Head of FX Strategy
Summary: Commodity markets are commanding the most attention across markets and may be dragging bond yields down on the implications for easing inflation. In turn, then, shouldn’t JPY find a bit more support, as it did today when EU core bond yields cratered on weak flash June PMIs? Also, today the Norges Bank surprised many with a 50 basis point hike, although the NOK price action in the wake of the decision is underwhelming.
FX Trading focus: Waiting for the next FX catalyst when historic moves in yields see little more than a polite nod.
Yesterday’s weak flash June PMIs from the Eurozone and the US triggered a massive rally in bonds. By later in the day, the German 2-year Schatz yield had fallen the most in a single day (25 basis points) since the day after Bear Stearns was sold to JP Morgan – so the most in 14 years. And back then, the German 2-year was over 300 basis points versus just over 100 bps before yesterday’s rally in safe haven bonds on the weak data. US yields were also marked sharply lower, with the 10-year event trading all the way to 3.00%, but that move has been chopped in half from yesterday’s lows.
Given the recent focus on the immovable Bank of Japan policy that caps Japan’s yields for 10 years and shorter, one would have expected a historic rally in EU bonds and chunky rally in US treasuries to support a fairly solid rally in the JPY on the reduction of pressure on EU-Japan and US-Japan yield spreads. The JPY did rally, but the scale of the rally was distinctly underwhelming in light of the underlying spread adjustment. This lack of reactivity is remarkable and has me reserving judgment on the potential for a more significant JPY rally here, even if I’m happy to revisit JPY upside potential if USDJPY droops through the 134-133.50 zone.
As I discuss in what has moved the remarkable USDCAD chart over the last month, I suspect FX traders are caught in the crossfire of narratives that is keeping us rather bottled up in the ranges for most USD pairs. On the one hand, the profound reversal in Fed expectations out the curve is quite USD bearish, but on the other, if we are headed for a weaker global economy on still-tightening financial conditions, the USD could yet prove a safe haven until the Fed is not only marked to hike less, but to actually actively ease policy. Far too early for the latter. Next week will prove interesting, with the next round of data, including the June ISM’s from the US, and whether these corroborate the private initial June PMI’s from this week. As well, we’ll get a look at the May PCE indicator, even if markets are looking more at commodity prices, especially energy, as a forward inflation indicator.
Chart: USDCAD over the last month
From late May through early June, the USDCAD pair broke down through key support and the 200-day moving average on the persistent rise in crude oil and as US equities had rebounded sharply from the lows of May. CAD was the strongest G10 currency for much of this period. Then, things suddenly turned south for CAD and USDCAD launched a sharp rally higher from nearly 1.2520 to 1.3000 when global stocks suffered an ugly rout from June 9-11, accelerated by the US May CPI release on June 10 that send US and global yields soaring in anticipation of a tighter Fed and the WSJ tip-off that the June 15 FOMC meeting would deliver 75 basis point hike. USDCAD peaked (and risk sentiment bottomed) on June 17, two days after the FOMC. Since then, the WTI crude oil benchmark has backed off from highs well north of 120 dollars per barrel to as low as 101.50 before rebound to about 106 as of this writing. That is extremely CAD negative, and yet USDCAD has traded in a tight range over the last week because off-setting that is the USD-negative sudden mark-down in Fed hiking expectations accelerated yesterday by weak flash June PMI data that mimicked the weak EU flash June PMI data. The market has marked the peak rate from the Fed by around 50 basis points and pulled the anticipated peak in the policy rate into very early next year. So what is to drive USDCAD from here? As long as yields continue falling and risk sentiment prefers to celebrate that fact rather than fact that this is an expression of the fear of recession, the pressure for the USD to rise fades. But if the next batches of economic data show that the Fed can’t back down any time soon due to persistent inflation readings from services inflation, rising rents and/or a still-tight jobs market, the USD could yet rise on a re-adjustment back higher of Fed tightening anticipation. On the other hand, if risk sentiment begins to falter on recession concerns, the US dollar may trade higher as a safe-haven. Technically, the comeback of the last couple of weeks is remarkable and trend-followers will look for a solid fall of the very well-defined 1.3000 area to indicate and next leg higher toward 1.3500. The tactical situation to the downside is rather more uncertain due to the huge swings in both directions within the range in recent weeks.
Table: FX Board of G10 and CNH trend evolution and strength.
The CHF enjoying the falling yields here and is the strongest of G10 currencies of late. Watching the relative fortunes of the commodity currencies on the recent wobbles and the USD and JPY as discussed above.
Table: FX Board Trend Scoreboard for individual pairs.
EURCHF is poking aggressively lower and looks set for a test of parity and USDCHF is eyeing major range lows. Watching the status of individual JPY pairs after the big rate shock yesterday failed to drive as much JPY volatility as one might have expected. For USD pairs, USDCAD and AUDUSD look the most pivotal in terms of the proximity of major levels (1.3000+ for USDCAD and 0.6830 for AUDUSD).
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