FX Update: A not so peaceful, uneasy feeling

FX Update: A not so peaceful, uneasy feeling by Michael McKenna
Summary: FX moves were muted yesterday relative to the histrionics in US equities, but the sense of caution was palpable, with the US dollar and Japanese yen rising as volatility spiked and US treasury yields diving sharply in what looks like a bout of safe haven seeking. A PBOC check of liquidity overnight and concerns that the US stimulus package may prove smaller than expected leave us with a defensive stance on risk exposure here.

FX Trading focus: USD and JPY bob back higher on signs of safe haven seeking.
US equities suffered a crazy pump and dump yesterday on signs that retail traders, and likely amplified by sharp operators front-running their order flow and measuring their intent with algorithms, are moving against the most shorted stocks, an issue we discussed extensively in this morning’s Saxo Market Call podcast. The transmission into FX on yesterday’s volatility was rather muted, as we’ve come to expect for the last many months, when the margin of potential policy action to do anything about it seems rather minimal. Still, there were signs of safe haven seeking galore, as the US dollar and JPY were bid up yesterday, and most notably, US treasuries rallied sharply. Good luck finding diversification in the positions in your portfolio these days, as too many things move in synch on a day like yesterday.

Speaking of US treasuries, the US treasury unloaded $60 billion in 2-year notes on the market yesterday with no problem at all, and is set to sell $61 billion in 5-year notes today and $62 billion in 7-year notes on Thursday. That is quite the blitz of issuance and this year will see the treasury issuing a trillion or more in US debt beyond the Fed’s purchases, not including the Biden stimulus. For the US public to continue to absorb staggering US deficits beyond the Fed’s QE purchases would require a very high savings rate. Is that likely in a post-vaccine opening up?

The FOMC meeting tomorrow is one without a refresh of forecasts and the dot plot and we seem to have just settled the debate on tapering – with the consensus among the important Fed voices that it remains too early to discuss. The year of 2021 will show at some point that the Fed has made a terrible policy mistake – but which one?

There are a couple of ways that this can pan out, but either way, I sincerely doubt that the Fed will leave this year without considerable egg on its face. On the one side, the excess of support going to financial markets and credit as opposed to those most in need on main street could see some destabilizing popping of an asset bubble, with the usual deflationary implications that require another Fed response (inadequate when it has already shot its full set of measures?) to mop up the mess. Yesterday’s shenanigans might be a distant (or proximate…) early warning on that front.

On the other side, a bout of hot inflation into mid-year as pent-up savings are unleashed on the economy could see the Fed’s trigger finger on signaling rate hikes too itchy and set up a policy mistake as the Fed proves too hasty to signal tightening – again aggravated by a frothy, over-extended speculative market.  Either way, the Fed’s ship will be tough to navigate between Scylla and Charybdis of a blow-off speculative episode on the one hand (with or without the Fed doing anything more) and responding to an inflation rises on the other. FX could prove less volatile than in previous cycles, depending on the outcome, but there will plenty of room for huge moves in the USD to the upside on a Fed policy failure.

Elsewhere, AUD was surprisingly little moved by the PBOC moving to check liquidity overnight (unusual for it do so before the New Year holiday there, which normally sees liquidity expansion) and an official with the central bank mentioning the risks of asset bubbles – the relative stability of CNY is the likely culprit in the modest reaction in the Aussie.

In the US, Biden signaled that he is willing to lower the income ceiling for those set to receive stimulus checks, and other bits of the full $1.9 trillion Biden stimulus are likely to get whittled down considerable. Watching for further signs there, as well as how the US political situation shapes up over the Trump impeachment trial.

The recent sterling rally stalled out yet again after a marginal new high in GBPUSD, shown here, and last week after EURGBP managed to make its first multi-month low in a long time. While the UK leads many major countries in its roll out of Covid vaccines, sterling is unlikely to thrive in an environment of weaker risk sentiment relative to the US dollar, and this very ugly rally of endless small rises and extensive backfilling may be at risk of a positioning  cleanout that could see a retreat back to the 1.3250, or even 1.3000 area if markets are set to retrench here with an episode of caution, which could be a risk on a less generous than expected US stimulus and concerns of slow vaccine rollouts.


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