FX price action against the backdrop of global macro developments
The dollar was lifted early last week by safe-haven demand as China’s multi-month collapse of Evergrande sparked a sort of panic attack in global markets. The dollar strengthened after the initial drop following the FOMC meeting. Confirmed Fed tapering announcement is likely at the next meeting (November), but it’s a good idea. The market also expected a few other officials to see a rise next year, if at all. This too was delivered as planned.
The real news was that regardless of the exact start date, the cut would be complete by the middle of next year. Some Fed hawks (eg Bullard) wanted to see the cut end by the end of the first quarter, but that seemed too aggressive for the majority. The mid-year completion was in line with our expectations, as we assume the Fed is keen to maintain maximum flexibility, which means it allows two rate hikes, not just one, next year. Three FOMC members are looking for this, up from two in June, and the rotating voting members will bring in a more hawkish contingent in 2022. The market has nearly integrated a September 2022 hike and slashed the odds of a second hike by about 25%. . .
The coming week promises to be less eventful. The economic agenda is less important with fewer central bank meetings. Two emerging market central banks, Mexico and the Czech Republic, are notable exceptions, Banixco is the close appeal of the two. The central bank appeared to take a break after rising in July and August. However, price pressures remain firm and the bi-weekly measurement was higher than expected. The Bloomberg survey of six economists found unanimous projections for a rise, but the one-month return of 4.65% suggests it may not be fully reflected by the market. The Czech move is an easier call. The central bank has signaled its intention to raise rates, and the market expects a 50bp hike after 25bp moves in June and August. Russia and Hungary raised rates less than expected earlier this month, but the Czech central bank is more orthodox and the August CPI has accelerated more than expected to over 4%.
Dollar index: A range of around 93.00 to 93.50 contained most of the price action last week. The high for the year was set for August 20, slightly below 93.75. Consolidation looks bullish. The MACD is gradually rising, while the Slow Stochastic is stretched too far, and a little weakness will likely bring it down. The upper Bollinger Band starts the new week a little below 93.55. The Dollar Index peaked at near 103.00 in March 2020 and hit a low of around 89.20 at the start of the year. The retracement target (38.2%) is 94.50, which means that the DXY is broadly in the low since the start of the year.
Euro: Everyone and their sister agree that the Fed is ahead of the ECB in adjusting monetary policy. Still, European 10-year rates have risen 20-25bp over the past month, while the US benchmark is up just over 15bp. The US two-year yield has increased by around 4.5bp over the past month, while the German (and Dutch) two-year yield has increased by almost six basis points. Most other two-year rates are up 2-4bps. In response to the FOMC meeting, the euro fell to $ 1.1685 before rebounding, but the $ 1.1750 area turned out to be formidable. The MACD is going down as the Slow Stochastic has entered oversold territory and may be trying to move up. The lower Bollinger Band is around $ 1.1680. Recall that the $ 1.1700 area corresponds to the retracement (38.2%) of the euro rally from the March 2020 low (~ $ 1.0635) to the early January 2021 high (~ $ 1.2350 ). The euro hit a year’s low last month at $ 1.1665. Initial support on a breakout can be seen around $ 1.16, last November’s low, but the next retracement target (50%) is a little below $ 1.15.
Japanese Yen: Rising US yields are arguably the most compelling explanation for the dollar’s surge against the yen. The 60-day sliding correlation of US 10-year yields and the exchange rate has hovered above 0.60 for the past few months. It rallied in the last three sessions, the longest advance of the month, and hit nearly 110.75 JPY, just below last month’s high. The year high was set in early July near JPY111.65. Momentum indicators point up. The cautionary note from the charts is the proximity to the upper end of the range and the close above the upper Bollinger Band (~ 110.55 JPY). Often times when the exchange rate seems to be trending, it will move to a new range. The current range is around JPY109 to JPY111. If it moves into a new range, last year’s peak was around 112.25 JPY and the 2019 high was a bit higher, around 112.40 JPY might attract.
Pound sterling: Two notable price developments took place last week. First, a huge hike in UK short-term rates following the BOE meeting meant that if needed, it would hike rates while continuing to buy bonds. Less than 24 hours earlier, the Fed’s Powell was explaining why that didn’t make sense. Given that the BOE is expected to complete its bond purchases at the end of the year, this was seen by many as a hawkish signal. As a result, the UK 2yr yield rose 13bp last week to almost 0.38%. The implied yield on the December 2021 sterling futures contract increased by five basis points last week, and the yield on the March 2022 contract increased by around 11 bps. Second, the British pound underperformed last week, falling almost 0.5% against the dollar. This is the third consecutive weekly decline. The British pound tested support near $ 1.36 and rebounded to around $ 1.3750 in response to the BOE, but failed to hold above $ 1.3700. The MACD is moving sideways and the Slow Stochastic is oversold. A break out of the July low near $ 1.3570 could signal a test of the year-long low set in January around $ 1.3450. A move above $ 1.3750 raises the tone.
Canadian dollar: Following the dramatic drop in stocks early last week, the US dollar appreciated to close to CAD 1.29. A rally in stocks appeared to cause a pullback to CAD 1.2635. The general strength of the US dollar and weaker stocks saw the greenback hover around CAD 1.27 heading into the weekend. Momentum indicators favor the downside, but the US dollar has held above CAD 1.26 for the second week in a row. The Bank of Canada has warned that the economy may have contracted in July and the official estimate is due on October 1. The market feels more comfortable with the Bank of Canada’s rate hike around the middle of next year. The implied yield on the June 2022 Bankers Acceptance futures contract has increased nearly 15bp since the start of the month.
Australian dollar: The Aussie has been trending down since peaking near $ 0.7480 in early September. Bearish momentum waned and a base was forged around $ 0.7220. The ensuing rebound hit resistance at $ 0.7315, which roughly matches the retracement (38.2%) of this month’s decline. The next retracement target (50%) is closer to $ 0.7350. A break of $ 0.7200 targets the low of the year set last month just ahead of $ 0.7100. The $ 0.7050 area is the retracement (38.2%) of the rally from last year’s low of near $ 0.5500. The MACD is flat, while the Slow Stochastic appears to be trying to move into oversold territory.
Mexican Peso: Most of the price action this quarter has been between MXN19.80 and MXN20.20. In late August, the dollar topped the MXN20.4560 a bit, but returned to range in about a week. In the first half of September, it was based around 19.82 MXN. The pendulum swing of the market’s risk appetite helped push the greenback to MXN 20.20 early last week. It then fell back and hit the week’s low on Wednesday near MXN19.9370. He came back to test the MXN20.00 level before the week and he held up again. In addition to the dollar’s general direction and broader risk appetite, there is room for a surprise next week from Banxico. The absence of a rate hike could cause the peso to fall in the immediate reaction, but the rate hike cycle is not over, and at least one and perhaps two hikes could be delivered before the end of the l ‘year.
Chinese yuan: The dollar remains remarkably stable against the yuan. Last week, mainland markets were closed for a public holiday on Monday and Tuesday, as the market reflected on the implications of Evergrande’s demise. However, when all said and done, more was said than done, and the dollar ended the week virtually unchanged, slightly above CNY6.4660. The PBOC injected liquidity into the banking system. While things may change, the liquidity provisions are primarily aimed at the end of the quarter and the vacation week in early October. There still appears to be a high degree of confidence that the contagion will be mostly confined to China and the real estate sector. The “official” PMI is expected next week, and broad stabilization is likely after falling over the past three months. In fact, the Composite PMI has only risen twice this year (March and May), and in August it fell below the expansion / recession level of 50 for the first time since February 2020.