Article / 23 September 2016 at 14:30 GMT

FX 4 Next Week: High-yielders facing wave of volatility

Head of FX Strategy / Saxo Bank
  • AUDUSD likely headed lower on rising volatility
  • Kiwi rally over as higher-yielding currencies face pressure
  • GBP nearing key triggers, Article 50 could spark a plunge
  • USDJPY could spike if resistance breaks

The Australian dollar looks ready to be sent tumbling by a wave of rising volatility. Photo: iStock

By John J Hardy

This week’s key central bank meetings – the Bank of Japan and Federal Open Market Committee on Wednesday – saw a sharp market reaction with the yen soaring as the BoJ offered no immediate signs of new liquidity provisions while the USD was sold after the FOMC failed to hike rates (even as it indicated a preference to hike in December if conditions warrant).

The market did boost the JPY on the BoJ’s lack of immediate new liquidity measures and what was in essence a stealth taper of its QQE programme, but as we discuss in our "USDJPY higher" theme below, there are other considerations afoot as well. 

The Fed’s dovishness as expressed by its failing to hike rates Wednesday was seized upon as a green light for reverting back to the “reach for yield” theme that was in ascendancy since February. 

We’re not so sure, however, that the market’s complacent takeaway will persist. The BoJ move in particular speaks to the idea that central banks are losing their faith in QE and markets should take note – with or without the futile speculation surrounding a new Fed rate hike. 

Our general suspicion is that the reaction to the central bank meetings this week may not persist and that a rise in volatility will soon be upon us as the market’s faith in QE risks fading and as we look forward to the US presidential election on November 8.

AUDUSD lower

AUDUSD has chopped back and forth recently, at times rising on the AUD-supportive recovery in some key commodity prices and on the reach-for-yield theme at others, while it came under heavy pressure during the episode of heightened volatility earlier this month and when the European Central Bank showed signs of stepping away from its easing commitment. 

Our general belief is that the risk of rising volatility predominates and we’ll be looking for this to pressure AUD (note the interesting exception of AUDNZD below, which combined with this theme does of course mean a short NZDUSD position). 

We have leading signs that the Australian housing market is coming under pressure and Australian banks are tightening their mortgage lending standards.

Trading stance: AUDUSD bears may prefer the short side as long as the choppy descending channel keeps the pair capped, or perhaps below 0.7700. The downside focus is the important 0.7400/0.7375 area for whether the choppy range is maintained, or a solid new downtrend can develop.


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Source: Saxo Bank 

NZD weaker

NZD was on a run to the strong side for much of this year on the reach-for-yield theme – even as the Reserve Bank of New Zealand lowered rates twice this year – as the market was still interested in extracting what yield it could get. But after this week’s RBNZ meeting that lowered rate guidance, the NZD finally fell from its perch and could have a long way to go if we see rising volatility in coming weeks, which is one of our theses despite this week’s apparent complacency in asset markets. 

This would likely pressure the higher-yielding currencies as the reach-for-yield theme switches to a reach-for-safe-havens theme.

Trading stance: We got solid confirmation of the divergent momentum setup in AUDNZD this week (one of our trading themes for the week) with the sharp rally rejecting the sequence of new lows below the major prior low near 1.0315. 

Bulls in AUDNZD may look to scoop up dips for a try toward 1.07-plus. Those preferring NZDUSD shorts (see chart below) as a way to short NZD may look for a broad USD recovery and a breakdown through 0.7235 for an extension toward 0.7100 or lower.

Source: Saxo Bank 

Source: Saxo Bank  

GBP lower

Sterling was generally weaker this week through all of the back-and-forth elsewhere and appears to be nearing key trigger areas both in EURGBP and against the USD as the recent mention of an Article 50 invocation in early 2017 seemed to be the trigger for renewed sterling selling. 

If the pound closes the week on a weak note, the market may drive the currency to new lows in the major GBP pairs as confidence may remain low as long as the unknown of what a Brexit actually looks like will loom for a long time to come. 

Ironically, the low point may come at the point of maximum uncertainty when Article 50 is finally actually invoked and the market is too heavily positioned and realises that this isn’t the end of the world.

Trading stance: If GBPUSD closes the week below 1.3000, bears may look for follow through next week toward 1.2800 as long as the 1.3100/25 area remains in place as resistance. Sterling bears looking to avoid USD exposure might consider EURGBP, where a rise above the last Fibo resistance and highs this week near 0.8630 might point to a test of the 0.8725 highs and even beyond toward 0.8800.

Source: Saxo Bank  

USDJPY upside if resistance broken

It’s too early to tell what the market’s longer-run assessment of the Bank of Japan meeting will be. On the one hand, the decision to move to a flexible bond purchase scheme is a stealthy way to taper purchases (which likely came about due to the BoJ was running out of bonds to purchase). 

It also means, however, by abandoning any set amount that the monetary base must expand, the BoJ can vastly expand its purchases at any moment if necessary, whether because market participants decide to sell their bonds or to cover new fiscal outlays. 

In other words, this lays the groundwork for the fiscal authorities and the BoJ operating in coordination, as well as some form of “helicopter money”. The unknown factor here is how quickly the Abe government will announce new fiscal stimulus after the previous announcements were largely shrugged off.

Trading stance: The short-term technical resolution is entirely uncertain here ahead of the new week, but a solid rally to close the week or early next week is a sign that the knee-jerk reaction this week was false. 

The first step for bulls is to wait for a break and close above 101.25/50 as a sign. Then, bulls may find additional conviction on a re-entry into the daily Ichimoku cloud, which has a dynamic lower level as seen in the chart below, but an upper level near 103.25. Traders may target 107-plus ahead of the US election if these resistance levels fall in the coming one to two weeks.

Source: Saxo Bank 

Helicopter money
Expect the yen to wither at the first sign of take-off. Photo: iStock

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank 


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