Article / 25 July 2016 at 7:45 GMT

FX Update: Critical week for testing USD rally potential

Head of FX Strategy / Saxo Bank
  • EURUSD ended below 1.1000 for first weekly close below that level since February
  • Next level of interest in EURUSD is 1.0800 area and perhaps slightly lower
  • FOMC in mid-week will be test of USD rally's potential
  • Fed seen likely to issue mildly hawkish remarks to avoid September surprise
  • US FX futures traders have a heavy USD short, mainly in EURUSD and GBPUSD

US dollar
 The Fed policy meeting at mid-week may be a critical test of 
the USD rally's potential. Image: iStock 

By John J Hardy

The US dollar closed last week on a strong note, with EURUSD managing to finally post a daily close below 1.1000. Expectations of a mildly more hawkish stance from the US Federal Reserve this week are perhaps the chief driver and the Fed is likely to deliver sufficiently hawkish language to encourage the pricing of higher odds for a September or December rate hike in the event that the US economy continues to regain momentum. 

Looking over at the weekly speculative positioning report from the US Commodity Futures Trading Commission, US currency futures traders have on a heavy USD short position in aggregate, but nearly all of that is concentrated in EURUSD and GBPUSD, the latter of which is at -74,000 contracts (about £4.6 billion), surprisingly slightly short of the record short position from 2010. 

Meanwhile, the market is short some 100,000 EURUSD contracts ($12.5 billion), but is significantly short the US dollar against the Japanese yen (39k contracts) and Australian (33k) and Canadian dollars (22k), so we can’t speak of crowded USD long positioning.  Note that the record EURUSD short is on the order of 225,000 contracts, so there is plenty of room for further position expansion.

The G20 meeting came and went with the usual statements on the need for steering away from currency manipulation and encouragement of fiscal stimulus as the next step. With 20/20 hindsight, the meeting probably provided the reason for China’s strengthening of the renminbi all of last week, so we can see this week as an interesting inflection point for whether they re-engage in the steady weakening that has been the regime for months.

EURUSD was bottled up in the range for a long time after the Brexit shock, and despite last week’s rather uneventful ECB, the euro wilted against a generally resurgent USD, with all eyes on the FOMC this week for whether Janet Yellen and company are sufficiently hawkish to keep the USD bid. The next level of interest is the 1.0800 area and perhaps slightly lower, as the last Fibonacci retracement levels down there come into view after the 61.8% level just below 1.0950 seemed to stop the immediate bleeding after the Brexit vote.
Source: Saxo Bank

The G-10 rundown

USD – the greenback looks firm and needs to maintain that strength after the FOMC this week to keep a rally head of steam, otherwise there's a strong risk of the summer doldrums returning with a vengeance in August. Note that Trump is pulling even with Clinton in the polls, aggravating the uncertainty ahead of the US presidential election in November.

EUR – looking weaker after the 1.1000 break – key test today is the Germany IFO survey, though the single currency looks fairly neutral relative to other drivers facing other currencies.

JPY – supposedly, there is room for a JPY rally on a disappointing Bank of Japan this Friday, but at the same time, the backdrop of strong risk appetite works counter to any further JPY strength. So it may be easier than the consensus thinks for the BoJ to push the yen back weaker.

GBP – Sterling was punished for steep losses on the flash Markit PMIs on Friday as the market seized on the news. The subsequent strengthening, especially against the euro, suggests that the short sterling trade may be crowded and wouldn’t be surprising to see sterling resilience if risk appetite remains strong.

CHF – If we do get a modestly hawkish bump to FOMC guidance, the interesting pair to watch may be USDCHF after the recent failures to post a proper breakout to the upside, particularly now that EURUSD has pushed down through 1.1000.

AUD – we prefer AUD higher versus kiwi, with the key test for the pair this week the Q2 Australia CPI data on Wednesday. Meanwhile, AUDUSD is perched in a zone of uncertainty between 0.7300 and 0.7650 as we look for a directional resolution there.

CAD – USDCAD pushing on a key resistance zone above 1.3140 this morning, and we have long preferred a break higher and opening up of 1.3300+, driven by a more hawkish Fed and weaker oil prices as well as the ugly structural backdrop in Canada (private debt and weak current account).

NZD – the kiwi is having a hard time pushing lower after the recent aggressive drop as a dovish RBNZ has already been priced in, so the bank will have a rather high bar for dovishness to clear at its August 11 meeting.

SEK – EURSEK at 9.50 is still trying to hang in there – key local resistance ahead of the cycle/range highs above 9.60. A number of interesting data points this week from Sweden (confidence surveys Wednesday, unemployment and retail sales Thursday, and Q2 GDP estimate Friday).

NOK – EURNOK is pushing on key resistance in 9.40/45 zone as oil weakens. USD strength could see further oil weakness and therefore NOK weakness.

Upcoming Economic Calendar Highlights (all times GMT)
  • Germany Jul. IFO Survey (0800) 
  • UK Jul. CBI Trends in Total Orders/Selling Prices (1000) 
  • US Dallas Fed Manufacturing Activity (1430) 
  • New Zealand Jun. Trade Balance (2245) 

— Edited by John Acher

John J Hardy is head of FX strategy at Saxo Bank 


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