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The FX Trader: How much further can USD rally extend?
Summary: The USD has repriced sharply higher as a number of Fed members are out sounding far more hawkish, even as oil prices have eased forward inflationary pressures over the last two weeks. How much higher can the market price the Fed now that more than three more hikes are priced into the forward curve by mid-year next year?
USD surges amid repricing of Fed rate hike expectations
The US dollar is sitting atop a fresh surge sparked by the hot October CPI release (both core and headline running 0.1% ahead of expectation at 0.3% and 0.4% MoM, respectively) and on comments from Fed Governor Christopher Waller who brought the idea of a fifty-basis point hike into the conversation – linking a hot core inflation release of 0.3% (which is what we got later in the day) with the need to hike more aggressively. “Hiking only 25 basis points would put our credibility at risk, a risk I am not eager to take.”. That Waller rhetoric looks unusually aggressive given the recent massive markdown in crude oil prices, a key input in the recent inflationary surge. But other Fed officials, notably Hammack and Williams yesterday, have been out airing their own concerns on inflation. US 2-year treasury yields have backed up 25 basis points on all of this and are now within 10 basis points of the 4.95% highs of late September. That yield surge is certainly a solid justification for the boost to the US dollar – but how much more can the treasury market pile on relative to what is already priced in here? Not sure, but some key risks of many stripes are incoming next week (see below).
Looking at the price action yesterday, the US dollar strength looked surprisingly mild relative to the lift in US Treasury yields all along the yield curve and we have to wonder whether the USDJPY 160.00 level has held the US dollar back a bit more broadly. Recall that back in late September, just a few weeks after backing up from the massive late July intervention wave from the 164.00 area, USDJPY criss-crossed the 160.00 level for three days when the Ministry of Finance came in for a huge Round Two of intervention.
Bottom line: This USD move is justified by what is driving it, a significant repricing higher of Fed expectations, but how much more fuel is there in the tank on this theme? Fed Chair Warsh comments on Monday (more below) are the next critical event risk that will test whether the USD can maintain this surge.
Chart: USDJPY
The US dollar might have been stronger still yesterday were it not for the USDJPY 160.00 level coming into view again. Initially, the market was reluctant to press its case above the obvious previous resistance zone around 158.50-159.00, but with the overwhelming support for the US dollar from Fed hawkishness, the broad USD upside pressure has now pulled the pair to an even more significant psychological level of 160.00. Note that Japan’s Ministry of Finance came down heavy on USDJPY at this same level back in September, with prior episodes earlier this year around the same level as well.
Next week Fed Chair Warsh to speak on Monday Nvidia earnings Tuesday and AI focus next week US retail sales and key retailers reporting
Fed Chair Warsh will deliver opening remarks at the Fed’s Productivity and Jobs Task Force conference. If he thinks the market has moved too aggressively, he will have the opportunity to air his views, as he moderates two panels and participates in a fireside chat. He has often cited productivity as possibly critical for softening forward inflation risks, and the market will be highly reactive on any strong hints in his comments that move against this shift in Fed expectations.
The Nvidia earnings report feels like a critical test across markets as the company is at the center of the dominant global equity market sector. As long as the company’s travails fail to spread to the broader AI trade, it’s not necessarily a big market mover, but should something in the earnings call spook the broader equity market, it could feed through to nearly everything, even US treasuries, which might find safe haven appeal, and the US dollar, which might come under pressure if yields drop. There is another huge event in the AI space next week that I am unable to discuss that could prove pivotal for overall market sentiment.
It’s a big week for getting a read on the US consumer, especially interesting this time around after the latest quarter of significant pressures on household budgets from rising fuel and other prices. Besides the official October US Retail Sales data on Tuesday, we have DIY giant The Home Depot reporting earnings on Tuesday, Target reporting on Wednesday and Walmart reporting on Thursday.
US jobs report ahead – will it even matter? FX Board of G10 and CNH trend evolution and strength. The US dollar surge (and CNH maintaining its very non-technical solidity despite the USD move) is the obvious focus here, while sterling has maintained its relative strength in the crosses. Elsewhere, the AUD has been the weak outlier as metals prices have cratered and, while Australian rates have remained at high levels, the noise levels on downside risks to the Australian economy have been picking up. The yield surge has powered a huge negative shift in the Swiss franc over the last week.
With the markets fixated on this sudden global deleveraging event, not sure how the US jobs data will play today, especially as there is little pent-up focus or drama around the number. I suppose the bigger surprise side would be a positive one after last month’s weak number and any possible index on treasuries. Employment-related data usually lags the economic cycle and other data this week from the US, the JOLTS, ADP payrolls change, ISM Services Employment index and jobless claims were all benign to slightly strong.
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Table: NEW FX Board Trend Scoreboard for individual pairs. GBPUSD has slipped into a down-trend as of yesterday’s close, though the local price action looks very steep and we have key USD risks incoming early next week. Also, GBPUSD is still within the price range of the last couple of months, not yet in a real break-out. Elsewhere, USDCHF has likewise flipped suddenly with the negative impact from yields on CHF, though it is still barely within the range (note the important 0.8380 resistance on the chart).