Head of FX Strategy
Summary: Just as the US equity market is challenging above key resistance and risk sentiment globally remains strong, measures of the broad US dollar are looking at key supports as the US returns from the long holiday weekend today. The next couple of sessions look pivotal for establishing whether USD bears can establish real momentum.
Volatility measures for bond markets and in places for the FX market have receded to pre-Covid19 crisis ranges as risk sentiment remains strong and the market wonders how to take a strong view on DM currencies when all central banks have their feet jammed on the gas and yield curves are largely crushed flat. It is the kind of environment that works for USD bears as the greenback looks at key support levels in broad terms (see chart of Bloomberg’s USD index below). EM currencies have shown the most momentum recently against the struggling US dollar as they continue to track higher together with the general semi-melt up in global equities. On that note, the US equity market has now reached a key pivot level in crossing above the 200-day moving average and recent highs, with the small caveat that the cash market has been closed since Friday. The next couple of sessions and perhaps through this week’s close look critical for establishing the medium term status of this market rally.
And as we discussed on this morning’s Saxo Market Call podcast, we are reluctant to parrot news headlines suggesting that the market’s enthusiasm for risky assets is based on hopes for a post-Covid19 normalization. Rather, the foie-gras funnel of Fed- and other central bank liquidity forcing is the more likely culprit, as we have often discussed in previous podcasts and in this column, as we wonder how the market deals with mounting insolvency as opposed that the liquidity injections don’s address. For now, just as we can’t jump in front of an onrushing train as the equity market scales the biggest ever wall of worry, we can’t lean against a tactical break lower in the US dollar here – but do note that the move must extend quite a lot further to fully reverse the strengthening move from March.
The EUR is mounting another charge at the 1.1000 level against the US dollar as bulls hope that the recent signals from Merkel and Macron on funding a recovery package via the EU budget is a signal that the EU project is far from endangered. The ECB’s Villeroy yesterday said that more stimulus is on the way in the form of an expansion and loosening of the rules on the existing EUR 750 billion QE programme. (Specifically, Villeroy spoke against any adherence to the capital key rules that formerly required the ECB to purchase bonds in proportion with the size of each EU economy). In any case, options have gotten very cheap again – with the 1-month EURUSD implied volatility nearing 6% again and the 6-month implied pushing below 7% for anyone that would like to take a EURUSD upside view for the other side of the US election result. Germany-Italy 10-year yield spread has been crushed below 200 bps for the first time since early April.
I suspect the uncertainty over the US election result is one key factor that will hamper strong momentum until November, unless something breaks in the deteriorating US-China relationship (watch the 7.20 area in USDCNY on that note).
Chart: Bloomberg dollar index
This is our favourite USD broad index for now as it less EUR-dominated (32%) relative to the traditional USD index (at 58%) and because the technical support is so well defined since the massive USD surge in March. We are breaking down through that support level here, but arguably, the USD needs to move another 3% or so lower in broad terms to suggest a full reversal of the Covid19 crisis-inspired squeeze on global USD liquidity. Note that the 200-day moving average is only some 1.5% lower from here.
The G-10 rundown
USD – on the ropes, as noted above, but let’s give this market a couple more sessions to see if the breakouts in USD pairs are multiplying – and whether the move above resistance in the classic risk proxy, the S&P500, is confirmed.
EUR – EURUSD edging higher today and nearing the 1.1000 level again for the third time since mid-April. Happy to trade the break from a technical perspective, but preferring a combination of buying perhaps 2-month calls and a quick in-and-out on spot trades on a break.
JPY – the JPY weak together with the USD on strong risk sentiment, with the key resistance in USDJPY still in place up above 108.00 and implied volatility collapsing in line with the collapse in bond market volatility.
GBP – sterling finding support, perhaps as end to UK lockdowns seen here soon and on the weight of stronger risk sentiment and as the CBI data today on reported sales in May was less bad than expected. Still concerned about GBP upside potential if the BoE does go down the negative policy rate rout.
CHF – less relief for EURCHF than one would have thought, given the strong impression on other EU existential barometers made by the Merkel-Macron recovery plan.
AUD – the first G10 currency to break higher versus the US dollar together with NZD as the Aussie is arguably supported by the reflation narrative as Australian mining giants equities push to new highs here on strong commodities performance. Both AUDUSD and AUDJPY nearing their respective 200-day moving averages if the momentum continues higher here.
CAD – the oft-tested 1.3850 area in USDCAD coming into view again, and not likely to survive if the momentum in equities and crude oil continues here – still some work to do to reverse the rally – arguably sub-1.3500 needed for that.
NZD – a currency that looks an overachiever given the RBNZ’s clear intent to move to a negative interest rate policy and this currency one to watch for a violent direction . Like buying dips in AUDNZD, though unfortunately plenty of room for the consolidation to deepen before the rally possibly resumes further out.
SEK – Sweden making noises about recovery plan – good luck when you’re not even in the currency…the backdrop could not be more supportive of SEK so a bit taken aback that EURSEK hasn’t tested the last support zone into the low 10.40’s.
NOK – EURNOk having a look lower again and USDNOK poking to new lows – fully coincidental with oil and risk sentiment and actually a bit disappointed that the NOK hasn’t managed more given the recent fiscal Norges Bank fiscal package announcement.
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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.
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