FX Update: USD rally eyes GDP, FOMC

The US dollar surge paused a bit yesterday, running out of steam versus the commodity dollars in particular while USDJPY remains south of 112.00. Overnight, the likely culprit of USD weakness was a USDCNY drop.

US yields are stable in the wake of a large and indifferent seven-year US Treasury auction after the chunky drop on Wednesday. US initial jobless claims jumped back higher to 230,000 after the prior two weeks set record lows for claims on a population-adjusted basis. US equities managed to maintain an even keel even as chip giant Intel was out with very weak guidance for the year ahead. Ahead of the weekend, the USD rally will need to navigate the Q1 GDP estimate today, which is expected to show growth at an annualised 2.3%.

The risk for USD traders without a significant new data spark is that we get bogged down in a tight range if the market is waiting for signals from the Federal Reserve at next Wednesday’s Federal Open Market Committee meeting. The focus at that meeting will be the degree to which the Fed’s policy shift on inflation will see the Fed signal a rate cut soon, even as equities have roared back to all-time highs and the economic data are arguably not yet weak enough to spur action.

Some might say it is odd for the Fed to shift policy to allow inflation to run hot when PCE core inflation never reached the 2% target on a sustained basis since 2008, but they could leverage the same logic to argue that inflation needs to rise above the “symmetric” target for some time to compensate for the long period when it was below.

In any case, Fed rate cut anticipation has risen sharply this week, though we’re not yet back at pricing the high odds of a rate cut by December that the market priced in after the March FOMC meeting. Current odds for the December FOMC meeting are over a 60% probability of a lower Fed funds rate.

Before we all decide that equity markets will always celebrate a rate cut, consider that markets are usually in their worst state during the active Fed easing period as the central bank fights to contain the damage and is actually behind the curve.

On the other hand, 1998 has been proposed as an interesting parallel with the current situation, and in that case the Fed was merely reacting to a market mishap. At the time, the Greenspan Fed offered its support in the wake of the Asian financial crisis and after the LTCM debacle with three rate cuts following a brief intense correction in equity markets and spike in financial fear levels, even as the US economy was growing at 4% clip (though to be fair, inflation had been in free-fall for years and core PCE inflation had below 1.5% at the time). The rate cuts were seen as a key factor in sparking the subsequent 18-month  run in tech stocks.

So the USD outlook will likely hinge on whether the Fed has sufficiently pulled itself back ahead of the curve or already took QT and interest rate hikes too far and isn’t easing as quickly as it needs to if a recession and tightening offshore USD liquidity are to be avoided.

Trading interest

USD longs: EURUSD short stance, but preferred USD longs perhaps GBPUSD as long as price action stays below 1.3000 and AUDUSD as long as south of the 0.7100 region. USDCAD is a long above 1.3400.

Buying EURSEK on dips: We are looking for a test of 10.70+ as long as price action remains north of 10.55.

Longer-term trade: Selling AUDCAD rallies as long as price action remains south of the 0.9550 area for an eventual run at 0.9200 or lower.

Chart: EURSEK

The Swedish krona took it on the chin yesterday after the Riksbank served up its version of pushing rate hike guidance out over the horizon, moving the timing of its next hike to later this year or early next, which the market understood as 'never'. The move came even as the central bank upgraded growth forecasts for this year.

EURSEK jumped at the surprise, with the inclination to move so aggressively perhaps hinted at recently when a rather SEK-supportive backdrop had failed to see EURSEK breaking down through the 10.40 support area. This move begins effectively rejects the “triple top” chart argument and the pair could march to new highs not seen since the financial crisis, particularly in the event concerns about the EU economic outlook remain in place and risk appetite rolls over.