FX Update: Commodity FX all the rage. Tension in sterling outlook.

FX Update: Commodity FX all the rage. Tension in sterling outlook.

Forex 4 minutes to read
John Hardy

Head of FX Strategy

Summary:  Markets tried to put back on the relief rally yesterday, but the weight of concerns in the background forced a retreat as US equities closed on the lows of the day and sentiment continued to sour in the Asian session even if Europe is trying to save the day. One of the more interesting currencies to watch besides the yen here is sterling, where the spike in BoE expectations is not necessarily as supportive as one might think.


FX Trading focus: Commodity FX all the rage, sterling in a tense place

On today’s Saxo Market Call podcast, we continued to air our laundry list of concerns for the market, especially the global energy crunch that is bringing forward the next recession with every uptick in prices. The situation was aggravated again overnight by news of flooding in a key Chinese coal mining region. Elsewhere, volatility risks are aggravated by bond markets failing to provide any offsetting returns for the rough ride in equity markets over the last several weeks. In FX, the focus has been on bidding up commodity currencies on the stagflationary backdrop, while the USD has been middle of the road – on the weak side against commodity FX, but firm against the euro where yield rises can’t keep track against the rises in US yields, and very firm against the flailing Japanese yen, where the double whammy of rising import prices and a dead bond market weigh. As I mentioned in the podcast, I wonder if the commodity FX move can maintain altitude if risk sentiment goes into capitulation mode, but until then, the pressure is to the upside as long as commodities are generally bid.

One currency I am tracking particularly closely here is sterling, where it feels like there is considerable tension between the tradition positive of sharply rising expectations for a string of rate hikes from the Bank of England and then the negative macro backdrop for the UK: the sense of isolation from Brexit, capacity constraints in the economy, the country getting the worst of the ongoing European energy crunch, the yawning external deficits. On the spike in short UK rates that are traditionally a positive for a currency, the market has not responded consistently to this signal and eventually, the concern will arise, together with the government’s attempt to cobble together credibility on the fiscal front, that a recession is incoming. As my fixed income strategist colleague Althea pointed out on the podcast this morning, the market is not yet pricing a policy mistake as long Gilt yields are still rising even as the yield curve flattens (a policy mistake is generally predicted in yield curve developments when you see a flattening yield curve with rising/stable short rates and falling long rates). How does this shake out? Maybe the positive and negative balance out and we get a choppy mess in the coming weeks to couple of months, just as we have chopped lower in rather intermittent fashion since the 1.4200+ top in GBPUSD in June (And EURGBP has been sideways during the same time frame and even as far back as March) but my concerns are to the downside in the medium term if the factors listed above deepen.

The latest twist in the never-ending Brexit story is the ongoing situation in the customs arrangement for Northern Ireland, where the situation on the ground means little interruption of trade and the softest of customs borders on the island but a de facto customs border in the Irish sea. The UK is drawing up red lines on the issue and France is in a fighting mood over fishing rights, so accidents may yet happen.

Chart: GBPUSD
The battle lines are clearly drawn in cable, as the key zone of resistance in the 1.3600-50 area has been under siege after falling in the quick slice lower in late September. Technically, the pair needs an impulsive move and close back higher above 1.3700 to underline that the range lows are in place, while a capitulation back lower through 1.3500 would suggest momentum is in danger of turning lower again for a move into the next chart areas into 1.3000.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength
Note that the JPY down-trend reading is getting rather aggressive at -6.0, not that it can’t go lower still, but it will need constant refreshment from yields and energy price rises. Elsewhere, the CAD move is at the opposite extreme and looks overdone soon if risk sentiment continues lower – looking for places to get contrarian there – AUDCAD looks interesting after a reversal yesterday.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
EURJPY has flipped positive, with the move underline by yesterday’s blow-out move as JPY down-trends are across the board now, only in danger of a sudden reversal if energy prices suddenly reverse and global long yields do likewise.

Source: Bloomberg and Saxo Group

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