FX Update: USD can only thrive on souring sentiment

FX Trading focus: Weak risk sentiment feeds USD back-up. What it would take to jolt JPY higher.

Whether it was the sudden bitcoin and crypto-currency meltdown that has unfolded overnight and continued today (much broader this time across the crypto space and not just in Bitcoin itself, it must be noted) or the after-effects of US tax bills after the filing deadline came and went this Monday, risk sentiment in the US was weak yesterday and that weakness extended overnight and into European trading today. This has driven stiff headwinds for USD bears tactically, especially in the traditionally risk-sensitive currencies in the G10 (with EM volatility curiously muted). The EURUSD breakout was not immediately affected as that pair posted strong new highs yesterday and even into this morning before modest consolidation finally set in. German Bunds yields have managed to run to new cycle highs today as well, though the move was tempered after a high of -7.4 basis points was posted in early trading this morning. And that particular breakout is looking increasingly lonely among USD pairs together with the GBPUSD move higher, although the latter would perhaps have to slip and close below 1.4100 for immediate tactically bearish implications. Other USD pairs from AUDUSD to USDJPY never made it over the edge against the greenback’s favour this week. If risk deleveraging turns sufficiently vicious, the Bund move risks unwinding and then…well then let’s have a look at what the JPY does as I discuss below.

So ahead of the FOMC minutes, it seems the only upside path for the US dollar is relative misery elsewhere and a shift away from the themes that have driven it so low thus far:  fears of inflation and the idea that the Fed wants to run monetary policy at irresponsible levels until inflation is securely averaging well above 2%. It’s doubtful that anything in tonight’s FOMC minutes will suggest a pushback against the current Fed guidance, but we should always be on the lookout that a few members or more are getting restive on the risks of over-stoking the economy and inflation. On the Fed’s asset purchases, I have to imagine that there is more widespread questioning than the one-off hint from Boston Fed president Rosengren on the need to continue buying MBS at the current torrid clip when the US housing market is already white hot and more than fully recovered.

Chart: USDCAD
Watching today whether anything can reverse the USDCAD slide in a more determined way, after the pair poked to a new 6-year low intraday yesterday (below the low of the big dip in 2017) and not far from the magic 1.2000 level before weakening risk sentiment and crude oil pulling sharply away from recent highs took away support for the move lower. Zooming way out, we can see that an important driver for CAD strength for the cycle has been the move lower in two-year US-CA yield spreads, with the 2-year swap spread now back to the cycle lows from March around -40 basis points and with the Bank of Canada having announced its taper of asset purchase on April 21. This spread was last approximately achieved right at that major low of 1.2063 from 2017. Critical levels here on the downside, including the psychological 1.2000 level. There is some bullish divergent momentum here, but USDCAD will likely only be pulled higher by a significant further consolidation in crude oil prices and further deterioration in risk sentiment – but also watch for the price action in the wake of today’s Canada April CPI release. 1.2300-1.2400 would be the natural destination zone for a rally of consolidation within the context of this bear market – it would take considerably more upside to neutralize the trend.