Head of FX Strategy
Summary: The US dollar has supposedly become a pro-cyclical currency, enjoying the strength from strong economic performance and a surge in longer yields, but can we really continue to see a rising US dollar, rising US yields and rising risk sentiment for much longer? The US labour market report later today the next test on that front. Elsewhere, sterling has broken fresh ground and looks ready to trend higher.
FX Trading focus: Something contradictory in current USD developments.
We discussed this on this morning’s Saxo Market Call podcast, but it looks odd that the US dollar seems to be trading as a pro-cyclical currency, moving up in line with strong US data and higher US yields and higher risk sentiment. This is very much against the pattern of much of 2020 and the post pandemic outbreak experience. And on that note, something doesn’t feel right, because a stronger US dollar and higher US long rates are tighteners of liquidity and this is a market that has built itself aggressively on the assumption of an extremely accommodative policy stance and endless liquidity. At some point soon, especially if yields rise quickly from current levels, I would expect volatility in risk assets to ratchet higher and some of the speculative froth to come out of the market. But in such a case, would the USD then also prove a safe haven currency and stay firm? I suspect it would versus G10 small currencies and EM currencies, but I have a hard time believing that the USD is win-win proposition.
Something doesn’t feel right here – perhaps today’s US jobs report will provide some enlightenment, especially if it fits with other recent labor market data and is notably stronger than expected. Do yields continue to pull higher? If they do so, will risk sentiment fret the implications, etc.? Further out, if a huge post-vaccine boom awaits, it should be especially strong in the US with additional stimulus coming on-line soon there and inflation should overshoot the worst there initially, and meaning lower real yields (yield after inflation) than elsewhere. (That is, unless, as I asked in a recent post, inflation is more globalized, which allows the USD to hold its own a bit better as other FX would be more quickly impacted by falling real rates on higher inflation – the EUR but especially the JPY certainly at risk if we are talking about an all-out inflationary scenario in energy).
The January US Nonfarm Payrolls change for today is expected around +100k vs. the -140k notched in December, while the ADP number registered a +174k gain for Jan. The Covid case count in the US is falling like a stone – with the 7-day moving average down by almost 50% in the just over three weeks since the peak. The US was never good at locking down and a horde of service jobs will come back quickly once normal activity can get the green light – hopefully soon.
Chart: EURUSD at a crossroads
EURUSD has broken down through the key 1.2000 area and the upward loping trendline and is now having a look at the 100-day moving average. If the pair cannot stage a strong recovery here back well above 1.200 and heads even further south to below the 61.8% Fibonacci retracement around 1.1890, the prospect for a test of the 1.1600 old range low or even a push all the way to 1.1500 begin to open up, which would require a reassessment of the weaker USD narrative for at least the medium term. In short, EURUSD looks at a crossroads here.
Sterling ready to trend?
I broke down the sterling reaction to the Bank of England meeting yesterday, with the headlins simply that taking away the NIRP option for the foreseeable future is a green light for capital inflows. The entire UK yield curve lifted higher yesterday as well, and some are even seeing signs that the Bank is turning toward an outright removal of accommodation, and the 2-year Gilt yield shifting from -18 basis points at the very beginning of the year to -11 basis points before the meeting to over -4 basis points now suggests that expectations for the BoE have indeed achieved a shift that could prove secular. And as for sterling, looking at where it is coming from on charts from GBPAUD and EURGBP, the pound looks ready to trend to the upside for a while.
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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.
