Head of FX Strategy
Summary: The interesting injection of volatility elsewhere this week revealed once again that FX is slow to react to inter-market developments. Subplots within the G10 abound however, as the USD and JPY race are joined in the race to the bottom in recent sessions by the kiwi, while European currencies, led by NOK, have risen to the top.
The turmoil across markets earlier this week – most likely triggered by a steep back-up in US yields across the curve and enhanced by a train wreck of position unwinding in the overbought precious metals market – showed that FX remains a laggard in responding to market stimuli, extending the evidence of the same since the post-March and April panic phase of the COVID-19 crisis. The strong rise in US yields was a chance for the US dollar to shine, but it largely failed to do so, merely backing up slightly before over again yesterday and into today as risk appetite staged a comeback and the slide in bonds and especially precious metals prices yielded to a bounce. Yesterday’s monster $38 billion 10-year treasury auction went off smoothly and is followed later today by a large 30-year auction.
Elsewhere, the rise in yields has proven more decisive for the Japanese yen, as USDJPY has now fully rejected the recent breakdown attempt (only placing it back in the range limbo higher and needing some heavy lifting before we can call this anything but a neutralization of downside threat). With the euro beating a path higher again this morning, this has EURJPY on a rocket launch trajectory and at its highest levels since early 2019, a move I find a bit mystifying. EURUSD for its part is launching a fresh bid at the cycle highs as we discuss in the chart comment below.
On the strong side, we find NOK leading the G-10 pack higher, followed by CAD, both of which are soaring despite only modest support from a bounce-back in oil prices (though many may see vaccine hopes feeding most quickly into oil prices on the assumption that a supply shock could await if demand normalizes more quickly than expected.)
Not sure where to look for a catalyst or fresh developments, but the USD bears are having a hard time finding fresh momentum, EURUSD looks crowded, and NZD downside interesting on the AUDNZD break higher and the RBNZ on the warpath against its own currency.
Chart: EURUSD
The strength in the euro has broadened notably – particularly in EURJPY, but EURUSD deserves focus on its fourth attempt today back toward the key 1.1900+ area highs. The latest currency futures positioning data shows speculative longs at a record +181k contracts, a very extended position. Sometimes, extremes in positioning coincide with extremes in price, but there have also been examples in which the trend continues with narrower participation – this was most notable in the July 2012 low in EURUSD, where positioning had contracted notably from the June extremes even as EURUSD trended to new local lows ahead of Draghi’s famous “whatever it takes”. The largest net positions in history have been on the short side – as large as -227k contracts. Technically, the 1.1700 area has corralled the sell-offs effectively on two occasions and that leaves us sandwiched between 1.1900 and 1.1700 awaiting developments, with the ultimate trend test in the 1.1500 area lower if 1.1615 fails. Fundamentally, we are struggling with the immediate catalyst for further USD weakness to extend here without some more notable catalyst.
The G-10 rundown
USD – the back-up in bond yields earlier this week offered a chance for the US dollar to shine, though we never got more than a one-session hitch in equity markets, so the narrative that the US will lead the world to reflation has not yet been properly challenged. Yesterday’s high US CPI reading, if it is a sign of things to come and does not see other countries following suit, in fact amplifies the US negative real rates story (risk of inflation rising while policy rate seen rising only very far down the road.).
EUR – the chief hurdle here for EURUSD bulls is the level of positioning, which suggests the going higher could be heavy here even if the trend continues in that direction. As well, the lack of Fed balance sheet growth is an off-note in the background - but bears have no technical case for a sell-off just yet.
JPY – the yen scraping bottom as today’s session developed as safe-haven bonds are weakening ahead of the US 30-year auction later today.
GBP – positive noises from UK Brexit negotiator David Frost on the ability to reach agreement on post-Brexit transition period in September, but EURGBP is stuck in the middle of the range established as far back as June after the UK reported the worst GDP growth of any major economy from COVID-19.
CHF – EURCHF is treading water – interesting to note the relative stability of CHF during the market volatility earlier this week – possibly a sign that CHF less likely to trade as a safe haven from here – especially when precious metals (and possibly US stocks – gold and tech stocks are large SNB holdings) volatility is the source of concern.
AUD – the Aussie can’t catch a major impulse in either direction here – iron ore and other metals prices have stalled out – technical rout danger only picks up, however, if AUDUSD punches down through 0.7050-00.
CAD – strength here beginning to look overdone – though I think the AUDCAD repricing and even more so NZDCAD repricing looks fair. Next area for USDCAD is 1.3000 if this move below 1.3350 sticks.
NZD – the weakness well deserved and could extend with COVID-19 back in New Zealand and requiring an Auckland shutdown (was the outbreak triggered by refrigerated product shipments?) and with the RBNZ this week declaring that it is in “active preparation” for negative rates.
SEK – the EURSEK sell-off pausing for breath near the key sub-10.22 range lows, needing constant risk sentiment and vaccine hopes to support an extension toward 10.00. Note that 200-week moving average (currently 10.21) has come into view – EURSEK broke above this average after a couple of false starts in early 2014 (the average below 9.00 at the time).
NOK – the 200-day moving average in EURNOK has given away again, but 10.50 the likely psychological focus as we only have one daily close below that level since the COVID-19 crude oil meltdown.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
