Head of FX Strategy
Summary: Markets are trying to stabilize again after a traumatic couple of days, and USD bears are trying to get back on track as the week winds down into the close today. We note a hot inflation reading from the US PCE inflation data series today after the hot reading out of Germany yesterday and from elsewhere earlier this week. US yields are back sharply higher, boosting the sense that the markets are trying to shake off the distractions of the last couple of days.
FX Trading focus: Was that it?
The last couple of days have seen wild gyrations in asset markets linked to the intense short squeeze of a basket of popular (among hedge funds) shorting targets, most notably in the US, and FX traders have been innocent bystanders as the usual correlations have kicked in when risky assets lurch into a spot of trouble (i.e.., USD strong, commodity dollars and EM weak), save for the marked weakness in the JPY, something we noted over the last couple of session. Today things are looking a bit less odd in that at least US long yields have kicked back higher, even after a strong 7-year treasury auction of a staggering $62 billion yesterday. It is worth noting that the US 10-year benchmark rallied sharply, but failed to take out the 100 bps level and if yields head back higher again, we’re unlikely to see the JPY stage any sort of major comeback in broad terms. Still, I would expect that if global markets shake off the zany risk-off episode that roiled markets this week, the USD could yet underperform the JPY unless US yields surge to significant new highs for the cycle.
The jury is still out on what will unfold in the very short term after the vicious volatility of the last couple of days, but a huge rally in bitcoin and precious metals and the aforementioned sell-off in US treasuries suggest the inflation/reflation/run-from-fiat trade is being put back on to a significant degree today – also note the considerable comeback in the commodity dollars and EM today, which suggest that the bottom may already be in for the sharp consolidation in these trades, though markets seem to change direction daily, so I would like to see risk appetite and inflation-linked trades post a strong close today and thus for the week to have more confidence on that front.
By the way, inflation readings are coming in hot all over the world lately, with today’s US PCE core in at a +0.3% QoQ and +1.5% YoY vs. +0.1%/+1.3% expected, respectively, and German inflation came in very hot yesterday as well, not to mention the hot readings in Q4 for New Zealand last week and Australia this week – two countries where currencies were actually quite strong for the quarter. Just wait until we see the other side of basing effects in March and April…
Chart: EURUSD
A glance over at EURUSD suggests nothing much of all has been transpiring across markets, which could hardly be farther from the truth, with drama muted in this pair because the euro has outperformed the risky currencies during this latest bout of volatility, leaving EURUSD very range bound. The medium term setup is still clear – that the pair had a nice orderly consolidation that tested just below the 38.2% retracement of the large rally wave from late last year (1.2050 local low), which is the tactical support for remounting a charge on the highs for the cycle, and if we avoid an uglier deleveraging event here, the EURUSD higher trade is a less volatile way to trade for a resumption of the USD bear market, adding possibly EM and commodity dollar trades to the mix next week if those recovery smartly versus the USD into the close of the day and week today and into early next week. The key upside objective to take out is the 1.2200 area for the bulls.
A brief word on CNY and CNH
The most notable development in FX at the moment outside USD direction and the JPY’s sometimes erratic correlations is the considerable strength in the renminbi, as authorities there are tightening liquidity for some reason just ahead of the two-week New Year holiday, an important move that some suggest is a being made to avoid financial bubbles and the subsequent need to clean up after these. Note that the big surge in the CSI stock index, for example, which recently threatened above the 2015 spike high and looked to even have a go at the even higher 2007 highs (when nominal CNY size of Chinese economy was less than 25% of today, it should be noted) Both of those episodes were PR embarrassments for the country. There has also been rhetoric from official sources inveighing against real estate speculation. Something to watch, for sure, but for now certainly puts a bit more pep in USD bears’ step to see USDCNY plunging to new lows ahead of the weekend.
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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.
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