Head of FX Strategy
Summary: The US dollar rallied briefly overnight on the fallout from civil unrest across China, but tilted lower again during the European session even as risk sentiment remained wobbly, with the euro posting the most remarkable round trip from weakness overnight to new multi-month highs versus the USD by lunch-time in Europe today. Commodity currencies meanwhile, particularly NOK and CAD, are suffering as crude oil prices have plunged to the lowest since January.
FX Trading focus: US dollar teases tipping points in USDJPY, EURUSD on weekend developments in China. Commodity currencies weaken.
The US dollar jumped higher on the open on the news of widespread civil unrest in China in opposition to Covid policy there. This is the standard playbook for “risk off”. But since then, we have seen a lot of churning by European lunchtime today. At first, the Japanese yen was stronger still as both US long yields and energy prices dropped sharply overnight, but the JPY then weakened sharply in the crosses and pulled off the new lows posted intraday in USDJPY. Elsewhere, the euro went from weakness to pronounced strength, as discussed below in the EURCAD chart, even managing a marginal new high against the US dollar before the EURUSD pair eased back from the cusp of 1.0500. The most straightforward story on the news out of China was the weakening of oil-linked currencies CAD and NOK, and even more so the commodity- and China-linked Aussie. Of course, the renminbi was also sharply lower, if rather volatile, as USDCNH jumped above 7.2000.
The news of civil unrest in China is a sudden and considerable reaction to what was supposed to be the focus this week: the strength of the important incoming US data this week. If developments escalate further in China and point not only to the risk of further delay in Chinese demand coming back online, but also to new supply-side disruptions, this could prove a game changer. Imagine fresh inflationary risks driven by supply-side constraints that are entirely un-addressable by central banks. We’ll have to give the story some time to mature, but in the meantime, this issue pulling on our attention at the margin could reduce the reaction potential around US data releases this week.
Chart: EURCAD
Having a look at EURCAD today to emphasize the huge divergence in these two currencies in recent weeks. CAD is limping on oil prices rushing lower still after last week’s plunge after the news out of China over the weekend, with major oil grades trading at new lows today not seen since all the way back in January. The euro has enjoyed the tailwind of falling oil prices, the sense of emergency around gas prices this winter fading (however fragile the longer term outlook) and on the ECB getting more serious on signaling further rate tightening. Some of today’s boost in the euro may have come on ECB’s Klas Knot (widely considered at the hawkish extreme among ECB members) arguing that “To bring inflation back to target we will need a protracted period of time at which at least growth is below potential because otherwise we will never get the disinflation going.” Still, short EU rates were only a couple of basis points higher from Friday’s close. Can the pair go higher still? I suspect the answer to that is joined to the question of whether EURUSD can run higher still. So far, we have only seen a healthy correction after a tremendous slide in the euro, further euro- upside beyond another percent or two may get more difficult from here if a) US data remains persistently resilient and especially inflationary and b) if the developments in China begin to impact supply side constraints once again.
Not a surprise to see that sterling has struggled to rally on a day like today, with a backdrop of downbeat risk sentiment, but we also got some very weak data the CBI’s reported Retail Sales for this month, even if it is a volatile data series. EURGBP has surged off range lows below 0.8600, while GBPUSD has been choppy today as the 200-day moving average continues to fall toward the current price action, with that average now below 1.2180. It twice served as resistance for GBPUSD in this secular bear move since the 2021 highs, once in October 2021 and then again in January.
Bank of Japan governor Kuroda testified before Parliament overnight and expressed the view that upward pressure on wages would strengthen gradually, as wages are seen as the most important variable for whether inflation is becoming more entrenched, thus requiring a change to the current policy mix. This coincided with USDJPY challenging support overnight and even hitting a new multi-month low near 137.50 today before the price action bounced on US yields stabilizing and recouping their loss on the day.
Table: FX Board of G10 and CNH trend evolution and strength.
CNH is the weakest of the lot here – but that can quickly change depending on the approach that authorities take to the future of zero Covid policy. CAD is the weakest elsewhere on soft sentiment, soft oil prices and the soft US dollar.
Table: FX Board Trend Scoreboard for individual pairs.
USDCNH has jumped higher, flipping the trend reading well into positive now, even if the USD is trending negative everywhere else, if barely so in USDCAD! Interesting to see how the market absorbs incoming US data this week now that the USD has been taken to the technical tipping point in some of the most important crosses (EURUSD 1.0500 area, USDJPY sub-138.00 area).
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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.
