FX Update: USD punched lower despite only modest yield dip.

FX Trading focus: USD punched lower despite only modest dip in yields. Signal or noise?

The US October jobs report wasn’t worth much of a reaction, as there was something for everyone: a solid beat on payrolls, a small beat to the upside on average hourly earnings, but an ugly household survey that dragged the unemployment rate sharply back higher despite a small fall in the participation rate. It made sense that US yields took a break on this mixed data after their aggravated rise on the back of the hawkish Powell FOMC presser on Wednesday, but the huge reaction in the US dollar to the downside suggests something else may be afoot. I am not entirely ready to commit to what that might be, but it could simply be so much noise from hefty hedging or pent-up flow around the US jobs data, or it could be a sign that we are reaching or have reached peak Fed tightness, at least for a spell. As the USD continues to trade with a range here even after the chunky sell-off Friday and into today, nothing technical has yet broken down. And we still have what has proven the most important macro data point of the last few months ahead this week: the October US CPI data point on Thursday. So: holding off judgement until after that data point this week, with the most interesting scenario a softer than expected core number and how the market treats that.

Elsewhere, and possibly more importantly, there is considerable noise on the potential for a Chinese policy pivot on zero Covid, even despite the latest official commitment to that policy at the weekend. The scale of the market reaction on Friday to further chatter on a Chinese Covid policy pivot (copper, AUDUSD, etc.) suggests what may unfold if we do get more confirmation of a lifting of this growth-stifling policy: namely higher commodity prices, especially for energy and metals. This in turn could of course also aggravate the risks of higher inflation globally – not at all what a stagflationary Europe can absorb well or that the ECB or BoE will have an easy time responding to, if possibly a positive for EU-based exporters.

Similarly for the US, the Fed is likely hoping that that a slowing economy will at least help to ease price pressures from weaker demand for commodity inputs as in prior cycles in recent memory. But if China is driving a new global inflation impulse (rather than the “helpful” disinflation that it has provided over the last 12 months of keeping its economy in some degree of lockdown) the Fed and other central banks will have a hard time easing up much as they could in previous easing cycles. Shortly put, Friday may have shown us that an eventual change in China’s policy stance on Covid may have far greater impact than further Fed guidance, as incoming US data may fail to drive Fed expectations materially higher from here.

Chart: AUDUSD
A pair like AUDUSD sits across multiple themes, from the overall comparative pace of tightening of the two central banks to the possible impact on commodity prices from a shift in China’s policy on Covid, as discussed above. Technically, while we saw a tremendous impulsive comeback on Friday in AUDUSD, we continue to trade within the range. To see a large bullish reversal, we’ll need to see the pair trading above the neckline-like area indicated for the upside-down head-and-shoulders formation, or simply the most recent pivot high just above 0.6500. Above there, the next major upside swing level is arguably the 61.8% retracement way up at 0.6768, and the structural level of note isn’t really until 0.7000.