Sterling, euro gain as dollar dips

John Hardy

Head of FX Strategy

The US dollar sank yesterday for no readily identifiable reason, but perhaps on a bit of position squaring as China’s currency strengthened and ahead of today’s European Central bank and Bank of England event risks. Hope that we are finally winding our way to a Brexit deal has helped both the euro and sterling, though as we have discussed recently, uncertainties remain. We are hopeful as well and suspect high probability that something gets done ahead of the mid-November EU summit, but would prefer to express a view through options – for example, EURGBP put spreads rather than in what could be a very volatile spot market any time the UK political situation appears at risk of derailing the progress toward a deal.

The EU has taken the unprecedented step of voting to censure Hungary for its move away from EU guiding principles like the rule of law. Hungary’s Prime Minister Orban won elections in a landslide earlier this year and has promised a thorough review and change to the country’s constitution, which has already been revised once under his leadership and included changes that weakened the judiciary and the independence of the press. The forint was sharply lower in these latest developments, but the weaker USD yesterday saw nearly all emerging currencies putting in a strong performance. The row between the EU and Hungary is a long-standing one and it would only be at the point that real sanctions against Hungary’s behaviour threaten capital flows and foreign direct investment that  a more profound move in the currency is a risk. Nonetheless, it all adds to the noise on the EU existential risks, the CEE/core fault-line, and whether the far larger Poland continues to copy Hungary’s governing model.

The Turkish central bank is set to announce rates today, with widespread expectation for a 300+ basis point hike of the key repo rate, taking the rate to 21%. The TRY has managed an extended bout of stability and a softer US dollar yesterday was wind at EM currencies’ back. That rate meeting today looks like a litmus test for investor confidence in the more fragile EM currencies.

Former dove and now hawk Lael Brainard of the Federal Reserve Board of Governors delivered a rather hawkish speech yesterday in which she more directly indicated that an inverted yield curve would not prevent the Fed from hiking rates and didn’t necessarily mean that a recession is imminent. She indicated that the Fed rate hike cycle could extend over the next year or two. If she is right, and the Fed continues the every other meeting pattern for, say, 18 months, including two the two hikes later this month and in December, the Fed Funds terminal rate will be above 3.5% in early 2020. A speech from Brainard some months ago already indicated in rather indirect language that longer rates might be excessively low for reasons dissimilar to the past, indicating a lack of concern about yield curve inversion already then. Fed rate expectations have pulled to the highest for the cycle, but this speech was no fresh catalyst.

The Fed’s Beige Book, meanwhile, was also released last night and was a mixed bag, with many of those surveyed enjoying strong current conditions but fretting new trade tariffs and implications for input costs. 

Up today we have an ECB meeting at which the ECB will roll out its latest forecasts. The lack of apparent inflationary pressures has many looking for a dovish spin in the forecasts, although the forward guidance on tapering and an eventual rate hike after next summer are not likely to see major shifts. Hard to see this meeting as major catalyst. The Bank of England is mostly a formality and I don’t see the need for Carney and company to send any further signals at this point. In the US, the CPI release today is the key data point for the week.

Chart: EURUSD

We have laid out our thesis that the recent powerful rejection of the run below 1.1500 was a bullish development, but subsequently, the implications of that reversal have been watered down by the amount of time that the pair has been stuck in neutral, meaning bullish conviction has ebbed again. Traders looking for a bigger move may have to sit on their hands here, with the downside level more clearly etched around 1.1500, while the upside levels are bit hazier, arguably a pivot zone of 1.1750-1.1800 needing to be cleared to launch EURUSD on a run to 1.2000 and higher again. Today’s ECB meeting and US CPI releases are a great tactical test of whether traders can gin up any conviction.
Enlarge
Source: Saxo Bank
The G10 rundown

USD – the greenback on its back foot, though the rate outlook is quite supportive for additional strength with positioning perhaps the chief hurdle for further gains. Continue to watch CNY and US 10-year yields around that 3.00% level as major coincident indicators as the US August CPI release is rolled out later today.

EUR – we discuss the euro chart above, but if we are about to lurch into another episode of risk on, led by emerging market currencies (not our thesis, but there is room for a relief rally), then the euro will likely languish in the crosses as the focus is elsewhere.

JPY – the yen not enjoying this environment as yield rises pressure the currency in the crosses – USDJPY upside interest only picks up notably if the entire US yield curve can lift.

GBP – we may have to wait for next week for signals from the EU and UK Prime Minister May on a possible Brexit deal. For now, it appear the Tory rebels are trying to mount a revolt so there is plenty of two-way risk if she is ousted.

CHF – the EURCHF bulls may see the solid recent bullish reversal in EURCHF as worth scooping up as long as we remain north of 1.1200, and as long as the Italian yield situation remains dormant.

AUD – a positive employment report helps for the moment, but the AUDUSD bounce so far fading at around the 0.7200 resistance as we await further key US event risks. Yield spreads suggest we should be trading much lower, but speculative positioning is a bit crowded, making for halting progress lower.

CAD – another spike higher in oil prices inspires a try through the pivotal 1.3000 level in USDCAD – that’s an important one for the bulls in a very messy chart.

NZD – the kiwi fading wilting before the Aussie’s modest rally as it should from a rate spread perspective. Next week’s NZ GDP release is perhaps the next catalyst.

SEK – a decent leg up for the krona as it is tough to argue whether either weak minority coalition scenario will mean much in the way of policy. Meanwhile, the rising Swedish short yields are a boost. Without general risk appetite mishaps, EURSEK could manage a move all the way back to the 200-day SMA, currently around 10.21. 

NOK – a big move in NOK inspired by technical rejection of the run higher, the rallying SEK, and stronger oil prices. Unlikely to maintain this kind of momentum, but a move back into the 9.50-40 zone would seem a reasonable prospect. 

Upcoming Economic Calendar Highlights (all times GMT)

● 1100 - UK Bank of England Rate Announcement
● 1100 - Turkey One-Week Repo Rate Announcement
● 1145 - ECB Rate Announcement
● 1230 - ECB Press Conference with President Mario Draghi
● 1230 - US Aug. CPI
● 1230 - US Weekly Initial Jobless Claims
● 1700 - US Fed's Bostic (FOMC Voter) to speak

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