FX Update: Trump’s backtracking boosts sentiment

Trading interest

• Maintaining long AUDNZD with stops below 1.0470 now for 1.0625 and eventually 1.0700
• Staying short EURJPY for 112.00 as long as remains below 119.50

Trump continues to sprint backwards on his latest tariff and sanction threats against China as his administration announced ahead of the weekend that Huawei will be extended a 90-day window to purchase US goods. A vague tweet about China (“We are doing very well with China, and talking!”) perhaps adding to the hopes on the margin that Trump’s bluster will quickly fold with every percentage point drop in the S&P 500.

We’ve seen a couple of recent stories with credible, but unknown sources citing Germany’s intent to expand its fiscal policy in the event of a recession, but now it’s getting a bit more official as German finance minister Scholz specifically indicated the potential to expand spending €50 billion, or about 1.5% of GDP  - fairly modest stuff, but a signal nonetheless. Still, German 10-year bunds are yielding below -65 basis points this morning.

The week ahead full of potential event risks, with political developments in Italy and a speech from Fed chair Powell at Jackson Hole on Friday the two most prominent items on the agenda, although a breakthrough in the Brexit stand-off is a possibility as well (see comments . As well, we get a peek at Europe’s flash PMI’s for August on Thursday, as well as the minutes from the most recent ECB meeting that day.

Powell’s speech this Friday is far and away the most important event risk for markets this week. Powell has been beset with criticism from all sides – with particularly withering commentary from President Trump. The title of the speech is a rather vague “Challenges for Monetary Policy”. Will Powell take the opportunity to be a bit more honest about what is driving the Fed to ease – other central banks’ relative policy and especially Trump’s fiscal excesses?  A real turn lower in the USD likely requires the Fed to cut more sooner and restart massive QE. Is Powell ready to go there and re-enact Bernanke’s famous 2010 Jackson Hole performance (which pre-announced QE2) or will he remain behind the easing curve?

FX implied volatility has jumped sharply in recent weeks, but trading ranges seem to collapse quickly and the realized volatility on a three-month time frame is still very modest by historic standards – particularly given the parabolic moves in global bond markets. The sympathetic move in the JPY and CHF, as well as GBP volatility on the rise in hard Brexit risks have been the chief drivers of volatility.

Chart: USDJPY
The USDJPY move lower having a hard time finding additional fuel as the recent slide in global bond yields – usually the main motor of yen strength, seems to have lost its ability to drive further JPY strength at the moment, perhaps as the recent revival of risk appetite has confused the picture. The more recent shorts could begin to drive short covering if USDJPY heads above 107.00 here.