Article / 05 October 2016 at 7:48 GMT

FX Update: USD strengthens as US rate hike odds rise

Head of FX Strategy / Saxo Bank
Denmark
  • USD rallies on Chicago Fed chief Evans' remarks
  • ECB report shows bank considering bonds taper
  • Kiwi declines against dollar, AUD on weak milk auction

USD
The greenback has grown some wings on the back of Chicago Fed 
chief Evans' hawkish remarks. Photo: iStock

By John J Hardy

The USD rally broadened yesterday to virtually across the board with the market supposedly choosing to pay attention to a hawkish-sounding Chicago Federal Reserve head Charles Evans (who doesn’t even vote in December). 

The rise in December odds has been modest, if persistent, recently, while the rise at the longer end of the curve has been more profound. This could perhaps be due to the overarching theme we have discussed of a switch to a fiscal focus from QE focus eventually meaning much longer, higher rates.
  
But late yesterday, Bloomberg ran a story on the European Central Bank considering tapering asset purchases, quoting unnamed officials. There wasn’t a lot in the story as those same officials likewise said that the current rate of bond purchases could continue beyond the March, 2017 horizon established by the ECB's forward guidance. 

Eventually, however, due to the obviously impossible size of the ECB’s asset purchase programme and the silly behavior it is encouraging in corporate debt markets in Europe, the ECB will, like the Bank of Japan, have to yield to the fiscal authorities across Europe to stimulate the economy. 

In the meantime, barring new EU systemic uncertainty from a new political crisis or a new recession in Europe, the natural tendency on any commitment from the ECB to slow its QE purchases would likely driver the euro stronger as the Eurozone runs a large current account surplus with the rest of the world. 

For the very short term, however, if the US dollar remains firm, it wouldn’t take much of a comment from an ECB official to knock EURUSD back lower.  

Today, the we watch whether the USD remains firm against the JPY and USDJPY remains within the Ichimoku cloud or even breaks above (upper bound at 103.25 level) and whether the euro continues to match the US dollar’s gains. We had high hopes for yesterday’s USDCHF rally, but the ECB taper story dragged it back down via EURUSD. Still on the lookout for something there.

There is also a possibility for USD traders that firmer rates start to impact risk appetite more heavily and thus position squaring for the enormous risk parity trade, meaning potentially more negative consequences for EM and commodity currencies as opposed to the JPY or EUR. There are signs of this in the commodity dollars this morning...

NZDUSD

NZDUSD is finally through the 0.7200 area after a weak milk auction yesterday (which likewise sent AUDNZD on a sprint higher). This is further evidence that the NZD is turning lower from overvalued levels and will be vulnerable on any further rise in rates and/or weakening risk appetite. 

The next critical area for NZDUSD is just below 0.7000, the prior support that refused to give way and where the 200-day moving average now lurks.

nzdusd

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Source: Saxo Bank 

The G-10 rundown

USD – US dollar firming on the general theme of QE winding down (BoJ and now ECB) and firmer expectations for a December Fed rate hike. To call a full-blown rally, we need another leg higher to build new momentum – could this come on today’s ISM non-manufacturing or Friday’s jobs report?

EUR – the single currency is bouncing on the QE taper story, but this is a longer-term signal and could be emphatically denied. Still, the euro could remain firm.

JPY – The yen selloff stopped near the 103.00 level in USDJPY, with 103.25 the next technical break level for a possible run significantly higher. Again, a key coincident indicator appears to be long US rates. So traders should have an eye out for these as well.

GBP – sterling continues to melt lower and 1.2500 could be the next focus in GBPUSD. The EURGBP rally was aggravated by the ECB taper story, and that pair has worked higher into an important resistance zone above 0.8800 and the last level ahead of the post-GFC high at 0.9800-plus is the 0.9000 area.

CHF – a tantalising look higher for USDCHF yesterday through 0.9800 and the 200-day moving average that was driven back lower by the ECB taper story via EURUSD – still interested in whether USDCHF higher is a sleeping giant of a trade if US rates continue higher – watching the layers of resistance there from 0.9800 to parity.

AUD – AUD should suffer increasingly relative to the most liquid currencies if we see a return of higher yields and weak risk appetite.

CAD – CAD would be trading much lower were it not for the persistent rally in oil and we have key Canadian data up today (international trade) and Friday (employment) that could yet knock CAD lower with or without a selloff in oil. As well, consider this story on the potential for a financial crisis in Canada linked to its housing market and private debt bubble...

NZD – a weak milk auction and headwinds from weak risk appetite and higher long bond yields should weigh very hard here. Watching the quality of the break of 0.7200 in NZDUSD.

SEK – will the Riksbank be the next bank to cry uncle on QE and negative rates? EURSEK showing signs of exhaustion above 9.60...

NOK – the ECB taper story is finally stemming the EURNOK selloff, which is probably overripe for some consolidation, especially if we see a deepening in risk aversion on higher bond yields.

Upcoming Economic Calendar Highlights (all times GMT)

  • 0715 – 0800 – Euro Zone Final Sep. Services PMI 
  • 0730 – Sweden Aug. Industrial Production/Industrial Orders/Service Production 
  • 0830 – UK Sep. Services PMI 
  • 0900 – Euro Zone Aug. Retail Sales 
  • 1215 – US Sep. ADP Payrolls Change 
  • 1230 – US Aug. Trade Balance 
  • 1230 – Canada Aug. International Merchandise 
  • 1400 – US Sep. ISM Non-Manufacturing 

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

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