Head of FX Strategy
Summary: A strengthening US dollar and higher US yields continue to drive much of the action across markets, but a riveting side story is the USDJPY exchange rate more or less holding the line, while the Chinese yuan has crumbled before the big USD and has traded well below the range lows since 2019 and at the lowest since 2008. But roiling markets around European lunchtime is a Bank of England move to launch emergency QE in order to counter dysfunctional moves in the UK gilt markets. Weren’t they meant to be selling gilts, not buying them?
FX Trading focus: BoE Emergency QE! CNH In focus as USDCNH crosses above 7.20.
Breaking: BoE moves with emergency QE to avoid systemic meltdown. Just before I was about to send the report below out, the Bank of England announced that it would purchase long date UK gilts to stabilize the market in a “temporary operation”. It was stunning to see sterling rally on this, even if a brief kneejerk! This is an admission that the currency will have to take the impact if yields rising elsewhere, since UK yields can’t rise as rapidly as they have recently without triggering a systemic-type event that requires BoE easing. Still, riveting to watch the action from here – the move forced UK yields sharply lower, with the 10-year UK Gilt yield moving 40+ bps lower quickly in response, but US yields were also some 10 bps lower. Given my comments on the Fed “breaking things” below – the UK financial markets just got broken, who is next, when is it the US’/Fed’s turn, and will signs that risk sentiment is celebrate this BoE move as the canary in the tightening coal mine pan out, or is it a red herring for now? Stay tuned.
Back to the original program: The market is spooked by the ongoing rush higher in US treasury yields, with the 10-year treasury benchmark reaching the symbolic and real support level of 4%, which held the line for an extended period. Whether the juggernaut of treasury selling can stop so quickly simply because this level has been reached is an open question, but round levels have often proved major sticking points in the past. Already at these levels and after the tremendous acceleration in yields higher, the treasury market is strongly at risk of “breaking something” with the USD the accompanying wrecking ball here. More thoughts on that below.
But sentiment has also been driven lower by an aggravation in an already fraught geopolitical backdrop after the Nord Stream 1 and 2 pipelines were severed by coordinated explosions yesterday. The medium to longer term outlook for energy inputs into especially Germany’s industry was always hazy beyond the heroic efforts to ensure gas supplies through this coming winter, but this development throws up a dark cloud over the longer term outlook as well, since even regime change in Russia and a shift in attitudes on both sides would still require extensive repairs of the infrastructure to get the gas flowing again. A bit surprised that the euro has held out as well as it has in the face of this latest news.
Chart: CNHJPY
The US dollar rally finally took USDCNH above the 7.20 area that defined major tops on two prior occasions in 2019 and 2020 and set a new high water mark for USCNH in the history of the offshore CNH currency above 7.26 at one point this morning. The official USDCNY exchange rate has not traded this high since early 2008. The move comes ahead of a major holiday next week in China, with markets closed for the entire week, which will leave markets in limbo next week as USDCNY won’t trade.With USDJPY holding the line despite the US dollar strength, it is riveting to watch the CNHJPY yield for whether we are finally set to see a major mean reversion in this most important of Asian currency pairs. Note the trendline and the 200-day moving average that will come into view quickly if the sell-off extends.
USD climax – now or soon? The USD move this month has been epochal – as of this morning up over 5% in Dollar Index terms, up over 6% versus the Aussie, up over 8% versus sterling, and up a staggering 10% versus NOK. We are probably just about there for the extent of this USD move in time terms and in momentum terms, even if the amplitude of the spike could worsen further before the move finds resistance – the Fed is on the verge of breaking the treasury and currency markets, and the economy will follow with a lag. For now, it will be interesting to see, as month-end and quarter-end approach, whether portfolio rebalancing can put some support under the treasury market and or a ceiling on the US dollar, or if even a tactical consolidation in the two markets will require a change of direction from the Fed. At some point if the twin USD/US treasury wrecking balls continue to swing, the Fed will have no choice but to intervene with balance sheet re-expansion or a yield cap policy – but will this require an all-out equity/risk asset market rout first?
Table: FX Board of G10 and CNH trend evolution and strength.
The USD trend strength reaching staggering levels near 10 – are we near the end of this trend for a spell? Most likely, in time terms, but trends like this can end in impossible climaxes. Note elsewhere the JPY strength sticking for now.
Table: FX Board Trend Scoreboard for individual pairs.
NOKSEK broke down through 1.0500, a key technical development, but look at USDNOK at an absurd reading of 10.1 (And USDCAD at 11.1 and USDCNH at 13.1!).
Upcoming Economic Calendar Highlights
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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.
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.
