FX Update: Powell is a victim of his own success.

FX Trading focus: US dollar teases tipping points in USDJPY, EURUSD on weekend developments in China. Commodity currencies weaken.

The US dollar jumped higher on the open on the news of widespread civil unrest in China in opposition to Covid policy there. This is the standard playbook for “risk off”. But since then, we have seen a lot of churning by European lunchtime today. At first, the Japanese yen was stronger still as both US long yields and energy prices dropped sharply overnight, but the JPY then weakened sharply in the crosses and pulled off the new lows posted intraday in USDJPY. Elsewhere, the euro went from weakness to pronounced strength, as discussed below in the EURCAD chart, even managing a marginal new high against the US dollar before the EURUSD pair eased back from the cusp of 1.0500. The most straightforward story on the news out of China was the weakening of oil-linked currencies CAD and NOK, and even more so the commodity- and China-linked Aussie. Of course, the renminbi was also sharply lower, if rather volatile, as USDCNH jumped above 7.2000.

The news of civil unrest in China is a sudden and considerable reaction to what was supposed to be the focus this week: the strength of the important incoming US data this week. If developments escalate further in China and point not only to the risk of further delay in Chinese demand coming back online, but also to new supply-side disruptions, this could prove a game changer. Imagine fresh inflationary risks driven by supply-side constraints that are entirely un-addressable by central banks. We’ll have to give the story some time to mature, but in the meantime, this issue pulling on our attention at the margin could reduce the reaction potential around US data releases this week.

Chart: EURCAD
Having a look at EURCAD today to emphasize the huge divergence in these two currencies in recent weeks. CAD is limping on oil prices rushing lower still after last week’s plunge after the news out of China over the weekend, with major oil grades trading at new lows today not seen since all the way back in January. The euro has enjoyed the tailwind of falling oil prices, the sense of emergency around gas prices this winter fading (however fragile the longer term outlook) and on the ECB getting more serious on signaling further rate tightening. Some of today’s boost in the euro may have come on ECB’s Klas Knot (widely considered at the hawkish extreme among ECB members) arguing that “To bring inflation back to target we will need a protracted period of time at which at least growth is below potential because otherwise we will never get the disinflation going.” Still, short EU rates were only a couple of basis points higher from Friday’s close. Can the pair go higher still? I suspect the answer to that is joined to the question of whether EURUSD can run higher still. So far, we have only seen a healthy correction after a tremendous slide in the euro, further euro- upside beyond another percent or two may get more difficult from here if a) US data remains persistently resilient and especially inflationary and b) if the developments in China begin to impact supply side constraints once again.