FX Update: Fed terminal rate hits new highs. China recovery story misstep. FX Update: Fed terminal rate hits new highs. China recovery story misstep. FX Update: Fed terminal rate hits new highs. China recovery story misstep.

FX Update: Fed terminal rate hits new highs. China recovery story misstep.

John Hardy

Head of FX Strategy

Summary:  The terminal Fed funds rate reached a new cycle high above 5.25% yesterday in the wake of stronger than expected CPI data and fresh Fed jawboning, with the USD chopping all over the place before finding new strength overnight, possibly on concerns that the Chinese recovery story has been over-played. This morning, sterling hit an air pocket on soft CPI data that will likely give the Bank of England the green flag to soft-pedal further rate increases.

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FX Trading focus: Fed expectations at cycle high, soft UK CPI data points spoils GBP comeback attempt.

The US January CPI print saw headline and core inflation running hotter than expected for the year-on-year measures, while the month-on-month data was in-line with expectations at 0.5% at the headline and +0.4% for the core. Doubters pointed to the “core services ex shelter” measure (the one the Fed has highlighted as driving the most concern on its part) only registering a +0.3% rise month-on-month (though that in turn was pulled down by a steep -0.7% decline in the very choppy Medical Services data series). All in all, after a very choppy reception to the data, the market decided it wasn’t that much the wiser and the greenback was relatively unchanged late yesterday, outside of USDJPY pulling above resistance and 133.00. Some late jawboning by various Fed officials helped as well as the CPI data to take the terminal Fed rate to a cycle high of 5.26%, but with a muted advance in the longer end of the US yield curve, the inversion of the US yield curve reached a new record low for the cycle of -87 bps for the 2-10 part of the curve.

An entirely different driver materialized in the Asian session to drive the US dollar higher, which was negative action in a confluence if indicators that are all proxies for the China reopening story (copper, AUD, Hong Kong equities). Not entirely sure of the cause-and-effect of this development, but a Bloomberg article out overnight does reveal that at least some of the credit impulse that Chinese officialdom is mobilizing to boost consumption is instead finding its way into paying off higher-yielding mortgages or is even being uses to speculate in equities. The sense, if this story is broadly true and the behaviour widespread, is that the Chinese recovery story will need to prove itself from here.

Today’s soft UK CPI release more than erased the impact of yesterday’s firm labour market data, as the negative 0.4% miss on core CPI YoY at 5.8% YoY (vs. 6.2% expected and 6.3% in December) will more likely keep the Bank of England happy with its complacent inflation forecast and rate guidance (seeking to avoid further tightening as long as inflation continues to drop). UK 2-year yields are coming in 15 basis points lower today after this data release while the US 2-year yield closed at a local high yesterday on the US’ own CPI data yesterday. This has engineered a steep sell-off after the zany pump in GBPUSD yesterday that conveniently touched the very technical 61.8% retracement level of the prior sell-off near 1.2270 before the subsequent 200 pip plunge. Next levels of interest to the downside include the pivot low near of 1.1961 and the 200-day moving average coming in slightly below, but the most important level is the 1.1842 pivot low. Elsewhere, the BBC is out with a story suggesting a Boris Johnson political comeback attempt, in a bid to “save” the Conservative party after its polling hit record lows last year.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength.
Still weak trending indicators for most of G10 as the recent action in many cases is moving against the prior direction (GBP selling off after sharp rally, for example). Most noteworthy in relative strength terms is the weakness in the precious metals as higher yields are biting there, together with a softening in the copper price, which has correlated very closely with the CNH direction for months on the post-Zero Covid recovery narrative. AUD certainly jolted overnight, but it has been trending higher in many places in prior days.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
The EURSEK and USDSEK backups are a real disappointment for those looking for an extension in SEK strength, watering down the potential for something interesting unfolding there. Note EURGBP so far trying to reject the attempt to establish a new downtrend with today’s action, while GBPUSD affirmed the still young downtrend yesterday after the squeeze higher.

Source: Bloomberg and Saxo Group

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