USD rally survives amidst CNY unease; NZD weak ahead of RBNZ

John Hardy

Head of FX Strategy
John Hardy joined Saxo Bank in 2002 and has been Head of FX Strategy since October 2007. He focuses on delivering strategies and analyses in the currency market as defined by fundamentals, changes in macroeconomic themes, and technical developments.

Stories suggesting a further softening of the Trump administration’s stance on inbound investment in key industries did little to engineer a rally in risky assets yesterday, suggesting that this is not the only issue on the market’s radar at the moment. Chinese equities were in for another drubbing overnight as the key CSI 300 index has crossed the threshold into bear market territory.

In FX, the most interesting recent development has been the sharp weakening of the Chinese yuan over the last couple of weeks. The degree to which this has failed to trigger an even more widespread sense of unease is rather remarkable this time around, given the near panic that spread across markets when China changed its FX regime back in 2015. 

The complacent view is that China will make good on its commitment to stability and that this is just an unwinding of unnecessary strength in light of softening Chinese data. The hope is that China will merely take the yuan back to a more neutral level versus the wider basket, meaning that the move will have to end rather soon. Only a small minority are suggesting that the overvalued yuan is finally set for a new devaluation of a magnitude that will exceed the 2015-16 move. We have preferred to take China at its word on the desire for stability as the nation seeks more widespread use of its currency in global trade in a move towards strategic “de-dollarisation”, but both eyes on the CNY charts in case that assumption proves misplaced, as global markets are not ready for a large CNY devaluation and its implications.

Elsewhere, the recent EURUSD rally finally petered out right at a very technical Fibo retracement level above 1.1700, providing the local line in the sand for whether the USD rally survives there. The EU political fracturing should be in wide evidence at the EU council summit tomorrow and Friday and we still have the open question of whether Angela Merkel’s leadership of Germany has a future.

The kiwi is in focus over the Reserve Bank of New Zealand meeting late today (early Thursday for Asian traders) as new governor Adrian Orr has made a splash with his two-way guidance and the RBNZ’s new dual mandate – similar to the Fed’s – softens the focus on inflation, not that the latter has been an issue of concern locally. NZDUSD looks very elevated in the wide angle lens, given the ongoing divergence in central bank policy that has taken the 2-year yield spread to the US to its most negative level in modern history at below -50 basis points from north of +300 basis points back in 2014. 

Chart: NZDUSD weekly

NZDUSD is threatening big levels ahead of the RBNZ meeting tonight. While the market has recognised that Orr has shifted the outlook to more potentially dovish than previously, the NZ economy hasn’t been throwing off any strong signals – rather the NZD is likely to be swayed more by the regional FX weakness inspired by the weaker CNY and weaker risk appetite on top of Orr’s dovishness. A clean break here of the somewhat blurry line in the sand around 0.6800 could open up for a full-bore sell-off into the post-Global Financial Crisis lows below 0.6300. 

The G-10 rundown

USD – the greenback rally is surviving for now and USD resilience likely to continue as long as risk appetite globally looks under pressure, with the possible exception of the JPY. Yesterday, I came across a great piece parsing some of the Fed’s Powell’s language  and suggesting that the Powell Fed is far different from its predecessors in wanting to avoid financial instability and bubbles.

EUR – while EURUSD was turned back at an important resistance, we’re rather impressed with the euro’s resilience given the drumbeat of EU existential risks from here will only be picking up. Also, on another downdraft in equity markets, shouldn’t EURJPY drop much lower?

JPY – the yen should be hitting its stride in these conditions – but we have the constant headline risk of Trump trade policy providing bursts of strength over the last couple of sessions. We would expect JPY outperformance across the board on global risk deleveraging.

GBP – sterling looks very weak and lonely in this backdrop and on the grind of Brexit uncertainty. Bank of England governor Mark Carney will be out speaking later on the Financial Stability Report. Will EURGBP finally spill over higher after teasing so many times at the top of the range near the 200-day moving average?

CHF – the EURCHF is surprisingly  resilient despite the EU existential focus here – we’ll have to come up with an explanation if this continues.

AUD – the Aussie should remain out of favour – perhaps save for in AUDNZD as we discuss below – on the negative China focus. The big miners’ stocks are surprisingly resilient here however. Why?

CAD – the oil rally on Iran news is rather supportive, but weak risk appetite is softer and weighing more on the negative side. Governor Poloz will be out speaking later today.

NZD – we suspect the RBNZ’s Orr will continue to focus on two-way risks from here and he may even promote the downside risks on the latest exchanges over trade and the warning signals coming out of China. NZDUSD possibly on the cusp of a larger scale slide, especially if weak risk appetite worsens further.

SEK – the krona doesn’t do well in these conditions and EURSEK has a bit more room to run to the upside before threatening more important resistance near 10.50.
 
NOK – NOK downside risks prevail in this environment despite the bid tone in oil. EURNOK risking another leg higher if it works above 9.50, though NOK increasingly too cheap. 

Upcoming Economic Calendar Highlights (all times GMT)
0830 – UK BoE’s Carney to Speak about Financial Stability Report
1100 – Czech Central Bank Rate Announcement
1230 – US May Advance Goods Trade Balance
1230 – US May Durable Goods Orders
1430 – US Weekly Crude Oil/Product Inventories
1500 – US Fed’s Quarles (Voter) to speak
1900 – Canada Bank of Canada’s Poloz to speak
2245 – New Zealand RBNZ Official Cash Rate

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