Will Powell hold the QT line?

John Hardy

Head of FX Strategy

The market managed to close Friday on a positive note, and the Asian session today was without drama in the major currencies, though we continue to note the divergence in the US equity market, which closed within a percentage point of its all-time high, and the Chinese mainland market which continues to sound a sour note. 

The yuan, meanwhile, has pulled back to the strong side in sympathy with the US dollar’s recent weakness.

For the week ahead, we will be watching five themes:

Trade wars: The market tried to put a positive spin on China’s move to send an official to Washington for “low-level talks”. Our position is that we are unlikely to see any breakthrough in the near term as President Trump will only sign on to something that looks like a victory and could be spun as such, while China will not want to appear weak or lose face. The previously announced tariffs on $16 billion of goods will go into effect on Thursday.

Turkey and EM volatility: The line in the sand on a further contagion from Turkey is now rather well established at the 7.00 area in USDTRY. If Turkey’s recent moves to limit speculation can’t hold this level, we could see TRY weakness driving further EM contagion. My suspicion is that emerging market investors/traders are holding their collective breath for signals from the Powell Fed (see below). TRY has so far been stable to start the week despite downgrades on Turkish debt by S&P and Turkey’s refusal to release US pastor Brunson.

Italy’s bond market and the signals on the upcoming budget: The clock is ticking on Italy’s budget process as the market awaits signals from the government on how large a fiscal deficit it intends to run. A Bloomberg article states that the market is providing its own discipline in setting Italian rates and the clock on the European Central Bank's QE is also winding down over the next few months. Ten-year BTP yield spreads to Germany closed last week near 280 basis points, nearly matching the highest levels this year and therefore since the EU sovereign debt crisis.

Chinese yuan: The CNY weakness has taken a breather as we have a third session in a row with the USDCNY rate easing away from the pivotal 7.00 level. The CNY is a non-issue if USDCNY trades lower – it’s whether 7.00 comes into play that is critical for whether recent risk appetite wobbles turn into something a bit uglier. Here we also stress the importance of signals from Fed chair Powell this Friday that will drive USD direction.

Powell’s Jackson Hole speech: This is the week’s primary focus. Fed chair Powell has shown every sign of wanting to stay the course and continue to tighten US monetary policy, but a chorus of voices is beginning to speculate that the Fed can’t ignore the risks of an EM meltdown. Any hint that his stance is softening (second-guessing the current QT schedule?) could trigger significant volatility in FX, likely providing a massive sentiment boost for global markets and a steep USD sell-off. If Powell continues to shrug off global liquidity risks from the Fed’s tightening regime, meanwhile, we could slip back into risk-off mode, with EM currencies under a new bout of pressure and risk contagion back on the menu. I suspect that Powell generally fails to deliver anything hinting at a second guessing of the current course. The difficult bit is understanding whether this is also the consensus view. Given a gargantuan speculative short in US treasuries and sizable USD speculative long, the “surprise side” in positioning is certainly anything remotely dovish or possibly even non-hawkish.

Chart: AUDUSD

The AUDUSD chart is the major USD pair that is perhaps closest to challenging the strong USD trend as the Aussie has taken heart from the bounce in risk appetite and USDCNY pulling away from the brink of 7.00. But it’s hard to believe that any reversal back higher through the 0.7300-50 zone will stick unless Powell sends a message this Friday that weakens the USD broadly.

Enlarge
Source: Saxo Bank

The G10 rundown

USD – the most recent CPI release printed a new high for core inflation and the New York Fed’s leading “underlying inflation” gauge marches inexorably higher month after month, currently at 3.3% and the highest since 2005. Not expecting anything decisive on the USD this week until the other side of Powell’s Friday speech.

EUR – EURUSD creeping higher again as the US dollar rally fades a bit – won’t have a decisive read on that pair until the other side of Powell’s speech – meanwhile we have Italy’s BTP yields as a sub-plot this week. 1.1500 is the critical line in the sand for maintaining a downside view.

JPY – the USDJPY chart is a mess as the yen tends to track the USD direction on the shifts in risk appetite. Suspect we don’t get a bigger move here until we see more notable shifts in US yields in either direction.

GBP – sterling only got a boost recently on the euro’s woes – stability in the latter could lead to weakness in the former as we watch for further Brexit signals and whether EURGBP closes above 0.9000, risking further sterling weakness.

CHF – despite Italy’s elevated yields, EURCHF managed to claw its way back above 1.1300, suggesting that stability allows weakness, while fresh pressure and new wide spread levels would be needed to drive a run into 1.1200 to 1.1000.

AUD – AUDUSD entering the key tactical pivot area between 0.7300-50 – hard to believe we get a sustainable reversal back higher through this area unless Powell sends a supportive signal.

CAD – the loonie got a shot in the arm from a strong headline CPI reading on Friday of 3.0% year-on-year versus 2.5% expected and the “trim” core reading matched a cycle high at 2.1%, but Bank of Canada rate expectations didn’t shift much on the news. The 1.3000 pivot zone has to be retaken in USDCAD to trigger notable technical developments to the downside.

NZD – The 1.1000 level in AUDNZD is hanging in there – we’re constructive on upside potential.
SEK – EURSEK pushing above the last resistance ahead of the 10.695 top, perhaps with a nervous eye on the September 9 election and political uncertainty.

NOK – Norges Bank is going to hike in September, but the market second guessing policy potential beyond then, seeing Norwegian rates lower and EURNOK above 9.60 again – the last real resistance line is 9.70 ahead of the 10.00 top .

Upcoming Economic Calendar Highlights (all times GMT)

   • 1315 – Bank of Canada’s Wilkins to Speak
   • 1500 – US Fed’s Bostic (FOMC Voter) to Speak
   • 1800 – ECB’s Weidmann to Speak

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