FX Update: AUD and NZD first to try to push USD over the edge.

Volatility measures for bond markets and in places for the FX market have receded to pre-Covid19 crisis ranges as risk sentiment remains strong and the market wonders how to take a strong view on DM currencies when all central banks have their feet jammed on the gas and yield curves are largely crushed flat. It is the kind of environment that works for USD bears as the greenback looks at key support levels in broad terms (see chart of Bloomberg’s USD index below). EM currencies have shown the most momentum recently against the struggling US dollar as they continue to track higher together with the general semi-melt up in global equities. On that note, the US equity market has now reached a key pivot level in crossing above the 200-day moving average and recent highs, with the small caveat that the cash market has been closed since Friday. The next couple of sessions and perhaps through this week’s close look critical for establishing the medium term status of this market rally.

And as we discussed on this morning’s Saxo Market Call podcast, we are reluctant to parrot news headlines suggesting that the market’s enthusiasm for risky assets is based on hopes for a post-Covid19 normalization. Rather, the foie-gras funnel of Fed- and other central bank liquidity forcing is the more likely culprit, as we have often discussed in previous podcasts and in this column, as we wonder how the market deals with mounting insolvency as opposed that the liquidity injections don’s address. For now, just as we can’t jump in front of an onrushing train as the equity market scales the biggest ever wall of worry, we can’t lean against a tactical break lower in the US dollar here – but do note that the move must extend quite a lot further to fully reverse the strengthening move from March.

The EUR is mounting another charge at the 1.1000 level against the US dollar as bulls hope that the recent signals from Merkel and Macron on funding a recovery package via the EU budget is a signal that the EU project is far from endangered. The ECB’s Villeroy yesterday said that more stimulus is on the way  in the form of an expansion and loosening of the rules on the existing EUR 750 billion QE programme. (Specifically, Villeroy spoke against any adherence to the capital key rules that formerly required the ECB to purchase bonds in proportion with the size of each EU economy). In any case, options have gotten very cheap again – with the 1-month EURUSD implied volatility nearing 6% again and the 6-month implied pushing below 7% for anyone that would like to take a EURUSD upside view for the other side of the US election result. Germany-Italy 10-year yield spread has been crushed below 200 bps for the first time since early April.

I suspect the uncertainty over the US election result is one key factor that will hamper strong momentum until November, unless something breaks in the deteriorating US-China relationship (watch the 7.20 area in USDCNY on that note).

Chart: Bloomberg dollar index
This is our favourite USD broad index for now as it less EUR-dominated (32%) relative to the traditional USD index (at 58%) and because the technical support is so well defined since the massive USD surge in March. We are breaking down through that support level here, but arguably, the USD needs to move another 3% or so lower in broad terms to suggest a full reversal of the Covid19 crisis-inspired squeeze on global USD liquidity. Note that the 200-day moving average is only some 1.5% lower from here.