Head of FX Strategy
Summary: The rise in global bond yields this week has buffeted risk sentiment, but a strong buy-the-dip mentality in risky assets seems to prevail, especially this morning in Europe, helping the USD back lower and sending GBPUSD to 1.4000 and AUDUSD to new cycle highs. Can sentiment continue to look through higher yields? That is a knotty question, which I attempt to answer today.
FX Trading focus: USD weakens afresh as market shrugs off yield rises
Today’s action suggests I have been getting ahead of myself in fretting the implications of higher global yields, as the market mood has brightened considerably this morning after another wobbly session yesterday for risk sentiment. And the US dollar is dropping across the board as the market can apparently deal with bond yields at these levels. Arguably, as we move forward, rising yields don’t even necessarily have to trigger any notable meltdown in risk sentiment as long as the market is comfortable that real interest rates will continue to decline (i.e., the inflation “outperforms” or rises faster than any rise in yields). But to get to that place, we will still need to see the Fed vastly expanding its QE purchases, as the market simply can’t absorb the net US treasury issuance later this year without much higher real yields, which would eventually be toxic for asset markets.
So, in terms of the scenarios I outlined on Wednesday for the path from here if yields continue to rise, an extension of today’s action looks very much like “Scenario 1”, which to quote from my FX Update Wednesday is as follows:
Scenario 1 – the slow burn. if the yield rise slows, but persists, while risk sentiment remains stable to positive, the USD would likely roll over again, possibly with the USDJPY trading more or less sideways to slightly higher and EURUSD somewhat boring while EM and commodity currencies rise strongly again. Eventually, however, yields rise to a level that crashes sentiment and spikes the USD higher (and possibly the JPY as well) while the equity market, the Fed’s undeclared third mandate, suffers an ugly consolidation. The Fed comes riding in to the rescue once more, this time with yield curve control, etc…
One addition to the above – it is interesting that USDJPY is struggling to maintain altitude this morning and if that pair can’t maintain 105.00, the USD could be even weaker within the G3 than I anticipated as well when writing the above.
One factor possibly helping the US dollar lower at the margin was the latest and very terrible initial weekly jobless claims number yesterday from the US, which came in absurdly above expectations at 861k vs. 773k expected. And the revision of the prior week to 848k from 793k suggests that there is very little if any improvement in whole swathes of the US labour market. As the US moves post lockdown, perhaps accelerating in April, this single indicator really needs to drop off a cliff for any sense that a normal job market is returning – not a guaranteed development. For what I mean by that, please refer back to our Outrageous Predictions for 2021 (especially the two discussing UBI driving the decline of big cities and the Citizens Technology Fund) and also have a listen to this morning’s Saxo Market Call podcast, in which our Steen Jakobsen questions whether the Fed is making a policy mistake in assuming that full employment can return in the way it did before the pandemic.
Chart: AUDUSD
A new strong boost to risk sentiment in Europe today together with hefty new buying in industrial commodities has helped to drive AUDUSD back toward the highs of the cycle as the AUD plays its role as one of the highest beta currencies within the G10 to weakness in the US dollar. If the market is able to absorb recent yield rises and further yield rises here, the AUD could continue to lead the pack and AUDUSD may be on the path to testing the next major chart resistance above 0.8100. But first, let’s see if the pair can stick the landing into the close today – I have always found moves on Friday in AUD tough to interpret as they usually come after Australia has headed home for the weekend.
The G-10 and CNH rundown
USD – as long as yields don’t rise too quickly to spook risk sentiment, the USD getting the worst of it and could be set for new cycle low s on a weak close today. Watching real yields closely and a busy week from the Fed next week (Powell semi-annual testimony, and Clarida out speaking later in the week)
CNH – the yuan not leading the way in rising against a weaker USD here and interesting to note that AUDCNH is trading near the cycle highs.
EUR – a bad head fake for the EURUSD bulls in yesterday’s sell-off, which we suddenly find wiped away in early trade today. But EUR unlikely to prove a leader in any global reflation scenario – and reality on the ground in the EU still sad on Covid lockdowns, etc. (but some hope in the flash Euro Zone Manufacturing PMI improving to a nice 57.7 even if the Services PMI was a lousy 44.7)
JPY – even the JPY managing to rise against the US dollar today. Note that long JGB yields are also coming a bit untethered, with the . Still, on further rises in yields and risk sentiment, would expect broad JPY weakness even if the yen manages to firm further against the greenback.
GBP – the EURGBP sell-off extended to 0.8650 and GBPUSD even had a look above 1.4000 this morning. There is more revaluation potential higher for GBP, but at some point, the same structural concerns for sterling as for the USD will weigh (Gilt issuance vs. BoE QE and more important, if UK negative real rates worsen on higher UK inflation from the fiscal outlays)
CHF – weakening sufficiently here to deserve a bit of attention. Look at the action in GBPCHF, for example. But more focus if rising yields and distaste for negative yielders finally sees EURCHF 1.0900 falling.
AUD – as noted above, should do well in the current environment anticipating commodities inflation as copper prices roar higher and iron ore posted another strong session overnight. Watching whether AUDUSD can stick the close to the week.
CAD - oil prices finally finding some two-way volatility, which is holding CAD back a bit in the crosses, but USDCAD looks ready to have a go at 1.2500 soon, and possibly lower.
NZD – not much to differentiate AUD and NZD here, although would expect AUD to outperform if current themes heat up further. NZDUSD looking ready for more upside if it closes north of 0.7250 for the week here.
SEK – if we pull back to new highs for the cycle in European equities and the vaccination hopes pick up in the least here, surely EURSEK can manage a break below 10.00 soon.
NOK - giving up some gains in the crosses on the oil volatility, but would still expect NOK to outperform if markets remain in an optimistic mood and oil stabilizes quickly.
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