With updated central bank pivots, will the FX market consolidate?

Spectacular movements in the money market have led investors to expect the tightening cycle to accelerate in major economies. Japan is the exception as the central bank clings to the idea that rising price pressures will not be sustained. Other central bankers may talk about data dependency, but some data is more important than others. Price data and measures of inflation expectations are more important than real sector reports. Even after the announcement of the unexpected contraction in manufacturing output in May, the first since January, expectations of a 75 basis point hike next month have risen slightly.

The dollar spent the first part of June recovering after falling in the second half of May. The retracement was deeper than expected and the dollar made new highs against the British pound and the yen. However, against other major currencies, last month’s highs held. Our reading of the price action and technical condition warns that the Dollar’s rally is over. He is vulnerable to a setback. This fits well with a narrative that suggests the market has reached an extreme based on current information of a fed funds peak around 4.5% next year. It was hovering around 3% at the end of May. Note that the Fed’s midpoint suggests a maximum key rate of around 4%. The adjustment has been so rapid (~150 basis points in a few weeks) that some consolidation now seems likely.

Another notable development last week was the ECB’s emergency meeting which pushed the process towards crafting a new instrument to resist fragmentation (divergence) within Eurozone bond markets. The ECB argues that fragmentation interferes with the achievement of its price stability objective. However, we have argued that 1) such a tool already exists and 2) a critical obstacle always seems to be related to conditions (conditionality). The previous tool was market trades, targeting the short end of the coupon curve (1-3 years), and purchases had to be sterilized to minimize the impact on the balance sheet. However, the innovation now is that the ECB seems to be suggesting that it, rather than the country, will determine when to trigger it. There seems to be a greater sense (pride?) that officials can identify what President Lagarde called “irrational” moves.

Dollar index: The “buy the rumour, sell the fact” after the Fed’s 75 basis point hike saw the dollar index retrace half of this month’s rally. It found new offers around 103.50 after setting new highs slightly below 105.80. The MACD is in the middle of its range, but the Slow Stochastic is overextended and poised to decline early next week. Bollinger’s upper band was breached during the close early last week, but the pullback has brought the band down again. The upper band starts the week close near 105.50. The Dollar Index looks set to hit a new high, but we’ll be looking for a reversal pattern or some other sign that the bulls are getting tired. That said, the next major technical area isn’t until 1.08-1.09.

Euro: On June 9, partly in reaction to the ECB meeting, the Euro posted a bearish outside day, trading on both sides of the previous session’s range and closing below its low. The single currency was stuck around $1.0775. The sell-off extended to around $1.0360, with the bottom seen shortly after the FOMC announcement. Recall that the five-year low set last month was closer to $1.0350. The ECB has signaled its commitment to resist significant divergence in the EMU bond market. The combination of that and the US 2-year premium on Germany slipping below 200bp for the first time in nearly four months helped spur a short squeeze that lifted the euro, which briefly crossed 1 $.06. As core-periphery spreads narrowed further heading into the weekend, the euro lost its mojo and returned to around $1.0440. The MACD is moving lower and the Slow Stochastic is overextended. Although it looks like it might rise next week, remember that it remained in oversold territory from early April to mid-May.

Japanese Yen: The Japanese authorities succeeded in stabilizing the dollar-yen exchange rate despite the sharp divergence in monetary policy. About 24 hours after the FOMC meeting, the dollar fell from a fresh 22-year high near 135.60 JPY to 131.50 JPY, a nine-day low. The job was called off by the BOJ, which at its meeting gave no sign that it would change its monetary stance, even though the core inflation gauge hit its target. While acknowledging that a dramatic fall in the yen is destabilizing, Governor Kuroda has done nothing to shake the perception that he favors management. The BOJ statement said it will closely monitor the foreign exchange and capital markets. Does it really tell us something we didn’t know? Continuing to ease policy via the balance sheet and keep the 10-year yield capped at 0.25% is disrupting the functioning of markets, and last week the futures/cash nexus broke. The odds of intervention seem even more remote on this side of the BOJ meeting, not that we thought they were particularly high in the first place. The Slow Stochastic retreated, while the MACD rallied from a slight bottom. Still, the dollar looks set for potentially big gains next week. We will talk more about a move towards JPY140.

Pound sterling: The pound was pressured higher after falling to a new two-year low near $1.1935 on June 14. above $1.24. It reached the retracement target (61.8%) of the decline from the late May high (~$1.2665) which fell slightly. Support near $1.2170 was tested heading into the weekend. A break below $1.2100 warns of a return to the lows. Last week, Wednesday and Thursday’s 3% gain was enough to temporarily push the Slow Stochastic up, but the MACD appears to be pulling back. June 24 marks the sixth anniversary of the Brexit referendum. It pushed a little above $1.50 that day, but then fell to $1.3230 and stabilized around $1.3680.

Canadian dollar: Heading into the weekend, the Canadian dollar fell to a new low since November 2020. The aggressive mood for risk, buoyed by more aggressive efforts by many central banks to tighten financial conditions, appears to be offsetting the positive macroeconomic story of the Canada. An additional weight to last week’s 5.8% drop in the S&P 500 (risk proxy) was the continued reduction in Canada’s two-year premium versus the United States. It had hit a new high for the year of nearly 35 basis points on June 8 and by the end of last week had fallen to less than five. Momentum indicators give the greenback room to extend what could turn out to be a breakout up. The CAD 1.3025 area corresponds to the retracement (38.2%) of the decline of the greenback from the March 2020 high (~CAD 1.4670). The US dollar won last month, but it turned out to be a false breakout. The next retracement (50%) is near CAD1.3340. However, the sharp rise (from 1.2520 CAD on June 8) pushed the US Dollar above the upper Bollinger Band ~1.3035 CAD). Canada reports April retail sales next Wednesday and, arguably more important in the current environment, May CPI on Thursday. The swap market is only halfway to pricing 75 basis points higher from 50 at the July 13 Bank of Canada meeting. A strong inflation report could boost market confidence.

Australian dollar: The Australian Dollar approached last month’s low (~$0.6830) and found an offer near $0.6850. It fell to near $0.7070 after strong jobs data and hawkish comments from RBA Governor Lowe. However, this appears to be a proverbial dead cat bounce, and before the weekend it was back down to $0.6900 and the lower Bollinger Band. The two days of gains failed to lift the MACD. The Slow Stochastic looked set to turn lower, but weak price action ahead of the weekend means that may not be the case. The futures market now sees the year-end rate close to 3.85%, up just over 150 bps in the past two weeks. The rate premium to the US also jumped, but the Australian dollar depreciated nearly 4% over the two weeks. A break of $0.6830 could signal a move towards $0.6760, the retracement (50%) of the Aussies’ gain from the March 2020 low (~$0.5510). The Australian dollar’s correlation to iron ore on a 30-day rolling basis is at a two-year high (0.52), and new Covid restrictions have seen iron ore prices fall by 14% last week. last week, the largest weekly decline since last September.

Mexican peso: The dollar rose about 2% against the Mexican peso for the second week in a row, ending a five-week decline. From Tuesday to Thursday, the greenback stalled in the MXN20.69-MXN20.70 range. This is the highest level since mid-March. Momentum indicators are stretching. A break below MXN20.20 may be enough to turn them down. Shortly before the Banxico meeting on June 23, Mexico will release the mid-June CPI figure. The bi-weekly measure has stabilized between 7.5% and 7.75% for nearly three months. April retail sales will also be released ahead of the central bank’s decision. A small drop would not be surprising. Everyone agrees that Banxico is up 75bps after rising in 50bps increments in the last four meetings. The trend line taken from last November’s high (~22.1550 MXN) and March’s high (~214675 MXN) approaches 20.76 MXN early next week. A break could stimulate a move towards MXN21.00 initially.

The Chinese Yuan: The greenback fell slightly against the Chinese yuan last week. In the 15 weeks since late February, the dollar has appreciated against the yuan in all but three weeks. However, the strong uptrend ended a month ago after the dollar peaked around CNY 6.8125. Since then, it has been in a range, mainly CNY 6.65 to CNY 6.75. Maybe CNY6.60-CNY6.80 is acceptable. Chinese stocks held off the regional and global decline. The CSI 300 rose 1.65%, its third consecutive weekly gain and the fifth in the past six weeks. It’s still down about 12.8% for the year. By contrast, China’s 10-year rate discount to the US widened to 42 basis points last week. A small bounty had been reinstated in the second half of May.

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