FX Update: Big risk sentiment shift boosts smaller currencies

Trading interest

• Maintaining AUDNZD longs with stops below 1.0570 for 1.0950

Sterling continued its strong recovery into today as the immediate threat of a No Deal Brexit has been removed by the latest parliamentary maneuvers, as parliament will likely get its delay to avoid an October 31 No Deal (key question: what will the EU terms be for that delay?) and Boris Johnson’s attempt to call for snap elections in mid-October was defeated. There are still too many scenarios from here to signal the all clear – an election scenario that serves as a referendum on Brexit still presents the risk of an eventual No Deal. If sterling heads much higher here versus the US dollar, we will be tempted to look for ways to express a medium-term downside view through options.

The Bank of Canada yesterday entirely failed to deliver a dovish tilt in its latest statement, which, combined with the fact that USDCAD was trading in a pivotal area and the risk sentiment improvement also feeding a sharp comeback in oil prices, saw an exaggerated reaction in CAD crosses. The actual shift in Canadian short rates was negligible and this will likely go down eventually as a policy mistake from the Bank of Canada, where the recent strong Canadian GDP print was mostly a result of a large trade surplus, while other measures of the economy, like final demand, were the worst in years.

Sweden’s Riksbank today waxed far less dovish than expected, still insisting that it maintains course for an eventual rate hike, if the timing is a bit delayed to toward year-end or early next year. As with the reaction in CAD to the Bank of Canada, this prompted a sharp rally in SEK, though Swedish rates staged a more notable recovery than their Canadian counterparts. The stronger risk sentiment backdrop is a boost for SEK as well and EURSEK is now pushing down on the key 9.65-60 area that needs taking out to discuss a larger scale SEK comeback.

Watching the US ISM Non-manufacturing survey for August today and jobs and earnings reports tomorrow as the last major inputs for the FOMC meeting on September 18. If equity markets are bulling up near the highs for the cycle as they are currently and if the USD has eased off further, it is hard to see the Fed ratcheting the concern level higher in its outlook, especially given that the US and China have halted the trade war escalation and are on course for talks in October. So quite bad data misses today and/or tomorrow, and/or a move to fresh highs in the USD or sudden steep sell-off in risk would likely be a prerequisite for a large Fed rate chop.

Chart: AUDUSD
There is still a lot of work to do to turn the USD outlook from the upside to the downside, with AUDUSD a decent barometer of the status of the US dollar versus riskier currencies. While we are up against the resistance of the prior lows at 0.6832, we arguably need a full rejection of the prior sell-off wave from just above 0.7000 to provide any sense of an emphatic reversal. But for formality’s sake we note that the first Fibo retracement of note comes right in at the prior low and the 61.8% Fibo comes in about a figure higher at 0.6927.