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FX Update: USD dumps on risk rebound. RBA dovish surprise.

Forex 4 minutes to read
John Hardy

Head of FX Strategy

Summary:  The US dollar has reversed sharply lower this week, pushed lower by a stout recovery, or perhaps squeeze, in risk sentiment and possibly by end-of-month rebalancing flows. Overnight, the RBA waxed far more dovish than the market expected and yet AUDUSD remains heavily bid in early European trading, as risk sentiment may be dominating short term developments as fundamentals are ignored.


FX Trading focus: AUD firm even on dovish RBA, EURUSD bids for bullish reversal

Risk sentiment squeezed powerfully higher into month-end, perhaps in part on end-of-month portfolio rebalancing after what had been a brutal month for risky assets. As we pointed out in today’s Saxo Market Call podcast, the upside was greatest in the formerly most beaten down names, and the key question here is whether something new is afoot after the market has adjusted to a string of rate hikes from the Fed, or whether this was a one-off and ephemeral flow-based development that will quickly fade as the ongoing concern about the outlook for the economy and a tightening Fed reasserts itself.

It is remarkable to look at the relative lack of differentiation in how the US dollar sold off versus the euro and versus the Aussie by late morning today in Europe. Sure it makes sense to see significant back-filling in EURUSD after very strong German CPI number yesterday boosted short EU rates (also give the podcast a listen for more perspective) and as some may see this as possibly challenging the ECB’s commitment to dovish forward guidance at Thursday’s ECB meeting. But the RBA meeting overnight was overtly dovish relative to expectations and yet the Aussie also managed a steep rally versus the US dollar into late EU morning trading despite Fed expectations remaining at high levels.

Specifically, the RBA maintained that inflation will likely fall back below 3% next year after rising above that level this year, with inflation seen linked to “higher petrol prices, higher prices for newly constructed homes and the disruptions to global supply chains.” The RBA has persistently eyed wages as a key factor for whether to lift rates, and here the outlook remained dovish, as “Wages growth has picked up but, at the aggregate level, has only returned to the relatively low rates prevailing before the pandemic.”…and going forward “A further pick-up in wages growth is expected as the labor market tightens. This pick-up is still expected to be only gradual…” The real kick in the teeth for those looking for a more hawkish shift was the dovish guidance on rates, that “Ceasing purchase under the bond purchase program does not imply a near-term increase in interest rates”. As the RBA states that it “will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range”, the big debate from here will be what interval of time meets the criteria of “sustainably”, just as the Fed eventually stumbled over its “transitory” language. This was a very negative AUD development, which will require strong risk sentiment, perhaps Chinese stimulus and soaring commodities prices to offset. Still watching the 0.7000 level in AUDUSD as a major trigger area for significant further lows if it comes into view on another wave of risk-off.

Chart: EURUSD
The EURUSD pair squeezed violently higher yesterday and into this morning as the US dollar came under pressure, but with isolated euro strength proving a significant driver yesterday, particularly in the wake of a far hotter than expected German CPI print, but potentially also on end-of-month rebalancing. The buying took the price action back well above 1.1200, but technically, a more robust reversal of the recent sell-off wave might require a quick spring up to 1.1300-50 area. More important would be a signal from the ECB meeting on Thursday and whether these latest hot inflation prints (France will report Jan. Flash CPI today, Euro Zone Jan. Flash CPI tomorrow) will see the ECB pulling forward the potential time horizon for a rate hike, with risk sentiment also playing a role.

Source: Saxo Group

Elsewhere, UK PM Johnson’s dire political straits are not feeding much angst for sterling, where the EURGBP rally yesterday was linked to a significant recovery in EU short yields as some are gunning for the ECB to crumble on hiking rates before year-end. The ruble is on a steep recovery path as Russian foreign minister Lavrov is set to speak over telephone with US Secretary of State Blinken. The Swedish krona’s recovery looks muted relative to the recovery in risk sentiment and the jump in the euro.

Table: FX Board of G10 and CNH trend evolution and strength.
Curiously, the dovish RBA failed to even take the Aussie down in crosses like AUDNZD, with important employment and earnings data for NZ up tonight – interesting to see the NZD neglect despite the comeback in risk sentiment. Likewise, as noted above, with the scale of the bounce in risk sentiment and the euro, the SEK momentum shift to the positive looks moderate thus far.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Here, we are watching whether a fading of the risk sentiment bounce would see the USD firming up again on as a safe haven or failing to do so as Fed expectations might deflate slightly. If not, the USD trend higher is in for an imminent disruption. Certainly if long yields continue lower and risk sentiment rolls over, the JPY could shine, even against the greenback.

Source: Bloomberg and Saxo Group

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