USD in the crosshairs USD in the crosshairs USD in the crosshairs

FX Update: A problem of signal quality

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  Interpreting coincident indicators and important drivers of FX fundamentals is a difficult task when the presence of central banks in particular makes it tough to determine the quality of the signal. More specifically, what is the quality of the USD sell-off here? Elsewhere, the macro calendar this week features an FOMC meeting that will likely see a Fed very determined not to make any new impression.

FX Trading focus: A problem of signal quality

In determining the quality of the USD move lower of late, a check of key fundamental indicators makes it tough to find much support for the scale of the recent USD move lower, other than simply this: around April 1, US yields stopped rising and began consolidating and since then the USD has been weak. Finding a spread widening here or there in recent days and the last week or two doesn’t yield much support beyond that simple fact, as I pointed out on this morning’s Saxo Market Call podcast in trying to break down why the recent solid bout of risk sentiment and especially another strong rally in key commodities prices has generally failed to see AUDUSD do much more than find support and trade sideways (chart also displayed and discussed below).

Finding the simple narrative in support of a weaker US dollar is rather more easy: the US is passing peak stimulus for now and the fiscal impulse in the bag will drive US imbalances and stimulate elsewhere too, particularly China and Europe, with the latter on the cusp of opening up (hence EURUSD poking at the last major Fibo retracement level just above 1.2100 this morning), and the Fed is thoroughly sidelined for at least a few months, wanting to get a feel for the “transitoriness” of the inflation pick-up and how rapidly the labor market is normalizing before indicating any new guidance. So that is where we seem to be trading, on the narrative and flows, with few signals on the fundamental front in support, and the difficulty of knowing whether signals are impossible to find as price discovery in credit and yields in general is so warped by the heavy hand of central banks.

And what are we going to get this week that will increase fundamental conviction or alter the playing field? Not sure there will be much to hang our hats on, as the FOMC would probably just as soon not be meeting this week if it could somehow cancel this Wednesday. (more or less the net impression of the ECB meeting last week that saw President Lagarde stonewalling on providing any guidance in the press conference). We have treasury auctions today (2- and 5-year) and tomorrow (7-year) and here there is more room for a possible signal to develop if US yields pick up a bit more  steam, and or the long end in Germany sees a break-out after remaining bottled up near key levels (-20 bps for the Bund).

Chart: AUDUSD vs. 10-year nominal yield spread and US real yields (inverted)
I put up the chart below in this morning’s Saxo Market Call podcast to help answer my own question of why AUDUSD wasn’t already trading higher, given near record high copper prices and hard-charging iron ore prices to boot. The fact that US real yields are not pushing back toward the lows (in red – and inverted) offers little support for the USD bears in terms of falling real value (I even made a spread of Australian versus US 10-year real yields for further analysis (not shown here) and this indicator is actually mid-to low range relative to the last few months and going nowhere, suggesting no support at all at the moment for a breakout back higher). Also – the 10-year nominal yield spread has moved in sympathy from the lows, but not in recent days. Finally, there is the overall difficulty of whether yield spreads are worth much, as the RBA is expanding its balance sheet at approximately the same pace, relative to the size of the economy, as the US Fed.

Source: Bloomberg

USDTRY fading most recent pop today.

At the weekend, US President Biden officially recognized the killing of Armenians in 1915, during the last years of the Ottoman Empire as a genocide, the first president to do so since Ronald Reagan. This provoked an irate and dismissive Turkish response and USDTRY had another go toward the key 8.50 level (which doesn’t remain “key” for long save for in a psychological sense when you have the kind of underlying drift provide by monster carry differentials, as Turkey features a 19% policy rate. One-year USDTRY forwards are just above 10.00.). As I pointed on the podcast this morning, credit spreads are not showing much renewed pain, a divergence that looks interesting and could be linked in part to domestic flows on poorly announced move against cryptocurrency trading in Turkey last week that saw two Turkish exchanges go under before a walk-back of the severity of the announcement.

Table: FX Board of G-10+CNH trend evolution and strength
The strongest trend reading on the FX Board is the USD bear move, which faces a key test this week on the FOMC meeting and Friday’s PCE inflation data, not to mention whether there is sufficient strength in the narrative and the drivers noted above to drive it lower still in the near term. The fading gold move after some recent upside promise shows the difficulty in working up a head of steam on falling real yields as a driver.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
The JPY trades that tried to get interesting last week (JPY crosses potentially rolling over to the downside) certainly failed to do so thus far. Elsewhere, NOK strength stands out, though oil price action is not supportive and EURNOK has failed so far to sustain price action below 10.00.

Source: Bloomberg and Saxo Group

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