Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
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FX Update: Market volatility heating up with a big week ahead
John J. Hardy
Chief Macro Strategist
Summary: Equity markets are showing signs of another tantrum as US yields rise steeply again, with the US dollar following the lead from treasury yields. It looks like a potential explosive week ahead, as the FOMC meets on Wednesday and the Bank of Japan is set to announce the results of its policy review on Friday in the wake of a recent remarkable tailspin in the yen.
FX Trading focus: USD rises anew as yields clearly in control
Yesterday saw the EURUSD super-major tickling the 1.2000 resistance without breaking in the wake of a muddled forward guidance effort from the ECB, which announced an acceleration of PEPP bond purchases, but didn’t want to send the signal that it planned to increase the overall size of its purchases. Nor can it under the capital key rules, as my colleague Althea pointed out on this morning’s Saxo Market Call podcast. She also notes that FX-hedged US treasuries now yield considerably more than even Greek EUR bonds in EUR. The ECB follow-on comment about not increasing the size of the programme despite brining forward purchase was perhaps seen as hawkish at the margin and helped the EURUSD higher before if fell back lower. The latter move, and further downside in the pair today was driven by the fresh rise in US treasury yields, with the 30-year T-bond yield, in the wake of the orderly 30-year auction yesterday, trading well clear of the highest daily closing level for the cycle.
Cue next week’s bonanza of event risks around the world. Yesterday, I covered the dilemma for the Bank of Japan as it is set to deliver its policy review next Friday, one that will only be made easier if US treasuries stop their pressure cooker act on the JPY. I don’t have any expectations for the Fed to signal anything new on policy, as they have declared that they want to look through incoming high inflation in coming months due to basing effects. The more important question is to establish first, whether the Fed moves to relieve the “SLR” rule set to expire at the end of the month and addresses other issues in money markets and second, if they do, whether this provides any angle on yields out the curve. If the Fed does not extend the SLR rule, it will mean large US banks will need to shrink their balance sheets, likely aggravating the pressure on the treasury market. All in all, it looks set to be a volatile week.
Chart: EURUSD
Strong resistance found ahead of 1.2000 in EURUSD before a chunky rejection of yesterday’s rally in today’s trading. Let’s see what next week brings an intra-market environment that is very touchy on the frequent bouts we have seen recently of treasury yield rises driving volatility – i.e., the positive correlation in the movement of stocks and bonds, something the market is not accustomed to and has created some rather large swings of late and frequent direction changes. If yields finally do ease lower, however, could it be because risk sentiment elsewhere is crumbling? In such a scenario, we could still see the USD rising broadly, with the JPY and CHF suddenly pivoting to strength, while the Euro is somewhere between this trio and the more sensitive cyclical commodity and EM currencies. That is one scenario – alternatively, if yields continue to rise, this will likely weigh on the EUR and could take this pair to the 1.1600 area or slightly lower in weeks ahead.
Graphic: FX Board of G10 trends and momentum
JPY downside momentum flashing strongly read earlier today and still later in the day, though the intraday bounce in JPY has developed. Next week looks pivotal for determining whether spiking US yields continue higher and take the JPY down further (especially if the Bank of Japan insists on some manner of yield curve control, no matter how “mushy” the guidance is on actual levels, or if the JPY snaps back strongly on either a consolidation in the US treasury market, a steep risky asset sell-off and/or a Bank of Japan that doesn’t provide much guidance on long yields and expresses distaste for the speed of the recent JPY sell-off (last one probably too much to expect at these levels).
The G-10 and CNH rundown
USD – the US dollar and US yields not exactly moving in lock step, but if volatility picks up in the treasury market, the correlation likely tightens.
CNH – China allowing its currency to drift stronger against the basket recently, as it maintains a stable-and-strong yuan policy for now.
EUR – the euro backtracking sharply after the ECB delivered little and the EU looks very unattractive from a yield perspective, given the lack of more yield dynamism at the longer end of the curve. Yesterday emphasizes critical 1.2000 EURUSD level.
JPY – the yen practically spinning into the abyss recently – next week is pivotal for when and whether the currency can find support, with many irons in the fire (US yields, FOMC and BoJ policy review on Friday).
GBP – has sterling maxed out for now? The trade disruption to the Europe getting a bit more coverage now and they are rather profound – could be in for a period of consolidation versus USD and EUR.
CHF – the Swiss franc in the same boat as the JPY directionally next week, in all likelihood – tracking direction in gold and inversely, the direction in US yields.
AUD – the Aussie quite resilient, but turned tail against the US dollar near 0.7800 area in AUDUSD on higher US yields. A new local low there would likely require a chunkier consolidation in pro-cyclical commodities like copper and iron ore.
CAD – the CAD belting a bit above its weight lately, and have a hard time believing that oil can advance forever without a bout of consolidation, and USDCAD price action getting rather “churny”
NZD – losing out to the AUD here as AUDNZD looking at that key 1.0800-50 zone again next week – a break could open for 1.1000+, particularly if commodity prices rises pick back up.
SEK – the krona’s day will come when EU is post vaccine and inflation picks up, for now would rather sit on hands and wait for a squeeze in EURSEK rather than doing anything now, save for perhaps maintaining NOKSEK longs.
NOK – interesting Norges Bank meeting up next week – first go near 10.00 rejected yesterday, perhaps in part on the AstraZeneca vaccine halt yesterday, but still like the longer term picture for NOK upside versus EUR and SEK.
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