Head of FX Strategy
Summary: US yields are back lower in the wake of a tepid CPI report for February and a reasonably orderly 10-year US Treasury auction, and risk sentiment and commodity prices blasted higher in Asia, sending the US dollar and commodity FX higher. The first major test for the USD rally here is in EURUSD, where the pair is poking into a key resistance zone ahead of the ECB meeting later today.
FX Trading focus: EURUSD hitting pivotal resistance zone ahead of ECB meeting
The passage of the massive $1.9 trillion US stimulus in the House will see the bill passed to President Biden for signing, likely on Friday. This will supercharge the new era of fiscal dominance in the US – with all of the concerns of the inflationary implications (long term caveat – that outlays continue to accelerate and a mechanism is found to avoid force-feeding new treasury issuance into the market – an eventual necessity for proper MMT to carry the day). Meanwhile, frustrating the implications of this important development, the treasury market was orderly and US yields have retreated after a reasonable US 10-year Treasury Auction (though on this morning’s Saxo Market Call podcast, we discussed that the failure of sharply higher yields relative to previous auction to bring in a heavier bid from foreign bidders suggests some ongoing demand weakness, even if the bid-to-cover was reasonable). The Feb. CPI only inched 0.1% higher month-on-month, vs. 0.2% expected.
Chart: EURUSD
Fairly straightforward stakes here for EURUSD, which has bounced from the recent 1.1836 lows to the key zone between 1.1950, the area of the prior low and the psychologically key 1.2000 level. The pair needs to avoid a close above 1.2000 if the recent break lower is to retain meaning (arguably, the pair needs to see other side of next Wednesday’s FOMC meeting before we can rely on technical developments before then.)
Yesterday, I went through the challenges for the ECB to do much to aid the economy with monetary policy, which can’t move the needle at these levels of accommodation. The EU will remain the last major economic bloc to accomplish the transition to fiscal dominance because of the unstable multiple sovereign/single currency and central bank foundations. Still, the ECB could do enough to keep the euro weak if it panics and signals a desire to keep long EU yields capped today or in the near futures. This likely only serves as a notable catalyst for downside pressure on the euro, if US and other yields resume their recent rise to new highs for the cycle. Regardless, after an “orderly” US treasury auction yesterday and yields tamed for the moment, EURUSD is consolidating back into the key zone of resistance that must cap if the bears are to rule the day – the 1.1950-1.2000 shown in the chart below. With yields at the longer end of the curve in Europe also quite orderly, the ECB may be tempted to skip signaling any intent to do much higher. Lagarde and company would do well to rattle the EU commission’s and member governments’ cages on the need to expand fiscal stimulus.
Graphic: FX Board of G10 trends and momentum
USD momentum flagging badly here (biggest two-day negative shift in momentum), and gold momentum reversing as well as we await next week’s FOMC meeting, likely the chief arbiter of near term USD direction, together with US Treasury yields, with EURUSD already in a pivotal technical area today as noted below. Note as well the ongoing weakness in CHF (slowing downtrend, however, ) and JPY (not slowing) as well as NOK showing still positive momentum and the strongest rally reading.
NOK as EURNOK nears a critical threshold at 10.00.
Yesterday, I noted NOKSEK as an interesting pair to track for further upside potential on the EU’s sluggish vaccine roll-out and restricted fiscal impulse relative to elsewhere, while NOK is enjoying a high-flying resurgence in oil prices. EURNOK is certainly worth adding to the list of NOK crosses to watch as the pair nears the critical 10.00 level, a notable psychological one and actual chart point on many occasions in recent years. The Norges Bank is expected to be one of the world’s first among DM’s to hike rates and a rapid normalization of economic activity globally that boosts the oil price higher from here could send EURNOK well south of 10.00, to perhaps 9.50 later this year if oil trades to 75 or higher. NOK 2-year swap rates have risen some 30 bps since the beginning of the year to just shy of 90 bps.
Bank of Japan want to have and eat some cake
The Bank of Japan is in an increasingly awkward position as global yields rise – somewhat similar to the case for Europe. The rise in yields recently pulled the 10-year JGB to 18 bps, slightly above its highest levels since implementing a yield-curve-control (YCC) policy back in 2016. Let’s recall the reason that the BoJ originally implemented that YCC policy: it was an effort to ensure that long yields didn’t go to low – not too high, the opposite concern the bank has now. According to a Bloomberg article discussing those in the know on the Bank of Japan policy review, the bank is hopeful that it can have some cake and perhaps eat a little bit of it too by somehow engineering more dynamism in bond trading at the longer tend while ensuring that yield moves will have to remain constricted. Good luck. The one thing for certain is that the JPY has been supremely weak and getting weaker on the commodity reflation and rising global yields focus and the Bank’s final announcement on March 19 could have major implications if the bank decides to keep yields capped (and yields elsewhere then resume their rise). Mixed signals from Governor Kuroda and Deputy Governor Amamiya have rattled longer maturity JGBs – the bank needs to send a clearer message.
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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.
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