Head of FX Strategy
Summary: The US dollar powered through stronger still yesterday as the market has taken its expectations of peak Fed back to the high for the cycle. Overnight, the AUD and JPY put up a fight against the greenback on a more hawkish than expected RBA and a huge beat on December wage growth in Japan, the strongest in 25 years. Fed Chair Powell is set to speak later today, but incoming data has already done his job if he emphasizes the "higher for longer" rhetoric of the recent past.
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FX Trading focus: USD remains firm on higher US yields, though AUD and JPY put up a fight overnight.
US yields followed through higher yesterday after the Friday payrolls and ISM Services data shocks, with the 2-year managing a poke at 4.50%, the highest yield level for that point on the yield curve since late November, with forward curve expectations for peak Fed rates at one point reaching a new cycle high of 5.15% yesterday (two full 25-bp hikes would take the rate to 5.00-5.25%) before easing back slightly. Fed speakers in abundance today (Fed Chair Powell to sit for an interview with the Economic Club of Washington) while a bevy of FOMC voters are out speaking tomorrow, but if there is anything that the last week has highlighted since the FOMC meeting reaction, it is that incoming data likely outweighs any guidance that the Fed itself provides. The next major data point is next week’s CPI number, but as we have emphasized, the near-term inflation levels are far less in focus relative to data pointing to labor market tightness, wage growth and activity levels potentially picking back up again.
Overnight, the RBA adjusted the official cash rate higher by 25 basis points, taking the policy rate to a rather pedestrian 3.35% as most expected. The guidance was far more hawkish than expected after the RBA seemed more in the “warming to the idea of a pause soon” camp in the prior meeting, apparently finding a bit of religion after the hot Q4 CPI print. The waffling December statement that “The Board expects to increase interest rates further over the period ahead, but it is not on a pre-set course.” was replaced with the far more hawkish “The Board expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary.” At the same time, moderating the impact somewhat is the continued anticipation that the Australia economic outlook will soften this year. Australian 2-year yields rose about 16 basis points on the session as the market more fully priced another 50 basis points of tightening from the RBA in coming months.
Chart: AUDUSD
AUDUSD bounced fairly hard overnight after the vicious slide since mid-last week as the RBA waxed more hawkish than expected, forcing the market to tack on another 25-basis point hike before the RBA is seen reaching peak yields (still priced sub-4.00%) in the summer time frame. From here, the RBA’s relative hawkishness will always matter, but as long as the market is adjusting Fed expectations and US treasury yields higher, the AUD may have a hard time turning the corner again on the greenback and sustaining a new rally above 0.7000. The sharp sell-off here has been a hefty blow to the up-trend, though it would be far more damaging to see a follow through lower from here that takes out the next levels like the 200-day moving average just above 0.6800, which could augur for a move toward 0.6500-0.6550.
Elsewhere, the JPY weakness extended a bit yesterday on pressure from higher US treasury yields, but overnight, a very strong December wage growth report from Japan shocked the JPY back to the strong side, resetting some of the move lower since the weekend, when noted dove Amamiya was reported as the new front-runner to replace Governor Kuroda. I wouldn’t expect the JPY to get much of a further broad leg up unless yields rollover or at least head sideways, barring something more specific emerging on the future of BoJ policy.
Table: FX Board of G10 and CNH trend evolution and strength.
A changing landscape in the G10 FX trends in places, chiefly in the USD resurgence, but also as the AUD up-trend has faded, while CAD has found a sympathetic bid with the USD as Canadian rates have tracked US rates over the last couple of days. The suffering Scandies are noteworthy ahead of Thursday’s Riksbank and first test for the Riksbank’s new governor Erik Thedeen.
Table: FX Board Trend Scoreboard for individual pairs.
All G10 USD pairs are now in the USD-positive column, although barely so and rather fragilely in the case of USDCAD’s sluggish turn over the last few days. USDCNH is on the verge. GBPUSD is very heavy – breaking down below 1.2000 – can 1.1842 hold it? If note, we could be looking at 1.1500 test if US yields notch higher still. Note EURCHF at risk of a downside capitulation near the 0.9900 area and its 200-day moving average.
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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.
