Yesterday, the US Treasury released its latest semiannual report on foreign currencies and tried to have a little cake and eat it too by not accusing China of manipulating its currency, but expressing concern over the currency’s recent weakness. USDCNY is up into rarefied territory this morning above 6.93 as the whole world eyes the 7.00 level in that pair as a key sign that China will allow its currency to fall further.
The recent and very low realised volatility of late across the major currencies has likely been a side effect of this uncertainty on China’s currency policy intentions. Some might see the US Treasury’s report as the green light for a further slide in the renminbi, although China has declared that it is not interested in pursuing an intentional devaluation (market forces would do the trick, however).
Not sure the FOMC minutes were much of a catalyst, as the greenback was already on a rally track yesterday, but they were nominally hawkish, with some members airing the idea that policy could move above the neutral rate. US short yields are trading back toward the highs of the cycle, although were still a few basis points from the highest expectations for the Fed Funds rate for 2019 (the expectations distribution is centred on an expectation of two hikes next year beyond an assumed December 2018 FOMC meeting move).
Given yesterday’s Treasury report and USDCNY banging on the door at key resistance, the near-term risk of further USD strength and widening market volatility are the key risks. As well, a move by China could prove a punch below the belt for risk appetite in the knee-jerk reaction as we watch for whether this strong bounce off the lows in the S&P 500 (the most important proxy for risk appetite), and back above the 200-day moving average, is sustained.
EURUSD is having a go at the pivotal 1.1500 level again this morning and if it can manage a more convincing separation (may require China to allow CNY to slip), we could progress to a full test of the 1.1300 area lows and even somewhere into the 1.10-1.12 area. Anything below that might require significant escalation of EU existential strain linked to Italy, et cetera (to happen eventually anyway, the question is whether this is a 2019 problem more than an immediate one) as we feel the pair is getting too cheap at those levels.