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Article / 11 March 2016 at 15:30 GMT

FX 4 Next Week: Washington via Tokyo

Head of FX Strategy / Saxo Bank
Denmark
  • Bearish EURUSD traders could look at options for a longer-term move to 1.06
  • Longstanding soft risk sentiment/low USDJPY trend primed to turn around
  • EURGBP an option for traders looking to avoid FOMC volatility in the dollar
  • NZD downside move likely in the wake of central bank currency attack

Washington, D.C.
After the ECB surprise, focus returns to Washington as traders look for the FOMC's 
take on encouraging CPI and other data. Photo: iStock

By John J Hardy

We have had a crazy week with tremendous volatility around the European Central Bank meeting. This week, we ponder what to do in the wake of this huge market event, as well as where the USD and JPY are headed in the wake of next week’s Bank of Japan and Federal Open Market Committee meetings.

Strategic EURUSD downside via options

The enormous volatility around the ECB meeting caught traders of all stripes off guard as the initial steep plunge of the currency yielded suddenly to a brutal strengthening. There are perhaps three reasons for the euro to rise:

  • ECB head Mario Draghi basically indicated that the negative rate cycle is done (some would say he has surrendered in the global currency war and that this means the ECB is simply no longer able/willing to target the exchange rate directly). 
  • Central banks are pushing on a string because the market is highly sceptical of the efficacy of the benefits of quantitative easing or negative rates in particular (and this is an echo of the BoJ's negative rate move that the market so quickly rejected; i.e., nothing the ECB could have done would have impressed unless it was truly new, like helicopter money). 
  • Aggressive “credit easing” (lending to banks through TLTRO's at negative rates) is seen as positive for European growth and could therefore stimulate inflows. 
None of these reasons, either separately or together, look supportive of the euro beyond the nearest term as the US FOMC is seen as more likely to raise rates next week on higher CPI data (on top of recent higher-than-expected readings showing the core CPI to be above 2.0% already), with the pressure off the USD and risk appetite in a generally positive mood. 

That latter development could actually favour a weaker euro through renewed interest in policy divergence and the euro carry trade. We look for a rather low ceiling on further euro strength, while admitting very poor visibility on the timing of potential new weakness. 

Trading stance: EURUSD bears may look to establish bearish puts and/or put spreads on any further surge in EURUSD on the back of this week’s move; we are looking for a test of the 1.0600 area in a three-month timeframe. 

A close back below 1.1000 argues for the lack of upside potential, though the degree of recent volatility may scare away bears looking to get aggressively push the pair below its recent range for another two to three weeks unless next Wednesday’s FOMC meeting provides some strong medicine for the greenback. 

Flexibility on USDJPY depending on BoJ/FOMC outcomes

Last week we discussed the potential for USDJPY upside in the event of a break above resistance. Alas, there was no breakout, and the outlook remains highly uncertain going into next week’s key BoJ (Tuesday) and FOMC (Wednesday) meetings. 

The USDJPY chart needs resolution soon as it has traded in a tight range since its fall through the key 116.00 area and these meetings, together with the direction in risk appetite, are likely to determine the direction of the break. The chart may resolve lower if risk appetite fails again after the recent test of key resistance (the 2,000 area in the US S&P 500 index) and if the USD is broadly weaker after the FOMC meeting, while the BoJ may be on hold. 

An upside resolution looks more likely in the event of a continued surge in risk appetite and a more optimistic tone from the FOMC. Our longer-term outlook is for higher levels to return with a near-term risk of one more, possibly significant, selloff leg. 

Trading stance: Bulls may look to establish half of a position in longer-dated options (middle or end of April) as long as USDJPY trades in a lower range and then add with spot positions if USDJPY can prove itself above 114.55 in the wake of next week’s BoJ and FOMC meetings.

Bears may look to establish short positions if USDJPY threatens below 112.00 on a closing level after the central bank meetings for a test toward 110 and beyond.

EURGBP downside in the event of a reversal

The EURGBP pair is an interesting test case for the euro rally in the wake of the ECB meeting (see the EURUSD idea above for why we are sceptical about the euro’s prospects) and could offer less volatile action less week for traders looking to fade euro strength, as Thursday's Bank of England meeting might sway GBP less than the FOMC does the dollar. 

Trading stance: If EURGBP closes back below 0.7700, euro bears may look to fade rallies for a test of 0.7500/50.

NZD downside

This is fairly straightforward: the Reserve Bank of New Zealand drew blood last week with a dovish assault on the NZD via a surprise rate cut, cautionary rhetoric on domestic and global growth developments, low inflation risks, and even an excessively high kiwi exchange rate. 

Two-year New Zealand rates were socked for a huge 20 basis points, and the kiwi looked overvalued even before this roundly dovish RBNZ meeting. The kiwi still has potential for further weakness on this development, particularly if risk appetite fails to improve further. 

Trading stance: NZD bears may focus on long AUDNZD trades on dips, eyeing 1.1500 in the next few weeks. NZDUSD downside may also prove a way to express a bearish NZD outlook, though the uncertainty surrounding next week’s FOMC should leave traders cautious unless we see a USD-positive signal against riskier currencies after the release of the committee’s new statement on Wednesday and NZDUSD working to new local lows.

Kiwi crossing




















And with kiwi crosses in general. Photo: iStock

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank 

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