Market really pressing its case on the Fed

John Hardy

Head of FX Strategy

Dark clouds continue to gather over many emerging market currencies, even as the USD strength has eased off slightly against the majors recently:

The Russian ruble is one of the weakest currencies on fears of new sanctions from the US side linked to election meddling, with measures on the table potentially focusing on Russian sovereign debt and/or sanctions against key Russian banks. The Russian central bank raised its forecast for anticipated net capital outflows to $30 billion versus an earlier estimate of $19 billion. 

The South African rand weakened sharply today after recent strength as President Trump asked his Secretary of State to “closely study the South Africa land and farm seizures and expropriations and the large scale killing of farmers”. 

Elsewhere, the Brazilian real is the latest meltdown candidate after TRY and ARS (Argentine peso) on election uncertainties, as the jailed leftist Lula is leading the polls ahead of the October election. The India rupee has also come under fire, but we continue to highlight that the key contagion risk that escalates the entire situation for EM and global markets is the Chinese renminbi and whether China insists on the CNY floor near 7.00. 

EM currencies will be sensitive in the first instance to the signals from Powell tomorrow (see below) and in the second instance by China’s stance on the yuan if the USD resumes strengthening.

Elsewhere, the Australian dollar has been knocked for a loop on political uncertaint as PM Turnbull is facing a leaderhip challenge within his own coalition as the latter’s popularity has sunk in the polls. A number of his cabinet have resigned and the “Trump-esque”  immigration minister Dutton is seen as eyeing the prize.

The USD longs have suffered a fitful, selective positioning squeeze ahead of this week’s main event, the Jackson Hole speech from Fed chair Powell tomorrow afternoon at 1400 GMT time. Market participants seem increasingly comfortable with predicting that the Powell Fed will cease its easing sooner rather than later, and the Federal Open Market Committee minutes flagged a number of concerns – especially on risks from trade policy and inverting the yield curve – that have encouraged this view. 

Also sidelining USD bulls this week was Fed voter Bostic claiming that he wouldn’t vote for any hike that actually inverts the curve. And the most entertaining USD headwind was provided by Trump’s bellyaching on Fed hiking rates – something the Fed will ignore for now.

Before we predict that Powell will send out signals, however cautious, that he is set to wax dovish, or at least conditionally dovish, let’s recall that he has often focused on financial stability and that the St Louis Fed’s financial stress index has dropped back to a more neutral reading and US equities have been pushing all time highs recently. 

As well, the Atlanta Fed’s GDPNow for Q3 growth is well above 4% and the PCE inflation forecast for the same series is at 3% while the Fed’s underlying. If the market sells off in the wake of Powell’s speech tomorrow, it will not likely be down to a sudden dovish change of course from the Fed chair.

Chart: EURUSD

Not entirely sure where all of the enthusiasm has come from for the euro, perhaps the easing of focus on Italian debt spreads and sidelining of the Turkish lira meltdown (for now) have seen a covering of aggressive shorts of the single currency. Regardless, technically, the pair has executed a solid bullish reversal in the tactical perspective with the recovery well above the old 1.1500 line in the sand, though has inconveniently done so before this week’s main even for the US dollar – tomorrow’s Jackson Hole speech. 

Safe to say that the speech will need to send some strong support the USD’s way to encourage the EURUSD bears again with a move back toward 1.1400. Otherwise, the move back higher has expanded the range toward 1.1750 if Powell’s rhetoric weakens the greenback. Elsewhere, and especially in USDJPY, support for USD upside prospects are within closer reach.
Enlarge
Source: Saxo Bank
The G-10 rundown
 
USD – the USD has backed off recent highs, but it isn’t exactly a rout for the moment outside of the impressive reversal in EURUSD. We’ll hopefully be able to draw a bead on the USD’s direction after tomorrow’s Powell speech, but we think the USD shorts are looking for too much from him for now.
 
EUR- the euro has achieved too much upside relative to the news flow – still, a change of tune from Powell could still drive further gains, but a sustainable rally needs more from Europe specifically to support.
 
JPY – the USDJPY rally confounds the idea that the USD is under broad pressure. A strong close for the week on any rebound in US rates post-Powell speech tomorrow could set up another direction change and new move back higher. Some combination of a weak US economy, signs of Fed changing directions back toward easing and ugly risk off needed to sustain any pressure to the downside in USDJPY.
 
GBP – sterling eyeing 0.9000 nervously again and hard to see what holds the pair down unless EU existential woes flare again – awaiting confirmation that probability of no-deal Brexit is seen rising.
 
CHF – the EURCHF bounce running into some resistance and looks correlated with EURUSD at the moment. Technically, the pair would need to move all the way above 1.1450-1.1500 to suggest a reversal – that looks too ambitious for now.
 
AUD - not sure whether the political turmoil has legs as a driver – more about USD direction, commodity prices and whether China abandons CNY floor for the Aussie.
 
CAD – a relative winner in the commodity space on the rebound in oil and the southern exposure to US’ booming economy. The 1.3000 level in USDCAD has been an awfully tough nut to crack, however.
 
NZD – kiwi trading mostly as an anti-Aussie at the moment. Let’s see whether Australian politics can keep AUDNZD below 1.1000. Meanwhile, NZDUSD has worked up into the interesting upside pivot area above 0.6700 recently ahead of the key USD event risk of the week.
 
SEK – election incoming with SEK looking very cheap relative to the EUR – downside options structures seem the only way to trade this as nothing technical to suggest a near term ceiling is in just yet for EURSEK.
 
NOK – EURNOK toppish unless we lurch back into full USD strength and global risk contagion, which is still an appreciable risk.

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