Head of FX Strategy
Summary: The Covid-19 pandemic is driving endless short-term headaches that are likely to get only worse in the near term, especially in the US. This will provoke a considerable new policy response that will mostly likely be felt most strongly when the galloping efforts of scientists are rapidly putting the Covid-19 crisis in the mirror sometime next year. Meanwhile, USD traders should have Georgia on their mind.
Today’s FX Trading focus:
Waiting and watching the USD, US rates and Georgia on my mind
The price action in FX has settled again, with implied options volatilies in key pairs staying low after dropping like a rock on the day after US Election day last week. The 3-month EURUSD implied volatility is back in the low 6% area that has been the low of the range since the Covid-19 spike in the spring, and the 1-year is in the same area and almost at a new low since then (the record low was posted in Jan-Feb of this year just below 5%). In other words, this seems a decent level to express a longer term view in either direction, although there is the risk that we head lower still until the US political situation clears up early next year.
On that note, Georgia is the last-ditch chance for the 2020 US Election to spring another surprise, as both Senate seats there are set for a run-off election on January 5. Both sides will engage in an epic fight to get out the vote and the stakes are national in scope, given that the Democrats taking both seats will completely alter the potential scale and focus of fiscal priorities as the 50-50 split of seats would allow Vice President Harris to cast the deciding vote. The market will have to hold its breath for this result, upon which the USD outlook also hinges, as we see larger fiscal stimulus as USD bearish on the relative inflationary risk and as it would aggravate US external deficits.
US yields are still at the top of the agenda if they rise back toward the 1.00% level and beyond for the 10-year US treasury benchmark, although the yield there did back off sharply yesterday and now stands at around 86 basis points. The shorter-term and longer-term outlooks are dissonant: right now we have the uncertainty of a terrible Covid-19 spike in the US requiring restrictions on activity (more likely self-imposed on public advisories rather than any risk of a France-style lockdown, for which Americans don’t have the appetite), but longer term, we trust that science prevails and delivers an effective vaccine.
In the meantime, the Fed and/or the US government can juice the economy with additional stimulus in reacting to this latest ugly Covid-19 risks before a vaccine starts to mitigate the damage sometime next year. When the light at the end of post-Covid-19 tunnel is properly becoming a new dawn sometime next year, a full US re-opening could release a considerable amount of pent-up demand (and pent-up savings from the US stimulus splash this year, much of which was saved) and drive US longer yields much higher – with the added response here over the winter piling on the inflationary potential. That would tend to be US dollar positive if yields are allowed to rush higher at the long end of the curve, although that story could change if the Fed signals a “Twist” operation or that it is mulling yield caps to tamp down longer yields, declaring that it simply will not allow financial conditions to tighten as long as unemployment is above, say, 5%. That would then likely turbo-chart the USD bearish argument on the risk of highly negative real US yields that have been the chief driver already in repricing the US dollar lower.
Chart: USDJPY
USDJPY tends to follow the direction of longer US yields, but investors ought to also consider real yields (the nominal yield less inflation), with Japan’s real yields slightly positive, while US yields are still negative, if rising for longer term treasuries. Incoming US inflation numbers and whether the Fed signals the intent to cap yields at the longer end of the US yield curve will be critical for whether an extension higher in US yields would continue to support USDJPY upside. For now, the technical bullish reversal after the attempt below 104.00 looks decisive until proven otherwise, but the tricky bit is that no rally has found legs in the pair in recent history and is unlikely to unless real – and not just nominal US yields rise from here. The Fed won’t want be willing to allow real yields to rise unless the US economy is suffering a proper over-heating, the last concern on the Fed’s list of concerns at the moment.
The G-10 rundown
USD – caught between the short term uncertainty and long term bearish conviction on the US dollar – the bearish technical case actually remains intact tactically outside of USDJPY, but needs follow through.
EUR - the EURUSD found support ahead of the final retracement levels and ahead of 1.1750, even as President Lagarde is clearly threatening a large December ECB move and tried to drop the exchange rate into the conversation earlier this week.
JPY- the yen on its knew as long as global yields on the recovery path and risk sentiment continues to look through short-term threats of another Covid-19 resurgence.
GBP – the sterling rally has faltered as Brexit talks wind up today with no sign yet that we are set for a breakthrough – 0.9000 the pivot area for EURGBP. We need a signal.
CHF – EURCHF is back above 1.0800 after nice tight consolidation on rally off the vaccine news at the start of the week. Something brewing on CHF downside here? 1.0875-1.0900 next key in the EURCHF pair.
AUD - a tight consolidation in AUDUSD after the rise off the US election results keeps the bullish case intact and long AUDUSD is one of our 2021 top picks.
CAD – USD bears need to see resistance come in ahead of 1.3200 to keep focus on downside. Some support coming into the oil market soon will help support.
NZD – the RBNZ’s “hawkish” adjustment was absorbed quickly, but is that all we get for NZD upside? I was all set to lean against AUDNZD downside if 1.0500 traded, but beginning to wonder if we ever get that low.
SEK – a solid consolidation setting in here as Covid-19 is an intense concern in Sweden as well – still prefer SEK strength to prevail in EURSEK as long as daily close remains south of 10.30
NOK – EURNOK needs to find resistance in the area it has traded this morning, well below 11.000, to keep the downside view intact – this is the area for NOK bulls to test their case with stops above 11.00.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Uncover the shifting focus in 2024's FX markets towards growth resilience and relativity, away from bond yields and inflation stories.
Embrace the metal revolution on the commodity market in the coming year, with a focus on gold, silver, platinum, copper, and aluminum.
The gloominess of geopolitical conflicts and the repetitive nature of political agendas. What else does 2024 hold in store for us?
The disheartening cycle of unresolved geopolitical conflicts, the rise of polarizing political parties, and the stagnation of productivity.
Understand China's political landscape in Q4 2023 and the impact on counter-cyclical initiatives, with a focus on the pivotal Q1 2024.
