Head of FX Strategy
Not long after EURUSD was probing toward the 1.1500 pivot level yesterday and other USD pairs has reached new local extremes of USD strength, a powerful bout of USD selling washed over the market, with every observer, including yours truly, trying to determine the source of the selling. The most likely answer is simply “flow”, but we can string together a couple of ideas that might have prompted the USD selling yesterday.
The first of these is that Norges Bank and the Bank of England both signalled a more hawkish than anticipated stance, with the latter the bigger surprise and triggering a large reversal in GBPUSD from new local lows. The Bank of England voted 6-3 to keep rates unchanged, with the influential Chief Economist Haldane voting for a hike this time around. As well, the Bank was positive on the economy and indicated that it is now set to begin reducing its balance sheet as soon as the policy rate reaches 1.5% (previously this was 2.0%). Despite the European Central Bank's rather dovish performance last week, the BoE meeting outcome, particularly its more hawkish guidance on unwinding of its QE purchases, enhances the narrative that the era of easy monetary policy is ending not only in the US, but elsewhere, reviving the “convergence” narrative that drove much of the USD weakening last year.
Another reason the market may fear taking the USD strength to new extremes is the risk that the strong US dollar gains negative attention from the US side in the ongoing trade war risk. It would be natural, at any random point in time, for Trump to tweet criticism of ECB and/or Bank of Japan policy, which is chiefly aimed at keeping the currency weak. Note the excellent Albert Edwards piece out yesterday arguing that the market is not focusing enough on the risks of trade tensions between the US and Europe and how central bank policy could be a bone of contention.
Given that this USD reversal arrived just as the USD had crossed above a key threshold, this may prove to have been a key reversal for the greenback from a regime of strength back to weakness. Today we look for where the USD closes the day and the week, offering further clues on whether we have just seen a key reversal. If risk appetite weakens, we would prefer to focus on USDJPY downside potential, but GBPUSD also looks compelling after yesterday’s bullish reversal if it can remain above 1.3200. This morning’s flash June PMIs out of Europe are also an interesting test of the relative US/EU economic strength narrative, after so many weak data points out of Europe.
Chart: Dollar Index
The 95.0+ resistance level from late 2017 and last month was breached just before a significant wave of USD selling washed over the market. The sell-off is still modest relative to the magnitude of the recent ECB-inspired rally (the dollar index is quite EUR-heavy at 58%), but the momentum picture shows some divergence and will quickly turn back lower if the USD doesn’t immediately turn back higher here.