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FX Update: Rates trump risk sentiment as USD driver.

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  The US dollar found only very modest support on Friday as US equity markets plumbed new cycle depths. As risk sentiment rebounded Friday and carried through higher to start the week today, the USD selling has become more aggressive. The fact that risk sentiment has only rebounded since Friday while the US dollar has been selling off for nearly two weeks suggests that US treasury yields, which peaked slightly ahead of the USD, may be the dominant market driver.


FX Trading focus: Rates trump risk sentiment as USD driver.

As noted on Friday, the near-term focus for FX traders is where and when the USD finds support, if it is going to find support. I suspect that the USD will only properly roll over for the cycle once the Fed has turned back toward easing – at least in a relatively sense, and perhaps this only becomes clear as a reduction in the perceived end-point of this rate hike cycle. In that sense, the market seems in a rush to declare that we have reached that point and that inflation is set to fade from here. Breakeven inflation rates peaked back In late March and have really swooned since the beginning of May. Yields at the short end of the US yield curve remain elevated, but are below the peak reached just before Fed Chair Powell took jumbo hikes of greater than fifty basis points off the table at the May 4 FOMC meeting. The longer end of the US yield curve has consolidated even more and I suspect the combination of the easing back of US yields and inflation expectations, combined with hefty long-USD speculative positioning, that have the USD on its back foot. I have a hard time that peak Fed rate expectations are in the rear view mirror a week before actual quantitative tightening has even begun, but let’s see

From here, there is still some room for the USD to fall further without reversing the well-established bull trend, but the comfortable (for USD bulls) portion of that room has been about reduced by half in today’s trade. The yield-fixated USDJPY is in its own category (given BoJ yield-cap policy and the enormity of the move since the pair broke above the 116.35 range top back in March) . For other major USD pairs, the next major area for EURUSD is into 1.0800+, for USDCHF is 0.09525, for USDCAD last gasp support is into 1.2660-1.2715, AUDUSD is discussed below. GBPUSD has a little resistance at the 1.2638 pivot high, but has a lot more wood to chop to suggest a trend reversal, as this downtrend started on the break below 1.3000.

Chart: AUDUSD
The AUDUSD has carried through higher after bobbing back above the pivotal 0.7000 level, one that has served as both support and resistance on many occasions since early 2019. Supporting the AUD are the structural shift in the country’s external imbalances for the better, the recent rebound in risk sentiment, a solid recovery in some industrial metal prices associated with Australia’s traditional export mix, and hopes that China is set to stimulate. Working against the Aussie’s favor are a new left turn from the Australian government at the margin, rising concerns that the global economy is set to slow, and the risk that we are far from the end of the asset market deleveraging cycle. From here, bears, for an ideal fresh trading hook, need a quick rejection of today’s action and for the price action to dip back below 0.7000. On the flipside, if this rally persists into 0.7250+ area (most recent major pivot high in that area and just ahead of the 200-day moving average) the latest down-wave would have been rejected and this would suggest the softening up of the bearish risk has been neutralized for now – the next figure (100 pips) in either direction looks very important here for the pair.

Source: Saxo Group

ECB President Lagarde was out jawboning today on rate outlook, with her comments largely rhyming with market expectations, therefore triggering a modest pick-up from intraday lows in forward ECB expectations, but a rather more pronounced reaction in the euro itself, especially as EURUSD cleared the local pivot high of 1.0642. She basically spelled out that the ECB will hike in July due to the winding down of asset purchases and in saying that a negative interest rate policy will be over by late Q3, suggests that another hike will come at the September meeting.

As background concerns continue to plague the Chinese economic outlook and a rise in Beijing Covid case counts has driven new fears of widening lock downs there, China has been out today touting new measures to encourage activity resumption elsewhere and other easing measures in the works, including SME loans and a tax cut on car purchases. Sentiment in general has also gotten a boost from increasing chatter that US President Biden could be set to roll back some of the China tariffs in the all-out effort to get inflation readings down ahead of the US mid-term election in November.

Table: FX Board of G10 and CNH trend evolution and strength.
For the trend window the FX Board operates with, the USD bull-trend has effectively been erased. As emphasized above, some USD charts still have more room to allow the USD to consolidated lower, but clearly USD bulls are down if not yet out. Otherwise, it is clear we are in flux when no trend reading has an absolute valuer greater than 2 save for NOK. By the way, Poland’s prime minister has been the first politician (that I have noticed) to call for Norway to share its windfall gains from high energy prices. Interesting to watch the political optics on this issue – certainly a forward risk for NOK.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
EURUSD is trying to cross into a positive trend reading today, but note that the chart context is important for trend status and the downtrend is so entrenched that it is too early to bite on this move. Likewise for USDCHF, although the USDCAD chart looks more credibly bearish on a weak close today.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1230 – US Apr. Chicago Fed National Activity Index
  • 1415 – ECB's Holzmann, Nagel to speak
  • 1415 – UK Bank of England Governor Bailey to speak
  • 1430 – ECB's Villeroy to speak at Davos
  • 2245 – New Zealand Q1 Retail Sales 
  • 2330 – US Fed’s George (voter) to speak
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