Forex

Dollar down as US yields retreat

John Hardy

Head of FX Strategy

Summary:  As Treasury yields sank to their lowest level in weeks, the dollar declined on perceptions of US slowdown risks and new hurdles along the Fed's hawkish path.


We are seeing a surprisingly quiet start to the week given the ugly atmosphere at the APEC summit in Papua New Guinea over the weekend, one that failed to produce a communique for the first time in its 25-year history, due apparently on China’s unwillingness to agree to a portion of a proposed communique that included the phrase “unfair trade practices”.

US vice-president Mike Pence’s attack on China’s One Belt, One Road initiative as a trap that would saddle countries with unaffordable debt and Xi’s criticism of US protectionist measures suggest that a US-China trade deal will not be on the agenda at the the G20 meeting in Argentina at the end of this month.

The USD opens the week on its back foot after further weakness Friday. The sell-off has deepened sufficiently to suggest that we may have a broad reversal on our hands after the USD managed to poke to new highs for the cycle in USD index terms. The key proximate driver of USD weakness is likely the dip in US yields all along the curve. Recent, more cautious wording from the Fed is seeing the market pulling back on pricing further rate hikes beyond the December Federal Open Market Committee meeting. At present, the market is pricing slightly higher odds that the Fed hikes once or not at all in 2019, assuming a December hike. 

A new US tariff schedule for Chinese imports may roll into effect on the first of January, just as the tax deal stimulus is beginning to fade, and this would likely give the Fed pause. US 10-year yields are also pushing lower and opened today only seven basis points clear of the pivotal 3.00% level. A significant plunge below this level despite the torrent of US Treasury issuance would point to a market that is extremely sceptical on the prospects for the US economy from here and is seeking safety in droves.

The initial impact of a weaker US yield curve may point to a weaker US dollar, but if the US economy is indeed rolling over in the coming quarter or two, some support may eventually arrive in the form of a safe-haven bid.

The Brexit situation has triggered a chunky downdraft in sterling, but due to the lack of visibility from here for the Brexit process, the real movement has been in implied volatilities, skewed to the risk of further sterling downside as the tough path for May’s deal with the EU points to a heightened risk of a no-deal Brexit. Three-month EURGBP volatility has spiked to near 11% and GBPUSD volatility to 13%, the highest since shortly after the Brexit vote in 2016. 

Traders should respect the potential for significant moves in sterling in coming weeks – any view may be safest to express with long volatility trades, and the only way to “safely” cheapen these (and by doing so giving up the ability to hedge as easily in the spot market) is via options spreads – for example, buying a EURGBP call and selling a call with a higher strike price.

Given the significant options skew and richness of the implied volatility for the lower-delta strikes, very attractive risk-reward strategies are available in the event that the bottom drops out of sterling in coming months. Over the weekend, the European Union’s Barnier proposed that the transition period last through 2022 to allow a smoother exit, with reduced funding of £10-15 billion annually during that period. This should be a busy week for headlines in the UK as we look ahead to the Brexit summit this coming weekend on November 25.

Chart: EURUSD

The attempt below 1.1300 has been rejected here and could point to the pair exploring the range back toward 1.1800, though there may be some potential hurdles for the euro remain in coming weeks and months, in particular Brexit, where a no-deal exit will see significant collateral damage back into the EU economy and the euro. We also have Italy’s ongoing budget impasse, where the next focus is on the mid-December EU summit. 1.1500 is a significant tactical pivot and choppy trading may rule the day.
EURUSD (source: Saxo Bank)
The G-10 rundown

USD – the greenback is on its back foot as US yields fall. Further progress lower may be halting and choppy until we have a look at the temperature between Trump and Xi at their meeting in Buenos Aires at the end of the month.

EUR – the euro has now more forcefully rejected the recent dip below 1.1300, but hard to see a persistent and profound bid for euro developing without clarity on Brexit and clarity on the immediate fate of Italy’s budget negotiations as the mid-December EU summit.

JPY – would have expected a stronger yen bid with US rates having dropped so quickly, but the strong bid for EM asset points to an interest in strong risk appetite and perhaps carry trading, which are not yen supportive. USDJPY in limbo until above 114.50 or below perhaps 112.00.

GBP – sterling likely locked in a nervous range as traders will prefer to take a position via the options market rather than suffering constant headline risk. May is hanging in there so far and will likely do so for quite a while longer if she survives this week.       
  
CHF – EURCHF likely biding its time until the December EU summit or firmer Brexit news – looks rather strong given the suddenly very shaky Brexit situation last week. 1.1500 the next key there.

AUD – strength in AUD hardly dented by the ugly atmosphere at the APEC summit and suggests more potential upside in the short term – the next focus area is 0.7450 in AUDUSD, the current location of the 200-day moving average.

CAD – USDCAD is a weak participant in the USD sell-off as the market has grouped the two currencies together in the crosses and as the massive oil sell-off weighs at the margin on CAD’s fortunes.

NZD – NZD getting rich in AUDNZD terms, but hard to wax bearish on the currency unless strong risk aversion returns or the recent large boost in yields at the short end of the New Zealand yield curve is reversed again or underperforms global peers. 

SEK – EURSEK stuck in neutral after the break below 9.30 that appeared so promising. Strong November EU PMI’s on Friday and/or hawkish rhetoric from Riksbank officials might be the quickest rout for follow through SEK strength.

NOK – the krone suffering as oil prices slide but we are not yet seeing the catalyst for a significant EURNOK rally beyond exploring higher within the range to 9.75.

Upcoming Economic Calendar Highlights (all times GMT)

• 1400 – Norges Bank’s Nicolaisen to Speak
• 1500 – US Nov. NAHB Housing Market Index
• 1545 – US Fed’s Williams (Voter) to Speak
• 0030 – Australia RBA Meeting Minutes
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