FX Update: JPY in crosshairs over month-end. CAD too strong?

FX Trading focus: Risk sentiment picture and end of quarter in our sights

The focus coming into this week was very much on the US treasury yield picture, given the recent spike that ended the day after Fed Chair Powell shrugged off rising long yields as merely a reflection of the improved outlook at last week’s FOMC meeting. This has left the treasury market to find its own equilibrium, with so far a rather shallow consolidation lower in yields. Yesterday’s 5-year US Treasury auction generated few headlines, with a slightly improved bid-to-cover ratio and a small uptick in foreign demand. There is arguably more focus on today’s 7-year auction, but it is doubtful we will see anything approaching the multi-sigma volatility acceleration we saw at the last 7-year auction. Another piece of the US yield puzzle is the quarter end rebalancing factor. The Japanese yen seems the most sensitive to US yield moves, and the USDJPY consolidation was very tight relative to the size of the prior range and the size of the move in other JPY crosses. If US yields poke back higher, the big 110.00 area in USDJPY could come under fire – the last level that bars the way to 115.00 there. On the flip-side, if rising yields go away as a threat for a time and the “Asian malaise” that is showing signs of moving into US equities as well, both the USD and the JPY could add on to their recent strength. Certainly, Covid concerns are globally on the rise again.

It doesn’t appear that the US dollar is keying off yield moves this week after these were the clear obsession in the prior couple of weeks, perhaps as very weak sentiment in Asia has taken over as a factor in Asia that is helping to support the big dollar, together with a consolidation in a widening number of commodity prices, most lately industrial metals. Overnight, copper is pressing below local support. The USD launched a swift move higher in several places over the last few sessions (vs. EUR, AUD, NZD, select EM), but the momentum is not building further on the actual break of the 1.1835 area in EURUSD, for example. A follow-on move higher in the US dollar of bigger scale could require. In Q2, we still look for the US dollar to turn back lower, but tactically there is considerable room for a rally extension as long as US growth growth prospects are seen as leaps and bounds beyond most of the rest of the world and as long as the Fed ignores the longer term impossible math of incoming treasury issuance later this year (and with an eventual Biden multi-trillion dollar infrastructure plan) relative to the current scale of Fed QE purchases.

Fed Vice Chair Clarida is out speaking today – would appreciate some thoughts on the longer term from him, but doubt if we will get any new message beyond the Fed’s belief that a bump in inflation in coming months will only prove temporary, as reflected in the staff projections from the March FOMC meeting and spelled out  by Powell this week in testimony before Congress.

Assuming oil prices are to remain bogged down here for a while (especially if this current Covid wave is seen as wiping out another chunk of the tourist season and delaying the demand comeback), one currency pair that especially sticks out as “wrong” is USDCAD, which looks in need of a consolidation back toward 1.3000.

Chart: USDJPY – a shallow consolidation indeed
A big week or two ahead, as the US yield consolidation could yield to a fresh bond sell-off, or see a short rally on portfolio rebalancing into quarter end,  with very different implications for the yield-sensitive JPY. So far, this consolidation in USDJPY has been very shallow and now we have the pair looking back toward the cycle highs. The 110.00 level a bit higher continues to look important as the approximate current top of the years-old descending channel, but also as a psychological level of  note and the last area before the more well-defined 114.50 area (let’s call it 115.00). Japan’s financial year end is March 31.