FX Update: The USD cannot sustain pro-cyclical strength for long

FX Trading focus: Something contradictory in current USD developments.
We discussed this on this morning’s Saxo Market Call podcast, but it looks odd that the US dollar seems to be trading as a pro-cyclical currency, moving up in line with strong US data and higher US yields and higher risk sentiment. This is very much against the pattern of much of 2020 and the post pandemic outbreak experience. And on that note, something doesn’t feel right, because a stronger US dollar and higher US long rates are tighteners of liquidity and this is a market that has built itself aggressively on the assumption of an extremely accommodative policy stance and endless liquidity. At some point soon, especially if yields rise quickly from current levels, I would expect volatility in risk assets to ratchet higher and some of the speculative froth to come out of the market. But in such a case, would the USD then also prove a safe haven currency and stay firm? I suspect it would versus G10 small currencies and EM currencies, but I have a hard time believing that the USD is win-win proposition.

Something doesn’t feel right here – perhaps today’s US jobs report will provide some enlightenment, especially if it fits with other recent labor market data and is notably stronger than expected. Do yields continue to pull higher? If they do so, will risk sentiment fret the implications, etc.? Further out, if a huge post-vaccine boom awaits, it should be especially strong in the US with additional stimulus coming on-line soon there and inflation should overshoot the worst there initially, and meaning lower real yields (yield after inflation) than elsewhere. (That is, unless, as I asked in a recent post, inflation is more globalized, which allows the USD to hold its own a bit better as other FX would be more  quickly impacted by falling real rates on higher inflation – the EUR but especially the JPY certainly at risk if we are talking about an all-out inflationary scenario in energy).

The January US Nonfarm Payrolls change for today is expected around +100k vs. the -140k notched in December, while the ADP number registered a +174k gain for Jan. The Covid case count in the US is falling like a stone – with the 7-day moving average down by almost 50% in the just over three weeks since the peak. The US was never good at locking down and a horde of service jobs will come back quickly once normal activity can get the green light – hopefully soon.

Chart: EURUSD at a crossroads
EURUSD has broken down through the key 1.2000 area and the upward loping trendline and is now having a look at the 100-day moving average. If the pair cannot stage a strong recovery here back well above 1.200 and heads even further south to below the 61.8% Fibonacci retracement around 1.1890, the prospect for a test of the 1.1600 old range  low or even a push all the way to 1.1500 begin to open up, which would require a reassessment of the weaker USD narrative for at least the medium term. In short, EURUSD looks at a crossroads here.