US dollar – rally or reversal?

John Hardy

Head of FX Strategy
John Hardy joined Saxo Bank in 2002 and has been Head of FX Strategy since October 2007. He focuses on delivering strategies and analyses in the currency market as defined by fundamentals, changes in macroeconomic themes, and technical developments.

The USD rally has squeezed to very uncomfortable levels for the bears – within reaching distance of the 110.00 area in USDJPY, poking below the 200-day moving average and the big round 1.2000 level in EURUSD and having a look below 0.7500 in AUDUSD. Cable has been sent spinning into the abyss by the latest weak UK GDP data (December short sterling futures have priced out some 19 bps of Bank of England hikes over the last couple of weeks) and USDSEK has gone nearly parabolic.  

Cue the Federal Open Market Committee meeting tonight. US bond yields have recently ramped up as the key coincident indicator of the recent USD rally, with the 2-year benchmark pushing on the 2.50% level and the 10-year recently interacting with the 3.00% level and 6-year high just above there. Fed rate expectations are poised finely on the “two or three more for 2018?” that is also reflected in the Fed’s dot plot forecasts for the rest of the year. 

A couple of forecasters are even looking for a hike at tonight’s meeting, a step/indication we doubt very much the Fed would like to make, even if Powell would like more flexibility in moving at non-press conference meetings (or possibly introducing press conferences at every meeting, as has been discussed). Beyond this December, the market remains sceptical that the Fed will reach its forecasts as curve expectations are largely flat beyond the December meeting.

The nature of the Fed’s statement this evening aside, the backdrop is devilishly difficult heading into the FOMC – is this a classic buy the rumour and sell the fact on the USD even if the Fed is relatively hawkish, or will the still-tremendous pile of USD speculative shorts feed an additional squeeze? As well, if US yields are the chief fuel, we have unprecedented shorts in US interest rate futures, providing a diametrically opposite pressure on the situation (i.e., a squeeze there would spell lower US yields) if interest rate traders don’t find sufficient hawkishness in tonight’s FOMC statement to extend their selling.

It is worth flagging the weak South Korean manufacturing PMI overnight, below 50 at 48.4 and suggesting weak demand from the Chinese mainland, which fits our “slowing China” thesis. Stay tuned.

Chart: USDJPY
USDJPY may prove the most sensitive pair to any decline in US yields on the back of tonight’s FOMC meeting – the pair has risen sharply from the ashes after a technical breakdown below 107.00 and any further upside through 110.00-25 and even the 61.8% level near 110.85. The closing level tonight and this Friday looks important as a status check on the immediate prospects for this USD rally.

FX Update focus on the greenback
 Source: Saxo Bank

The G-10 rundown

USD – the big dollar is charging hard into tonight’s FOMC meeting, where the bar is now much higher for the Fed to surprise on the hawkish side. Tonight’s and this week’s close are important for the next steps.

EUR – EURUSD is interacting with the key 1.2000 level and EURJPY doesn’t want to entirely give up and sell off after the recent bearish reversal. US rates will likely need to back off on a less hawkish Fed to see the 1.2000 area in EURUSD remaining sticky and the pair trying to make a stand here. Otherwise, the implications of a further sell-off point to 1.1500-1.1600.

JPY – the yen gets its lead from two sources – risk appetite and yields – if both head south, you have the most powerful support for a JPY rally, but that combination may be unlikely. We watch the 200-day moving average on the S&P 500, which is a glaringly obvious support point for the risk of a general risk meltdown that should prove supportive in JPY crosses, if less so in USDJPY (if the sell-off coincides with higher US yields as a key driver).

GBP – extreme weakness on the unwinding of Bank of England rate expectations over the last couple of weeks, it would seem that only a positive Brexit development or rate expectations declines elsewhere can bring back some support for the currency. The 1.3500-50 area is arguably the last support zone for the GBPUSD rally.

CHF – CHF is not cutting much of a profile as EURCHF doesn’t seem to want to challenge 1.2000, so USDCHF merely mimics EURUSD price action – though USDCHF focus could pick up if the 1.0000+ area resistance comes into view soon.

AUD - AUDUSD is having a look below the big range support at 0.7500 yesterday, but traders are perhaps reluctant to take it further until the FOMC meeting tonight. As we indicate above, the meeting is a key event risk for all USD pairs, and the 0.7500 area is now the line in the sand here.

CAD – the Bank of Canada’s Poloz was out with a long piece asking “Canada’s Economy and Household Debt: How Big Is the Problem?”. We would answer “very big!”. But Poloz’s conclusion is that the risks are manageable even as he outlines the concerns and suggests that the neutral rate for the Canadian economy is 2.50-3.50%, leaving plenty of room for tightening. Canadian short rates were a few basis points higher yesterday and CAD was supported in the crosses.

NZD – strong house price data, but a slightly disappointing employment change year-on-year leave the NZD in neutral for now around the 1.0700 area in AUDNZD and the more pivotal 0.7000 level in NZDUSD.

SEK – is there any period of more than two days when a Riksbank speaker is not out speaking? EURSEK has reached the top of its rising channel and USDSEK has gone completely parabolic – whenever the weakening move stops, it will likely be with an enormous reversal of short covering.

NOK – EURNOK is shying away from the top of the local range just above 9.70 – tomorrow’s Norges Bank is key for the next steps – rate expectations have actually held up relatively well after the dip in April on the weak CPI print.

Upcoming Economic Calendar Highlights (all times GMT)
07:15 – 08:00 – Eurozone Apr. Final Manufacturing PMI 
09:00 – Eurozone Mar. Unemployment Rate 
09:00 – Eurozone Q1 GDP Estimate 
12:00 – Sweden Riksbank Governor Ingves to speak 
12:15 – US Apr. ADP Employment Change 
14:30 – US Weekly Crude Oil / Product Inventories 
15:30 – ECB’s Weidmann to speak 
18:00 – US FOMC Rate Decision 

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