Macro: Sandcastle economics
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FX Update: Yesterday an odd day, a big surprise if it repeats.
John Hardy
Chief Macro Strategist
Summary: Yesterday saw broadly weak risk sentiment and a broadly stronger JPY. No big surprise there, rather the surprise was in the resilience of pro-cyclical currencies versus the US dollar, which was no safe harbor in the storm. Hard to believe that this is some new pattern that will persist, but 2022 will have many moving parts in pressurizing and repressurizing risk sentiment, particularly treasury yields, which are pulling back higher at the long end of the curve today.
FX Trading focus: An odd day yesterday as USD was no safe haven
A strange day in FX-land yesterday, as we saw a classic, broad risk-off move across markets that took US long yields a bit lower, US equities sharply lower (interesting discussion around the big cross-currents in equities, by the way in today’s Saxo Market Call podcast) and the JPY higher. What was not “classic” was the resilience in commodities and the US dollar staying mostly weaker against pro-cyclical currencies and even some EM currencies even if it has bounced back a bit in today’s trade. Not sure where to attribute the odd pattern, but would be surprised to see all of those developments extending. US long yields are back higher today after a somewhat mixed message from US treasury auctions over the last couple of days. The cycle highs in longer US treasury yields are not far away and can quickly dominate the narrative again and dominate the narrative for risky assets.
As we watch the USD’s losses since consolidate today, a bit of extra focus on the 1.1400 area in EURUSD and 0.7250 to as low as 0.7200 in AUDUSD as a failure of these levels to hold will suggest that this week’s USD breakdown after the US CPI release on Wednesday was merely a brief squeeze, signifying little or nothing, save perhaps that Fed forward expectations have to break significantly higher for act as a specific driver USD strength.
Chart: USDCAD
The USDCAD pair has gone far and fast to the downside since the crude oil market recovered swiftly from its December post-omicron breakout nadir and is now interacting with the psychologically significant 1.2500 area that slow happens to also be the 200-day moving average. Coming up next for the two currencies are signals from their respective central banks, with a hawkish raising of the bar from the Fed likely requiring, for example, calling an early end to QE already at the Jan 26 meeting and possibly indicating that “larger than 25 basis point” hike increments are under consideration. Perhaps too early for the latter, if not the former (what does the last few tens of billions of QE matter besides as a symbol). The Fed is priced to hike to about 1.0% through the December meeting, depending on the barometer. The pricing for the Bank of Canada is less reliable, but it is certainly priced to lead the Fed in hiking this year by around two hikes even if the spread for 2-year yields between the two countries has been relatively flat for over a month, so little new has been priced in on a relative basis recently. On that account, the move lower in USDCAD looks a bit over-extended without new signals from respective central banks. Other factors influencing the exchange rate will include whether oil continues to march to new highs or corrects and risk sentiment, where I suspect extended weakness will begin to offer more safe haven support for the US dollar if long US yields are also on the rise.
In other news, Japan’s five-year JGB’s have managed to break higher to the highest level in about six years, within a hair’s breadth of the 0% level that last traded before Japan implemented its negative yield policy back at the beginning of 2016. I also note that longer JGB’s have also tracked yields elsewhere higher – is the Japanese market making a bet that the new Japanese government is set to take a different approach to stimulus that will raise prices more durably? Adding EURJPY and AUDJPY to my watch list for break down potential (130.00 to start in EURJPY and 82.00-ish in AUDJPY, which have a strong 40-day correlation, respectively, with EURUSD and especially AUDUSD). In the upcoming Q1 outlook, I have pointed out the incredible divergence in the longer term real effective exchange rate of the JPY (weak) relative to the renminbi (strong) that is on a scale resembling the situation in 2015 when China made a dramatic change to its exchange rate regime that weakened the CNY sharply.
Table: FX Board of G10 and CNH trend evolution and strength.
Important to have a look at the relative strength of the broader CNH before judging that it is significant that USDCNH has traded back close to cycle lows – the CNH is back to trading with low beta to USD direction, a familiar regime. Many other themes are still relatively adrift outside of USD weakness and petro-currency relative strength. A big question mark above the sterling move higher – may wear off soon if this is a “the UK seeing the backside of omicron” premium.
Table: FX Board Trend Scoreboard for individual pairs.
CNHJPY has flipped negative – suspect that is a megatrend for the coming year. Also note AUDJPY close to flipping negative and EURJPY likely not that far behind in coming days if 130.00 falls there. Elsewhere, watching if the USD breakdown holds here.
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