FX Update: USD punching on key support with EURUSD focus

The last couple of sessions have shown that the US dollar seems far less dependent tactically on the “risk-on, risk-off” narrative, a refreshing change of pace, although it is still difficult to disentangle a weaker US dollar and reflationary and global growth recovery hopes, as a weaker USD is a prerequisite for a brightening outlook. Specifically, EURUSD bulls have to find encouragement in the pair’s ability to find a steady bid through the last couple of volatile sessions – and the same goes for AUDUSD bullish hopes on the lack of interest from that pair in reacting to equity market gyrations during the same time frame.

Indeed, the US dollar is punching on pivotal support levels, most importantly in the EURUSD supermajor, which is well above the 1.1400 level this morning, even ahead of the key event risks over the coming couple of sessions (discussed in the EURUSD chart caption below), though we’re not expecting these to necessarily throw up any barriers to further upside. A glance over at other USD pairs for confirmation, and it would be helpful to see AUDUSD vaulting and closing above 0.7050.

Perhaps the chief driver feeding a weak USD narrative is the ongoing prospect of the Fed providing strong balance sheet expansion (yes, the balance sheet expansion has reversed in recent weeks on the Fed reversal of some emergency measures like FX swaps, but this will inevitably reverse soon on the weight of ongoing asset purchases) but more importantly, we could see the fiscal spending in the US vaulting to levels above and beyond those in other countries due to two factors: first, that it’s an election year and second on the mishandling of the COVID-19 outbreak.

The US Treasury has a cash pile of over $1.6 trillion, and one assumes that Mnuchin and company are set to deploy as much of that as they can for maximum impact in the run-up into the US election on November 3, providing a massive flood of USD liquidity and possibly driving an “ugly real rates” narrative for the US dollar if commodity prices continue to vault higher. As well, the Fed appears to be increasingly concerned about the state of the US economy, with Deputy Governor Lael Brainard yesterday intoning darkly on the “thick fog of uncertainty” surrounding the US economy and the likely need to provide fresh easing: “it likely will be appropriate to shift the focus of monetary policy from stabilization to accommodation”. The tools she mentions later in the speech are forward guidance and yield curve control – arguably largely ineffective, except in the latter case as an auxiliary to the Treasury to accommodate the blitz of treasury issuance and prevent fiscal largesse spiking treasury yields.

Today is Bank of Canada day – not looking for any fresh twist here, as the numbers for the virus and for the economy are headed in the right direction for Canada and the Bank has declared the policy rate of zero to be the lower bound, so tinkering with the forward guidance horizon and pace of QE purchases are about the only thing on the menu. USDCAD is behind other USD pairs in showing USD weakness – the pair needs to work back below 1.3500 for downside interest to pick up .

Chart: EURUSD
EURUSD is breaking up and it is doing so before a couple of key event risks in the days ahead, including tomorrow’s ECB meeting and the more important EU Council summit on Friday and Saturday. Signs of solidarity at the latter and a brushing aside of the “frugal four” concerns could further charge this EURUSD rally. Looking higher, we would look toward the 1.2000 level as the first target for a break and hold above 1.1500 on the other side of this weekend.