FX Update: Treasury yields need to pivot higher if USD to avoid breakdown.

FX Trading focus: USD direction from here likely a question of treasury yield direction.

We saw a tremendous squeeze in equity markets late last week, taking the full move off the intraday lows in the S&P 500 on May 20 to over 10% if we included today’s follow through higher in equity futures ahead of today’s non-session in the USA (US markets are closed today for the Memorial Day holiday). In corporate credit, spreads have tightening sharply, suggesting a surge of risk capital into the space. The US dollar has not responded to these developments over the last two sessions, underlining the recent point that the greenback seems far more primed to respond to the direction in US treasury yields, particularly at the long end of the curve.

The narrative that seems to have developed over the last couple of weeks since the May 4 FOMC meeting that the anticipated Fed tightening has peaked for now after Powell pushed back against rate hikes greater than 50 basis points. The same goes for inflation, according to this narrative, after the April core PCE inflation reading on Friday showed the expected 0.3% drop to a 4.9% YoY rate. A few weak data points in the most interest-rate sensitive sector of housing buttressed this overall view as did other data points at the margin elsewhere (weekly jobless claims and regional manufacturing surveys). Pushing back against this would be a decent set of ISM’s this week – particularly in the more important services sector, and another strong advance in oil prices after we closed at the second-highest weekly close for the cycle last week. China coming back from Covid lockdowns would be a dramatic new driver of greater inflation risks from here.

In short, watching for whether the important data points this week from the US through this Friday’s payrolls and earnings data support or challenge this narrative, preferring to lean on the latter, with the direction of the USD pivotal on the charts against the most pro-cyclical G10 currencies like AUD, NZD and CAD. EURUSD resistance around 1.0800 is important ahead of the German flash May CPI today and EU flash May CPI tomorrow as that area falling could open up for 1.1000+.

Chart: AUDUSD
AUDUSD is rising toward the “final” resistance zone for the bearish case – into the 0.7260 that is both the 200-day moving average and an important pivot high back earlier this month. For those thinking nothing final is final, there is a last gasp level up at the 61.8% retracement of the entire sell-off sequence up just ahead of 0.7350. To provide a tactical bearish hook for fresh short positioning, the pair needs to dip back down through  0.7125 and perhaps toward 0.7050, breaking up this recent tight rising channel.