Head of FX Strategy, Saxo Bank Group
Summary: Risk conditions have shifted to the most aggressively risk-on in months and major markets are now perched at a tipping point at which the current melt-up either begins to fade or accelerates.
This situation arises after risk appetite melted higher into the Friday close, boosted by China’s latest credit data and Trump’s full court political pressure on Fed policy. Last week’s price action was a microcosm of the back and forth churning of the price action we have seen for many months as traders can’t decide what to do with the US dollar and risky currencies. The backdrop for risk-taking couldn’t be more supportive, as our Global Risk indicator is at its most positive level since just before the early 2018 meltdown.
To take an example, AUDUSD changed directions every day from Tuesday through Friday last week and is now perched just below the 200-day moving average, just as the US equity market is now less than two percent from its all-time highs again and long US treasury yields are perched at pivotal levels (10-year just above 2.50% and the 30-year just below 3.0%).
The JPY has been a bit more consistently weak, especially since early Friday, when China’s March credit data pointed to a full tilt effort to continue stimulating the economy.
The chief question is how aggressively the ongoing rally in risk sentiment can extend if yields begin rising again – particularly at the long end of the US yield curve. After all, aggressive moves higher in US yields preceded the major setbacks in 2018 as we note in the chart below. The ability of yields to progress higher even as risk appetite continues to melt-up would be a sign of a more durable “melt-up scenario” risk rally, one built on the hopes that China’s stimulus and the shift to a more dovish stance by global central banks will support a bounce in financial markets, though one that eventually will need confirmation in the economic outlook.
It is a bit early in the game for the rising yield question, because for the moment we are merely looking at a technical reversal of the falling rates regime if the US 10-year benchmark yield punches higher – but it is still a significant hurdle for the market and likely no coincidence that this key test for US yields arrives as major US indices have now rise to within two percent of their all-time highs from last fall – just ahead of earnings season. Also just ahead are the risk that US consumers are disappointed with their tax refunds and the seasonally weakest period for equities (Sell in May and go away). We’re a bit unwilling to call whether the melt-up scenario fully engages, but we’ll use another leg higher in long US yields as the key coincident indicator.
For currencies, an extension of the risk melt-up would likely coincide with a weaker Japanese yen, an almost as weak US dollar, and a stronger euro, the latter driven by hopes that China’s stimulus will benefit the export-driven motor of the Eurozone economy. Commodity-linked and EM currencies (RUB, ZAR, MXN) should also do well in this scenario, though the most China-linked Asian exporters may not see significant participation if China decides to allow the CNY to track a weaker USD lower.
Chart: US 10-year benchmark
Note that the two big sell-off episodes in risk appetite coincided with long US yields rising to new highs for the cycle. The first was in early 2018 when the US 10-year benchmark finally rose above the 2.50+% yield highs from late 2016. The second was the rise above the multi-year 3.10+% highs in early October last year. Note the local resistance at 2.50+% again.
USD – as noted above, the US dollar outlook bound up with the global risk sentiment outlook. Worth noting that the short end of the US yield curve has backed up as well, pricing out some of the easing predicted previously, despite Trump’s campaign for rate cuts.
EUR – the euro looks well positioned for further strength if the market sees China’s stimulus helping to rekindle the Euro Zone export engine - still some way to the major test for EURUSD up at 1.1500. Watch the German ZEW survey up tomorrow and the flash April PMIs on Thursday as the next key EU data points.
JPY – the yen stands to lose the most if the melt-up scenario fully engages as the JPY carry trade re-engages. Note the gauntlet has already been laid down for JPY crosses as especially AUDJPY bulled higher to close above major resistance on Friday.
GBP – our overriding concern is that the long Brexit delay will do sterling no favours. A close above 0.8700 in EURGBP and/or below 1.3000 in GBPUSD could set something in motion.
CHF – EURCHF has fully reversed back higher away from the major 1.1200 area with the clearing of the No Deal Brexit risk and widespread complacency helping the franc lower. Likely to continue to trade weaker if the melt-up scenario fully engages.
AUD – a risk melt-up scenario would be AUD supportive, but some caution now that the election has been called for May 18 and Labour is leading in the polls, as the election is seen to a degree as a referendum on environmental policy (potentially AUD negative if seen as eventually more strict).
CAD – the latest CPI and Retail Sales data up from Canada on Wednesday and Thursday, respectively. USDCAD price action has proven impossibly indeterminate – really need above 1.3450 or below 1.3200 to merit much comment.
NZD – AUDNZD may be overdone short term to the upside, but still like the idea that we have seen a structural low there. As for NZDUSD, the pair looks likely to provide high beta to any failure of the melt-up scenario to engage, given how little NZD has responded to a supportive backdrop (likely down to AUDNZD bounce and a dovish RBNZ).
SEK – if the market likes the prospects for the Euro Zone economy on China stimulus, then the cheaply valued SEK is an even greater bargain. At least, we need to technical traction lower in EURSEK to drive any temptation to trade SEK on the long side.
NOK – EURNOK stalling after probing new lows and the direction here likely linked to the melt-up scenario pivot or non-pivot. What has given constant pause for a more aggressive call higher for NOK is the fact that we haven’t seen a more notable bid already, given the massive support for NOK from the energy markets and anticipation of Norges Bank tightening.
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