.0600, an interest area as that is near the major 2020 post-pandemic outbreak low at 1.0636. Still, we have touched the 200-day moving average at 1.0430 today, the first touch since June of last year, a major milestone.
Chart: AUDUSD
AUDUSD is bulling up into a pivotal Fibonacci retracement, the 61.8% of the down-wave from the 0.7137 top just a scant few pips above this morning’s highs. This last leg of the rally has been driven by very strong risk sentiment in Asia on hopes that China is set to come on-line with more stimulus, given weak economic data overnight. As well, the friendly tone in statements from both sides after the Xi-Biden summit was a boost to sentiment. Still, Australia will prove far more sensitive to the RBA’s rate rises, which continue to lag the Fed’s. The RBA is rightly concerned about the coming impact to household budgets from rising mortgage payments as the majority of Australia’s mortgages are floating-rate, so even after a sharp mark-down in Fed expectations since last Thursday has failed to tighten the AU-US 2-year yield spread much. A more interesting test for AUDUSD somewhere down the road would be a backdrop of slightly lower yields on concerns about an incoming inflation and an equity market/risk sentiment that are in the dumps on concerns for the economic outlook. Instead, we have falling yields combined with a wild sprint higher in risky assets, particularly in Asia – a mix that will likely continue to support AUD as long as it lasts. Looking higher, the bigger structural level is perhaps 0.7000, a huge level in recent years, while the 200-day moving average comes in a bit below that level near 0.6950. Bears have nothing to go on here tactically, only a powerful pattern reversal would provide a trading hook, with a fall below 0.6500 needed to begin reconfirming the downtrend.
Sterling is in focus over the next couple of sessions, both on tomorrow’s October UK CPI release, but particularly on the Autumn Budget Statement from Chancellor Hunt on Thursday. It is too early to expect the kind of slowdown in inflation we have seen in the US data, but the market is looking for core UK inflation to ease to 6.4% YoY from the cycle peak thus far of 6.5% in September and the headline is expected in at 10.7% YoY vs. the cycle-peak matching 10.1% in Sep. An upside surprise may not provide sterling support as it points to a worse recession from more BoE tightening at the margin and fiscal tightening to bring inflation under control. But the big vote-of-confidence test that awaits the currency is the Thursday budget statement. New details are emerging, including the fiscally risky, but politically necessary likely reinstatement of the pension “triple lock” (indexing the state pension benefit to the highest of the CPI, average wages, or 2.5%) after it was suspended for 2022-23 because of a one-off increase in wages due to the pandemic response. Other measures include talk of a new 40% windfall tax on electricity producer profits, extending the windfall tax on oil and gas companies out to 2028 and raising that tax to 35% from 25%. Sterling has gotten a free ride over the last few sessions of wild risk-on, but EURGBP (a better pair for isolating sterling relative strength) looks volatile ahead of the CPI and the coming fiscal austerity points to a downward spiral into recession this winter. A move above 0.8830-70 suggests markets are concerned about the structural outlook for the UK and a new trading range for the pair up into 0.9000+.
Table: FX Board of G10 and CNH trend evolution and strength.
A very weak USD trending score – it is rare to see average G10 currency trends hitting an absolute value of 6 or more. (The aggregate reading for USD, for example, is the average of all the USD/G10 currency pairs) Elsewhere, interesting to note CAD moving in directional sympathy with the US dollar, while CHF has enjoyed the tick-down in yields and the SNB’s Jordan’s mention of a rate hike at the December SNB meeting.
Table: FX Board Trend Scoreboard for individual pairs.
A bit odd to see the Scandies not doing better here – is that some concern creeping in at the margin on renewed fears of rising energy prices as colder weather is finally set to settle over Europe in the days ahead? Some of the USD trend readings are getting into rarified territory – with spot gold at the hottest reading of 7.9. AUDCAD has tracked AUDUSD and is nearing the 200-day moving average.
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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.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
