FX Update: What is the best setup for USD bears?

FX Trading Focus: What would help the USD lower?

Note: I will host an FX Market Update webinar tomorrow at 1300 CET. Sign up here. In the webinar, I will try to provide perspective on what is moving the market and how the months ahead may shape up.

USD eases lower: what is the best setup for USD bears? The best setup for USD bears is more of what we got yesterday: risk sentiment that is able to continue stabilizing and little action in the treasury market with cooling energy prices. A strong US 10-year treasury auction today that keeps yields capped and a US January CPI number tomorrow that fails to trigger further rises in US rate expectations would also be a help. Although as I pointed out in yesterday’s update, it doesn’t seem the market gets much out of raised Fed expectations these days anyway after what we saw in the wake of the US jobs report shocker on Friday. As well, if the last “shoes to drop” on the need to tighten policy – the SNB and the Bank of Japan (more below in USDJPY chart discussion) do indeed drop, a further rise in US yields, even all along the US yield curve, may not necessarily support the US dollar as long as asset markets avoid a meltdown (i.e., reinforcing the point that increasingly, the last leg of USD support is ugly risk-off across markets).

European risk indicators of concern– on the surface, markets are putting on a show of stabilizing, but a couple of indicators are flashing red here for Europe and will have me reluctant to join wholeheartedly in looking for higher levels for the euro if their trajectory doesn’t moderate: first and foremost are the widening core-periphery yield spreads that immediately cropped up in the wake of the ECB meeting, particularly for Italy. The ECB and/or the EU’s political leadership needs to get ahead of this bad, old source of existential concern or there will be trouble once again that could echo the 2010-12 experience. The second is increasing strain showing up in corporate credit spreads, which have risen quickly to new cycle highs for all ratings of corporate debt in Europe, not yet to levels of major concern, but the trajectory bears watching.

Riksbank up tomorrow – I discussed tomorrow’s Riksbank at length in yesterday’s FX Update, and the SEK has firmed since yesterday, likely on the brighter tone in equity markets as SEK tends to be so risk-sensitive.

CEE currencies strong on backdrop of stronger euro and Poland’s central bank delivering another 50 basis points of tightening yesterday as expected, with an update later today that will provide further guidance from the bank’s governor Glapinski. The market seems happy to ignore the ongoing spat as Poland refuses to address the EU’s charges or pay the fines related to those charges as these are currently being deducted from fiscal transfers to Poland. The EURPLN rate is nearing the somewhat pivotal 4.50 area and the carry of over 300 basis points is quite rich.

Chart: USDJPY
An important decision lies dead ahead for the Bank of Japan if global yields continue to rise, as JGB’s have not avoided the pressure on sovereign debt globally, with the key 10-year JGB in recent days reaching within a few basis points of the Bank of Japan’s 0.25% yield cap under its yield-curve-control policy. We might expect a sudden and vicious JPY strengthening if the Bank of Japan shifts the goalposts or abandons the target entirely. Or, if it doubles down in its yield control commitment with a backdrop of rising yields elsewhere, the pressure on the situation would have to be absorbed by JPY weakening until the bank’s resolve is eventually broken. The JPY is so cheap already that it is difficult to understand why the Bank would be particularly afraid of its own shadow, but let’s see – the next Bank of Japan meeting is set for March 18. A BoJ member Nakamura actually spoke positively about the weak JPY overnight and said that rate hikes were not necessary unless wages were to rise.