FX Update: USD not that weak, given Fed distortions

Forex 5 minutes to read
John Hardy

Head of FX Strategy

Summary:  Signs abound that the flood of Fed liquidity is driving all manner of market distortions as the scale of Fed QE purchases is out of whack with the current state of the US economy and any need for the liquidity in the financial system. The surprising thing for FX traders, then is perhaps why the US dollar is not weaker still. Elsewhere, the RBNZ shocks kiwi stronger with hawkish guidance.


FX Trading focus: USD is rather weak, but look at the backdrop!

In the last couple of Saxo Market Call podcasts, including the one from this morning, we have discussed the flood of Fed liquidity and some of the distortions it is creating across markets, including what are probably unreliable signals like the one from yesterday’s auction of 2-year treasury notes, which was heavily oversubscribed and resulted in a yield near 0.15%. On the surface, this would suggest a market belief that the Fed is unlikely to achieve lift-off in the next two years, but in reality may just be a side effect of the Fed’s over-greasing of the wheels with its asset purchase programs. The Fed has declared an unwillingness to pull back from any of its programs for now (afraid that it could destabilize confidence on the one hand and on the other, that it is perhaps justifiably concerned that it has no idea how the economy will shape up once the crazy pandemic effects begin to fade3).

The USD was mildly weaker yesterday, in part on a slight miss on the Consumer Confidence survey and the bigger miss on New Home sales, but given the backdrop, it is somewhat surprising that the US dollar isn’t weaker still. It could be down to most other currencies failing to provide any notable yield off-set (note German Bund yields limping lower as well) and the energy having been taken out of the commodities move in recent weeks, helped along by China’s efforts to crack down on what it sees as excessive speculation domestically. Those countries where central banks have bothered to indicate a tightening bias have seen their currencies shoot higher, like Norway early this year and in New Zealand last night, or in the case of Canada, which actually has tightened policy with its policy taper announcement on April 21.

Other countries are using the Fed’s playbook in expressing extreme caution, so it is tough to get the kind of differentiation that a few of the smaller DM central banks cited above have provided. Gold shooting higher in recent weeks, however, reflects the general concern that the Fed is running too accommodative a policy and that other central banks won’t want to be caught out in any competitive devaluation game.

Another leg lower in the US dollar might require either that commodity prices pick up again – particularly the big kahuna - crude oil, which topped out all the way back in early March before its long-winded if relatively shallow consolidation. The two most likely things that might send market volatility sharply higher: One, the Fed finally capitulating and needing to send a signal (pressure building strongly now, but what is timing – June 16 FOMC?) and two, a huge break-out in crude oil higher that sets the inflation dynamics into over-drive.

As long as the Fed continues to peddle the message of transitory inflation, the price of a course correction and capitulation rises precipitously, given where the Fed’s accommodative message has taken risk appetite in every corner of asset markets, from equities, to the reach for yield in corporate credit, EM and really, everywhere.

Chart: NZDUSD
NZDUSD leaped higher on the RBNZ’s new forecast last night that rate lift-off could be set for as early as mid-2022. The contrast with the Fed’s and not least, the RBA’s guidance sent the kiwi sharply higher versus the USD and AUD. Note that NZDUSD has now cleared local resistance and only has the cycle top at 0.7465 remaining as key resistance, though I would like to see a broader based USD sell-off to believe that something major is under way just yet. Note that RBNZ Governor Orr is a very willing player in competitive devaluation games and will be quick to trot out rhetoric against this NZD move if it extends. He is set to appear before a Parliamentary committee tonight.

Source: Saxo Group

Elsewhere, the market is not exactly throwing off signals outside of the clear enthusiasm for gold as noted above. The USDJPY chart is hopelessly bottled up (JPY supported by low yields, but all-in hunt for yield elsewhere a conflicting signal), the AUDUSD chart has been so for even longer, and the very range-bound EURSEK suggests that the  market is having a hard time generating enough enthusiasm about the EU outlook and prospects for inflation to send SEK through the 10.00 level (for those believing in a move in either direction, longer term EURSEK vol is getting about as cheap as it ever has been, by the way.) Sterling can’t find fresh momentum against the US dollar and the list goes on. Bottom line: the backdrop looks quite negative for the US dollar, but its inability to suffer more downside contraction should be spooking the bears at the margin.

Table: FX Board of G-10+CNH trend evolution and strength
Note the kiwi momentum jumping to the positive, though it will take a couple more days of rallying for any broader trend to emerge. Gold is extremely positive and might be getting over-stretched soon and very sensitive to any back-up in safe haven yields. (Note that US 5-year and 7-year auctions are up for today and tomorrow, respectively. Weaker auction results here could suggest that the USD liquidity issues are focused more at the shorter end of the yield curve). While headlines tout the USDCNY fall to new cycle lows, the signal is still rather weak for the CNH broadly, showing that this development is more about USD weakness.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs
Here, note the strength of the USDCNH, which looks impressive and is not the result of a giant move, but rather the consistent grind lower in the price action since the pair topped out in early April. No surprise that the XAUUSD trend reading is the strongest on the board. Note AUDUSD and USDNOK trying to flip into a new USD bearish trend – need a strong move for confirmation there.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1900 – US Fed’s Quarles (Voter) to speak on economic outlook
  • 2110 – New Zealand RBNZ Governor Orr before Parliament committee
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