FX Update: USD momentum impresses. RBA next key CB meeting.
Head of FX Strategy
Summary: The US dollar continues to blast higher with brutal momentum as key levels give way in major USD pairs. The momentum is impressive and could be set to continue if longer US yields also become unanchored and rise together with Fed rate hike expectations. But other central banks will be in focus next week as we look for whether hawkish surprises can offer any counterpoint to the strongest weekly surge in the US dollar since the panic phase of the pandemic outbreak.
FX Trading focus: USD surges further, Fed not only central bank in town
The US dollar continues to track Fed rate hike expectations higher, with the USD back on an aggressive strengthening path today from the get-go, perhaps as long US treasury yields are back higher after their large dip yesterday – an un-anchoring of long US yields and the yield curve steepening somewhat from here could take the USD move farther than if the long end of the US yield curve remains tame. In my portion of our quarterly outlook that was released this week and written some two weeks ago, I forecasted that the US dollar “could prove resilient for some of the early part of 2022 against the usual pro-cyclical currencies”, as I assumed that risk sentiment could crater for a n extended period this quarter as asset markets continue to suffer under the weight of the Fed’s hawkish shift. I assessed that a “broad, aggravated extension of the [USD] strength we saw in late 2021” is unlikely on the assumption that those longer US treasury yields remain anchored. That is an important caveat, and long US treasury yields are creeping back toward the cycle highs. A quick move here significantly above 2.0% for the US 10-year treasury benchmark together with even higher Fed expectations could extend this USD move higher than I would have thought likely when writing the outlook or even after the FOMC meeting. If long yields stay tame, I have a hard time seeing the short end Fed expectations extending much further now that we have effectively already priced in five rate hikes for this calendar year.
Another important factor as 2022 wears on is that the US Federal Reserve is not the only central bank in town and if the Fed is moving in determined fashion to get ahead of inflation, we can expect other central banks to do the same – eventually even the ECB, especially as global prices are generally in US dollars and the price levels could rise even faster elsewhere. Next week, the first tests on this front are the RBA up already on Tuesday and the Bank of England is on Thursday. We expect the ECB to be heading toward capitulation at some point, but next Thursday’s ECB meeting is probably too early to expect much.
The RBA is certain to end its QE purchases as it has pinned the February meeting for a review of this stale policy after the embarrassing breaking of its prior commitment to the 3-year yield control. And after the hefty Q4 CPI surprise, together with ongoing inflationary risks that are aggravated by a weak currency, it is time for the RBA to wax far more hawkish, even though it has focused a considerable portion of its rhetoric on needing to see rising wage levels before raising rates. The market is looking for rate liftoff in April or May – this looks tardy and could be brought forward.
The Bank of England is on course for a 25-basis point hike next Thursday and its credibility on the rate normalization front has been the key driver of sterling strength in the crosses as EURGBP has poked to new lows.
Key US data is up next week, but the ISM Services could prove weak and jobs growth may ease up as the omicron covid variant has clearly impacted the services economy. The market may look through this for now as we probably have to wait for Q2 for a “cleaner” read of the status of the economy once most or all of the covid restrictions are lifted. The Q4 GDP estimate of 6.9% annualize growth was heavily affected by a massive inventory rise that won’t repeat and Q1 is likely held back by weak services activity on omicron, etc.
The AUDUSD has collapsed through 0.7000 and below the December pivot low just south of that level after the significant repricing of Fed expectations higher this week. Next week, we have the chance to witness the degree to which signals from other central banks are able to counter the USD strength, for example, if the RBA waxes far more hawkish than expected. This 0.7000 area is a major one and argue the last-ditch bull/bear line as we watch how the pair treats the RBA developments and the status of the USD rally next week. The next major downside area is perhaps the pre-pandemic major support zone near 0.6675.
Table: FX Board of G10 and CNH trend evolution and strength.
The Chinese New Year is next week, with Chinese markets mostly off-line, so would expect a fairly passive CNH for the week ahead. The USD strength is of course the big new development in town, while AUD weakness picking up pace is interesting ahead of the RBA next week, at which time I think it is time for the bank to wax far more hawkish as noted above. This may be felt initially more in the crosses than in AUDUSD.
Table: FX Board Trend Scoreboard for individual pairs.
Even USDCNH is now trying to flip positive on the trend reading as the greenback tries to make it a clean sweep in rallying across the board. Next week is an important test for the AUD crosses as the RBA is on tap and sterling crosses as the sterling strength in some of the crosses has gotten rather stretched.
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