FX Update: Remarkable complacency as USDCNY nears trigger zone

The US dollar is on its back foot after breaking down further against the G10 smalls yesterday, four of which (AUD, NZD, CAD, NOK) traded at new highs for the cycle versus the greenback yesterday. The US S&P500 index, no coincidence, is at the same time challenging above its 200-day moving average and the psychological 3,000 level today today after a brief wobble into the close late yesterday. As we discussed recently, the risk sentiment and USD outlook remain joined at the hip until proven otherwise – with suspense around the USDCNY exchange rate trading just below cycle highs adding to the stakes for both here.

The USDCNY situation remains critical as both the USD versus onshore and offshore yuan rates have rallied to within about 0.25% of the cycle highs. It is worth noting that by no means is the USD doing the heavy lifting in pushing the exchange rate higher as the greenback is weak elsewhere. The Trump administration has indicated it will respond to China’s move to establish a new security law in Hong Kong and the market should be waiting with baited breath on the trajectory of the US-China relationship and of USDCNY, but complacency continues – certainly worth keeping an eye on how the market absorbs any move in the rate above 7.20 after China’s exchange rate policy badly shook global markets back in August of 2015 and at times all the way until the end of 2016.

The euro has been bobbing back higher in fits and starts and this morning is notably doing so more forcibly against the CHF as EURCHF challenges the big 1.0650 area (more below). EU institutions appear to be pulling out all of the stops to bring more support to the EU economy after the signal from Merkel and Macron on a recovery package to be funded from the EU budget. Today, ECB president Lagarde voiced concerns that the impact on the EU economy from this crisis will be tilted more toward their extreme scenario, suggesting more stimulus in the pipeline. Denmark and Sweden, two of the “frugal four” of EU countries (Denmark, Sweden, Netherlands and Austria) voiced more flexibility on supporting recovery initiatives, though asked that it be in the form of loans. EU Commission president Ursula Von der Leyen will be out today before the EU parliament asking for even more than Merkel and Macron mentioned in their support for a half trillion euro recovery package funded by the EU budget. See our Christopher Dembik for more on the “grants vs. loans” debate.

Chart: EURCHF
EURCHF volatility has been suppressed by SNB intervention as weekly sight deposit data suggests that the SNB prevented what would have been a far deeper sell-off below 1.0500. As the EU tries to get its response to the crisis in order, and if it manages to avoid the tarnish of any new existential strains, the price action could pick up to the upside here as there is the SNB would be more than happy to see upside volatility in this cross on any reversal in safe haven flows. A big level here for this pair is 1.0650 – it may be too early to make a call on a break higher, but the coming few weeks look critical on the political calendar and for this cross, particularly the EU Council meeting on June 18-19. The EU has to put existential fears to rest for the cycle to get this pair off the mat.