FX Update: USD can only thrive on souring sentiment

Forex 5 minutes to read
John Hardy

Head of FX Strategy, Saxo Bank Group

Summary:  The US dollar sell-off has been halted in its tracks today and even reversed in places as weak risk sentiment is casting a shadow over the market and proving once again that when sentiment sours without any safe haven flows into bonds, the USD has a hard time dropping and the JPY has a hard time reprising its old role as a safe haven currency, though the JPY still deserves a second look.


FX Trading focus: Weak risk sentiment feeds USD back-up. What it would take to jolt JPY higher.

Whether it was the sudden bitcoin and crypto-currency meltdown that has unfolded overnight and continued today (much broader this time across the crypto space and not just in Bitcoin itself, it must be noted) or the after-effects of US tax bills after the filing deadline came and went this Monday, risk sentiment in the US was weak yesterday and that weakness extended overnight and into European trading today. This has driven stiff headwinds for USD bears tactically, especially in the traditionally risk-sensitive currencies in the G10 (with EM volatility curiously muted). The EURUSD breakout was not immediately affected as that pair posted strong new highs yesterday and even into this morning before modest consolidation finally set in. German Bunds yields have managed to run to new cycle highs today as well, though the move was tempered after a high of -7.4 basis points was posted in early trading this morning. And that particular breakout is looking increasingly lonely among USD pairs together with the GBPUSD move higher, although the latter would perhaps have to slip and close below 1.4100 for immediate tactically bearish implications. Other USD pairs from AUDUSD to USDJPY never made it over the edge against the greenback’s favour this week. If risk deleveraging turns sufficiently vicious, the Bund move risks unwinding and then…well then let’s have a look at what the JPY does as I discuss below.

So ahead of the FOMC minutes, it seems the only upside path for the US dollar is relative misery elsewhere and a shift away from the themes that have driven it so low thus far:  fears of inflation and the idea that the Fed wants to run monetary policy at irresponsible levels until inflation is securely averaging well above 2%. It’s doubtful that anything in tonight’s FOMC minutes will suggest a pushback against the current Fed guidance, but we should always be on the lookout that a few members or more are getting restive on the risks of over-stoking the economy and inflation. On the Fed’s asset purchases, I have to imagine that there is more widespread questioning than the one-off hint from Boston Fed president Rosengren on the need to continue buying MBS at the current torrid clip when the US housing market is already white hot and more than fully recovered.

Chart: USDCAD
Watching today whether anything can reverse the USDCAD slide in a more determined way, after the pair poked to a new 6-year low intraday yesterday (below the low of the big dip in 2017) and not far from the magic 1.2000 level before weakening risk sentiment and crude oil pulling sharply away from recent highs took away support for the move lower. Zooming way out, we can see that an important driver for CAD strength for the cycle has been the move lower in two-year US-CA yield spreads, with the 2-year swap spread now back to the cycle lows from March around -40 basis points and with the Bank of Canada having announced its taper of asset purchase on April 21. This spread was last approximately achieved right at that major low of 1.2063 from 2017. Critical levels here on the downside, including the psychological 1.2000 level. There is some bullish divergent momentum here, but USDCAD will likely only be pulled higher by a significant further consolidation in crude oil prices and further deterioration in risk sentiment – but also watch for the price action in the wake of today’s Canada April CPI release. 1.2300-1.2400 would be the natural destination zone for a rally of consolidation within the context of this bear market – it would take considerably more upside to neutralize the trend.

Source: Saxo Group

So what would it take to get a JPY rally?
This is well trod territory on my part that I will only summarize here, but the persistence of JPY weakness still deserves some highlighting here, as well as what it would take to see the JPY stage even a solid comeback, even if only on the scale of a respectable consolidation. Action since yesterday has reinforced the kind of action we have seen for some time in this cycle – weak risk sentiment feeds USD resilience against the risky currencies, but fails to see the JPY rally as treasuries, for example, fail to absorb safe-haven bids. As well, the new cycle highs in EU yields have been a huge distraction for JPY traders, keeping EURJPY focused higher on the ever yield-sensitive JPY. As well, many JPY traders in Japan are carry and bond-focused, and EM currencies and EM credit spreads have hardly reacted at all to this latest wobble in risk appetite, and neither have corporate credit spreads. A significant back-up in the JPY might need all three of: evidence that the market is giving up on the commodities being a one-way trade for a bit, safe haven flows into bonds on top of a further rout in equities, and a more significant widening in credit spreads. Until then, the JPY may have a hard time attracting buyers. (and have a look at EURCHF, with today’s action pulling it further away from the odd recent divergence from EURJPY performance).

Table: FX Board of G-10+CNH trend evolution and strength
It will take a lot more broad USD upside for this latest resilience to carry any meaning, while AUD is interestingly weak (just today Chinese CCTV reporting that China’s Cabinet is expressing strong concern on surging commodities prices and intends to step up its oversight of the market).

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
Still watching for the AUDUSD to flip either way more convincingly together with price action that takes it out of the tight range it has been in for the bulk of this year. And don’t look now, but is that EURCHF trying to reclaim 1.1000? If so, the downtrend cycle looks set to end today or tomorrow.

Source: Bloomberg and Saxo Group

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