FX Update: USD finds new gear on risk aversion

FX Trading focus:

USD: benign consolidation – unless…
The US dollar continues to back up, adding to its strength since mid-week last week. The initial pull higher was on the back of the break higher in long US yields that we gave prominent coverage last week, with this latest addition to the greenback’s resurgence on a bit of risk aversion to start the week. There are multiple angles on what may be driving a sudden risk off move, with the most straightforward simply a heavy dose of negative Covid-19 news, as the super-contagious variant could win the initial part of the sprint to vaccinate, and where previous major winners in fighting the virus are dealing with record levels (Japan) and with a sufficiently serious new outbreak to require the total shutdown of a major city (Shijiazhuang in China). Regarding that super-spreading variant plaguing the UK, it is rapidly spreading elsewhere and in Denmark, to take an example, it is expected to become the dominant strain of the virus by mid-February, frustrating any hopes that activity can normalize any time soon.

The negative tone today is quite a contrast with Friday, where equities surged to a new record despite US December jobs data coming in weak (-140k on December non-farm payrolls and only weaker participation driving the reported drop in the unemployment rate). Sure, it is no surprise to see major losses in the hospitality and other service jobs, but the market’s apparent trust that all will be well remains jarring relative to the news flow.

I suspect another potential source of unease could be the shutdown of Donald Trump by social media companies and the uncertainty on the risk of further unrest that could ultimately become more disruptive. The mob occupying Capitol Hill last week somehow failed to have any initial effect, but any aggravation or spreading of this phenomenon, whether in Washington DC or across the country could change the market’s stance on the issue. As counterintuitive as it sounds, US unrest could support the US dollar via weak risk sentiment. Specifically, pro-Trump groups are encouraging demonstrations on January 17 – this Sunday – and there is dark talk that some would like to show up armed for the occasion.

Finally, the US-China relationship is a credible source of potential long-term unease and uncertainty, just as headlines linked to Trump huffing and puffing on trade issues serially pumped and dumped the market for the year prior to the Covid-19 pandemic and the trade deal that was finally signed almost a year ago today. It seems that the outgoing Trump administration is laying down all manner of anti-China landmines that the incoming Biden administration will have to deal with from day one and seemed designed such that any step back from them can be used by the Republican opposition as proof of a “soft on China” stance.

Looking across the G-10 currencies, besides the stronger US dollar, the most interesting developments are the pull higher in USDJPY,  where 104.50-105.00 is the area where this consolidation would become something more. For sterling, GBPUSD is arguably already in trouble on any close back below the huge 1.3500 level. Other USD pairs are less close to levels that suggest a meaningful challenge to the bear trend, although that could change suddenly on an unanticipated deleveraging event of considerable scale. We use EURUSD, as noted below, as the key pair for assessing the status of the USD trend. Most other currencies are trading according to their position in the risk correlation hierarchy, although SEK is an interesting holdout in relative terms, especially versus NOK (NOKSEK longs were likely a recently popular trade on the oil resurgence).

Chart: EURUSD
The status for EURUSD is the anchor for the status of the USD sell-off, and still has plenty of room to consolidate lower without upsetting the USD bears’ apple cart. The next level of note lower is perhaps the 38.2% retracement area around 1.2065, followed by the important 1.2000 level, which looks the existential level for USD bears, although arguably the 1.1888 level, the 61.8% retracement of the last large rally wave, is the real “uncle point” that reverses the trend – it’s also below the 100-day moving average now. The straightforward approach for USD bears will be to buy half a position on dips below 1.2100 with initial stops well below 1.2050 and wait for a pattern reversal suggesting that support is coming in before establishing a full position.