Head of FX Strategy
Summary: The US dollar bounced after a strong University of Michigan sentiment report on Friday boosted US treasury yields. But the US dollar will likely continue to head lower if yields stay below recent highs and risk sentiment remains steady. Elsewhere, we have an important test up mid-week for sterling as the UK reports June CPI. And the pre-eminent focus, besides the US dollar breakdown is on the yen, where the next round of strength may be broader than last week’s rally.
FX Trading focus:
The US dollar bounced back modestly on Friday as US treasury yields backed up on a strong surge in the preliminary July University of Michigan sentiment numbers. The survey showed both Present Situation and Expectations readings surging some seven points to their highest levels since 2021. But the damage done to the greenback was decisive and will likely remain that way unless we get a huge shift back to negative sentiment.
Looking at the US macro calendar for this week, we only have the regional manufacturing reports dribbling in starting with today’s July Empire Manufacturing and the June Retail Sales report on Tuesday. The housing market data up Wednesday is unreliable as a general economic indicator because strength in the NAHB survey (activity related to new home builds) and Housing Starts/Building Permits is to a large degree linked to low supply of existing homes as those sitting on record-low pandemic era mortgages stay put to the degree they can to enjoy low mortgage servicing costs. The housing market is certainly bifurcated as well, as a the largest number of multifamily units are set to hit the market this year and next since the 1980’s, pressuring rents. So besides these items, we only have a weekly jobless claims number this Thursday and June Consumer Confidence survey next Tuesday ahead of next Wednesday’s FOMC meeting. The Fed will hike next week, with the strength of guidance. If equities remain anywhere near current levels or higher, the Fed can easily indicate a bias to hike once more without “pre-committing”. The market figures the odds for an additional tightening move after next week are rather low, with the first Fed rate cut now priced for March of next year.
JPY remains a key focus through next Friday
The JPY made its first big move starting the Friday before last, and with much of the focus on a weaker US dollar, USDJPY suffered a massive markdown from 145.00 to the low 137.00’s. The lows Friday were just above the 200-day moving average near 137.00, a key technical milestone that could open for 130.00 eventually if broken. Given that the trajectory for the ECB will likely largely track the Fed’s with a slight delay, why should EURJPY be trading up here if the Bank of Japan is finally set to shift to a tightening posture this year? Thoughts on the EURJPY chart below. And if we get a weaker than expected UK CPI number Wednesday, GBPJPY will likely prove a very volatile pair this week. Note that Japan reports its June national inflation data this Friday and that 10-year Japanese JGB’s are traded within two basis points of the 0.50% top of the yield-curve-control “band”.
Chart: EURJPY
With the ECB also seen reaching its terminal rate soon (market looking for two more hike through year end- one at next week’s ECB meeting and another in either September or October) and with the Euro’s real effective and trade-weighted exchange rate value on a nearly vertical trajectory, the Euro is looking very rich against the Japanese yen in a scenario of continuing deceleration of ECB expectations combined with even marginal tightening of BoJ policy in the months ahead. The technical cracks in EURJPY are few here, as we would need to unwind the entire rally extension above 150.00 to suggest a major top may be in place, starting with a breakdown through the 153.50 pivot from earlier this month. Nonetheless, I am watching for downside risks.
GBP: Key test on this Wednesday’s CPI
In last Thursday’s FX Update, I asked whether the sterling rally was showing signs of exhaustion after new lows for the year last Tuesday were rejected Wednesday. We are getting a bit of confirmation of further sterling weakness with an extension higher in EURGBP today, but the real test ahead is Wednesday’s June UK CPI data. We know that Governor Bailey is convinced that inflation is set to fall sharply later this year and after two months of much hotter than expected core inflation data, the market will likely be very sensitive to any downside miss. The Y/Y core inflation is expected unchanged at 7.1% and we may or may not get a negative surprise, but the volatility risk looks skewed more toward the downside than the upside for sterling this week after its remarkable run as the strongest G10 currency this year.
Table: FX Board of G10 and CNH trend evolution and strength.
Pronounced USD and CNH weakness (China reporting weak numbers overnight) are somewhat surprisingly nearly matched by the weak Canadian dollar here On the positive side, the sudden revival of the Scandies stands out on the positive side. The flat JPY reading shows how large a shift is needed to get the JPY on proper rising trend trajectory as so far, it has merely erased the prior weakness.
Table: FX Board Trend Scoreboard for individual pairs.
USDCAD was an interesting sour note for the USD bears on Friday, reversing from new lows of the year below 1.3100 to close well above 1.3200. Note some of the remarkably stretched trend readings in USDCHF, EURUSD and GBPUSD and EURCNH, etc…
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
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