Head of FX Strategy
Summary: A deepening funk in equities, combined with a fizzle in bond yields after their recent rise, is seeing the JPY edging out the US dollar as the safe haven of choice as risk deleveraging has continued overnight. This can continue for a time but only as long as longer yields can fall, with or without an ugly further volatility event in risky assets. Interesting data points are up later today and next week from the US.
FX Trading focus: The USD has broken higher – how far can it extend?
As we discussed in today’s Saxo Market Call podcast, equity markets have entered the danger zone in volatility terms in which only binary outcomes seem possible – either a continued and possibly accelerating sell-off or a huge bounce of equal energy to the prior down move – or first the former followed by the latter. In FX, we have seen an odd “tick-tock” in which first it was only the US dollar that was ascendant on the sharp rise in US yields in the wake of the FOMC meeting, followed by a now more vicious and steep rally in the Japanese yen after USDJPY spiked to new highs, as US yields then calmed as risk deleveraging continued. If the risky asset sell-off extends with treasuries sidelined and even rallying, the JPY may edge out the US dollar as a safe haven, but this would likely prove only a short-term development as long as yields are set to rise further down the line, as is our base case.
But really, we need to see the climax of this risk-off event in the rear view mirror before judging market potential here outside of the general idea that anything can happen: and FX volatility, as I also pointed out in the podcast and in recent comments, is still very low – EURUSD has only just now taken back 5.0% for three-month implied, and three-month USDJPY implied volatility is still below 6.0%.
Interesting data points are up today, though I’m not sure the market is particularly engaged on data right now. These include the US Aug. PCE Inflation indicator, expected to show a slight drop at the core, but already looking stale as this release isn’t very timely and the big price rises of note have been in September. We also get the Sep. ISM Manufacturing after inconsistent regional numbers. The private Markit survey suggests no cause for concern there. The September headline Euro Zone CPI was out today at 3.4% year-on-year vs. 3.3% expected. With natural gas and power prices at multiples of their prior moving averages before winter even settles over the continent, the inflation levels look set to stay elevated or rise even further in coming months. Next gets more interesting with the latest US jobs report and whether workers whose benefits are expiring are rushing to try to fill one of the record number of job openings.
Chart: USDJPY
USDJPY has reversed fairly hard here, probably as US treasury yields were the chief driver of the original rally sprint to 111.50+ and the pair looked overextended as long US yields eased back and traded sideway, as the focus shifted to deleveraging in risky assets. A total reversal here is note the base case here and would take more downside – falling back below 110.00 – with a coincident erasure of the recent pop higher in US yields at the long end of the curve. Barring a very ugly volatility event – which we by no means can do – the sights are set higher in the medium term, assuming the Fed is set to continue its path towards policy normalization. Still, it is interesting to note that a number of JPY crosses are sucking wind and poking back toward major support levels after this equity market consolidation – including GBPJPY dipping back near the important 148-50-149.00 area and EURJPY now closer to a major support zone around 128.00.
Still holding breath for US fiscal signals after House speaker Pelosi failed to bring the infrastructure bill to a vote as she didn’t have the votes to pass it – another attempt could be made as soon as today, but Dems are in an internal battle over the large social- and climate spending bill. Elsewhere, interesting to see if the debt ceiling issue gets wrangled from Congress – would certainly be a welcome relief from that particularly ridiculous distraction.
CEE central banks vying for credibility as the Czech central bank hiked 75 basis points rather than the 50 expected, taking the policy rate to 1.50% in a bid to get ahead of inflation. EURCZK traded back toward the cycle lows near 25.25, an impressive performance, given generally weak risk sentiment. EURPLN was also in for a sharp sell-off yesterday on the surprise signal in the Polish Central Bank minutes that showed a 190-basis point hike (to bring the policy rate to 2.0%) was considered but voted down at the most recent meeting. The central bank has looked dovish in sitting on its hands and waiting for the November economic, especially inflation-, projections before making its decision on whether to achieve lift-off, but a signal like this suggests that the move could be quite considerable once a decision is made.
Table: FX Board of G10 and CNH trend evolution and strength
The NZD weakness has likely been aggravated by position squaring in sympathy with general risk deleveraging. An RBNZ meeting next week look set to finally deliver that first 25-bp rate hike, in part after data this week showed that housing prices in NZ advanced an absurd 28% year over year in September. I will leave for readers to interpret the CNH showing the strongest trend reading of any currency on the board. Elsewhere, sterling is trying its utmost to reverse the broad one-off weakening move from Tuesday.
Table: FX Board Trend Scoreboard for individual pairs
Interesting to note the inconsistent volatility, with many pairs trade with small intraday ranges (ATR column shaded deep blue) while others are elevated (shaded orange – very elevated get a dark orange, with only USDCAD in that category today).
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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.
