FX Update: Weekend Brexit vote. USD turning lower?
Head of FX Strategy, Saxo Bank Group
Summary: The USD is on the defensive in most pairs, with several USD pairs and the broader picture now more firmly suggesting that the USD is turning the corner to the downside. For sterling traders, a very uncomfortable wait for the unusual Saturday Parliamentary vote on risks of a gap opening on Monday in either direction, depending on the outcome.
The US dollar is trying to turn lower. The key EURUSD pair has taken out the key 1.1100+ pivot area that was established all the way back in the spring of this year, AUDUSD is breaking above a local pivot and other USD pairs have also pushed to new local extremes against the USD’s favour. Yesterday’s move was particularly interesting in that there was no readily identifiable spark for the move, suggesting significant flow is behind the move. This contrasts with the prior period of USD selling ahead of yesterday, particularly against sterling and the euro, which was more clearly linked to the huge relief trade in sterling and GBPUSD and to a degree in EUR crosses, including EURUSD, on the breakthrough in Brexit negotiations.
From here, the critical support factor for a proper turn lower in the US dollar is assurance that the Powell Fed will continue to provide easing at every turn and at least stay on top of the curve if not get ahead of it in providing further easing in the form of rate cuts and balance sheet expansion. On that account, a reasonable coincident indicator is the basic 2-10 yield curve, where USD weakness may find further fuel on a continuation of the recent yield curve steepening as the Fed brings down short rates faster than long rates fall (if they fall further) and where the Fed continues to inject further liquidity.
Chart: Trade-weighted US dollar versus 2-10 yield curve
As we discuss above, a critical support for USD bears will be an increasingly activist Powell Fed bringing significant easing in the way of rate cuts and more aggressive balance sheet expansion from here, moves that steepen the US yield curve.
Decision time for sterling traders ahead of the weekend as the UK Parliament is set to sit for an ultra-rare Saturday session and vote on Boris Johnson’s deal, essentially the thrice-rejected Theresa May deal with the addition of selling Northern Ireland unionists down the river, if one is to be cynical. The upside gap risk for sterling pairs is rather clear on a yes vote, one made possible if, for example, the unionist Northern Irish DUP caves and votes on the deal on promises from Johnson’s team for significant fiscal injections into the already massively dependent Northern Irish economy. Without the DUP, the maths become tougher as far more Labour MPs will have to hold their nose and vote in favour of the deal. But the downside gap risk, while considerable (2%?) on a No vote, doesn’t at all mean we face a chaotic No Deal Brexit.
Now that Boris Johnson has his deal, there is no reason for him to threaten a cliff edge that was only necessary to maintain during the negotiation phase with the EU. A No vote allows him to credibly blame the lack of a Brexit on the opposition, call an election that is essentially a referendum on his deal, and ask for a delay until perhaps January to get things squared away, one way or another. The apparent menu of scenarios has narrowed to Boris’s deal now or Boris’ deal later, or a Remain. I think the deal will pass this weekend, but nothing is certain. We may be surprised at how modest the upside gap proves on the deal passing as profit taking may quickly cap any move and the longer term challenges we have often highlighted remain.
The Trump administration struck a deal with Turkish president Erdogan to commit to a temporary ceasefire that allows Kurdish forces in Northern Syria time to flee and largely leaves the Turkish military objectives accomplished. The Turkish lira celebrated the breakthrough and US promises to not assess further sanctions, though it appears Trump’s critics on this issue, also within his own party are far from satisfied, not viewing this, as only Trump could call it, a “great day for civilization”.
The G-10 rundown
USD – weak US housing starts for September making headlines yesterday, but this came after a spike higher in August and the NAHB survey was much stronger than expected, so we can brush this one off. Next key for cementing this USD move lower is the FOMC meeting on October 30.
EUR – EURUSD is turning the corner in rising above 1.1100+, the big pivot area stretching all the way back to the spring of this year. Looking for follow through on the sense that ECB. A yes vote at the weekend for the Brexit deal should also provide some modest support across Euro crosses in sympathy with the bigger move in sterling.
JPY – yen will react to the Brexit news, but recent yen weakness already looks so stretched to the downside here relative to a rather quiet bond market. Most interest here in the relative strength of USD vs. JPY as the pair mulls whether it is comfortable at local highs ahead of the bigger 109.00 area. USDJPY will likely take its cue from the slop of the US yield curve.
GBP – if our assessment is correct, gap risks are considerable (1-week implied options volatility in GBPUSD is at 20%) but may be less than the market is pricing, especially on a No vote (if it quickly becomes clear that there will be a delay).
CHF – the GBPCHF pair likely to prove a high beta pair over the weekend on the Brexit news – with EURCHF directionally tracking the move with lower beta.
AUD – local highs in AUDUSD look interesting for breakout traders – need to seal the deal early next week on this move by maintain above local support. US-China trade détente would be of great help.
CAD – USDCAD pointing lower but within the range defined by the critical 1.3000 area – the commodity dollars all on the move against the suddenly weaker greenback.
NZD – no momentum in AUDNZD after the positive AU payrolls data – making it less compelling to pay attention here, although yield spread developments are supportive of the pair.
SEK – EURSEK doing its best to break down here and the move doubly impressive on the weak Swedish unemployment print yesterday at a four-year high, though Sweden’s statistical agency was out yesterday announcing problems with the data collection for the series
NOK – the krone marching to the beat of its own drummer, and not in fitting with the rest of the market as EURNOK rips to new all time highs. The move looks unjustified from a fundamental perspective and may be driven by seasonality and a squeeze on positioning. Would expect a spectacular reversal at some point, but from what level?
Upcoming Economic Calendar Highlights (all times GMT)
- 1230 – Canada Teranet/National Bank Home Price Index
- 1405 – US Fed’s George (Voter) to Speak
- 1530 – US Fed’s Clarida (Voter) to Speak
- 1745 – UK Bank of England’s Carney to Speak
- Saturday – UK Parliament to Vote on Brexit Deal
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