FX Trading focus: Market making more sense now as USD in new tailspin
I noted in Friday’s FX Update that something was unsustainable in seeing the US dollar rallying at the same time as risk sentiment was strong and US yields were heading to new highs. It proved indeed that the US dollar was the weakest link and it rolled over badly on the weak US jobs report on Friday. Somewhat oddly, US treasuries were also weak despite the lackluster jobs market data for January, but after new highs in yield – especially for the 30-year T-bond, which kissed 2% for the first time since February of last year – treasuries found support and put in a chunky rally yesterday ahead of a 10-year auction tomorrow and a 30-year T-bond auction tomorrow. From here, I would expect correlations to make more sense: if yields are up sharply and risk down sharply, I would expect a firmer US dollar, while if yields are tamed or even slightly lower while risk sentiment is strong, I would expect the US dollar to fall apace. The turbo-charger for USD weakening would be any intent expressed by the Fed to cap yields Probably too soon for this and the whole situation may be a chicken and egg problem – i.e., that the Fed wouldn’t want to reach for yield curve control/yield caps unless these seemed to be denting market confidence.
Technically speaking, USD pairs are still in a zone of uncertainty as the bears need to take the USD fully back close to the cycle lows (or at least another leg lower as noted in the USDJPY chart below) to get the USD bear trend back on the rails – any faltering here keeps a cloud of uncertainty over the status of the trend.) One seasonal note of concern for any market volatility in the US dollar is the upcoming Chinese New Year holiday, with mainland Chinese markets closed this Thursday through next Wednesday.
Chart: USDJPY survives technical test
The USDJPY pair tested the 200-day moving average above 105.50, in part likely due to an over-positioned market disconcerted by the rise above what had proven a very well defined downward sloping channel, but also as US yields had backed up sharply recently – with higher yields generally associated with headwinds for the JPY. As well, JPY traders have also likely been spooked to a degree by the strong surge in commodities prices, as Japan is almost entirely dependent on imports of energy and other materials. Weighing against any JPY strengthening all the while has been an strong bid for credit risk in EM, where Japan’s investors like to invest for the carry. The pace at which USDJPY selling has come back in since yesterday’s highs suggests that the latest rally may prove merely to have been a squeeze. If the price action drops back down toward 104.00, the latest rally wave will have been fully reversed and traders will revert to focusing on the cycle lows just above 102.50 and possibly eventually to 100.00, although that eventuality may require that US yields stay capped (especially if the Fed hints at some point that it is willing to cap US yields until employment has improved sufficiently. If US yields rise aggressively, on the other hand, together with a continued strong resurgence in commodity prices, the JPY may prove a laggard in strengthening versus the US dollar relative to most other G-10 currencies.