FX Update: USDJPY to test above 110 if US yields continue climb

The market consensus aligns with our view on the US-Iran conflict, that the risk of overt confrontation seems minimal, even if the longer term risks of asymmetric warfare are unknown and simply can’t distract the raging bulls anyway that swoop in to scoop up equities on the slightest dip. Earlier this week, we saw a somewhat stronger than expected ISM Non-manufacturing survey and yesterday it was a blow out December ADP payrolls number and strong upward revision of the November data – even if this survey, as I pointed out in a chart yesterday on Twitter (even if I surmised that the ADP may be quicker to pick up developments in the jobs market – oops), correlates poorly with the NFP series.

With the conviction that the Powell Fed is willing to allow the economy to “run hot” before reacting on the policy front and newfound conviction that the US economy will skirt recession – and perhaps that a resilient economy and parabolic go-go stock market will do more to ensure a Trump re-election, the US dollar is ramping higher against much of the even lower yielding and less economically dynamic G10 while the market’s reach for yield saw EM putting in another strong day yesterday. It seems EM has become a pure play on risk appetite, ignoring for now the historic dislike of a stronger US dollar (although the rising CNY is another boost for EM and USDCNY explored new lows for the recent cycle yesterday).

While we have an open mind on the status of the US dollar and increasing evidence on the charts now that the US dollar is not set to turn lower here, we are increasingly concerned that this market environment – for however long it extends – will see a disorderly demise when we do reach a real inflection point, even if we have not inkling of the potential height of the current moonshot.

Chart: USDCAD
With the USD pivoting stronger versus several other G10 currencies here, we zoom in on USDCAD today as the pair has recently traded below the pivotal 1.3000 level after CAD was the strongest G10 currency in 2019 and today features a “fireside chat” with Bank of Canada Governor Poloz, who must be eyeing the currency situation with a bit of alarm. While it is possible that Poloz maintains a relatively sanguine view of the outlook from here, we note that Canadian data is registering much weaker than expected data and as we have noted before it is hard to believe that Canada wants to maintain the G10’s highest policy rate. A shot across the bow from Poloz today and we could see USDCAD pulling sharply back into the range, with a sharp move back to perhaps 1.3150 a forceful rejection of the recent downside sequence and suggestive that the higher range is to hold for now. If Poloz is reluctant to send any message, we may have to wait for the December jobs data from both the US and Canada tomorrow to provide an additional catalyst.