USD status, please: we saw the USD poking back to the strong side last week and offering a fairly compelling tactical reversal of the USD bearish case in some USD pairs, but it is tough to gauge the quality of this bullish reversal given the larger scale bearish trend direction and the strength in risk sentiment (which we see as generally USD-negative). Key pairs to watch include EURUSD, where a close back above 1.1900 begins to neutralize this move and a close below 1.1700 could accelerate the downside in the short term, especially given the massive USD short (mostly EURUSD long – link is to Ole’s great positioning charts). Another USD pair on our radar is AUDUSD, which has shown sluggish momentum for weeks and has been getting less support from commodity prices as iron ore touched a one-week low overnight. AUDU Finally, GBPUSD has churned in almost comical fashion for four days in a row – watching for resolution there as well.
AUDUSD bears have been frustrated at every turn as all three of the prior soft-patches from fresh highs have failed to punch lower with a follow-through wave lower. The key pivot zone to the downside remains the huge 0.7050-0.7000 area that has been a battle-zone on several occasions stretching back to late 2018 and is still some way off. An attack at this still rather far off level will likely require a significant and sudden consolidation of the reflation/negative real rates narrative, whether triggered by the Powell’s rhetoric this Thursday or by something else.
JPY turning higher or just a consolidation? Broader JPY direction is often correlated with broad USD direction, so not a huge surprise to see the JPY turning higher in a week that also saw the USD putting in a rally, and not least, as safe haven treasuries had a strong week. The bearish EURJPY reversal is particularly interesting, but this was backing up already today and we have yet to see any follow through wave lower in JPY crosses in the months since the trough of the crisis and shortly thereafter. JPY upside likely needs strong safe haven flows and a potent correction in risk sentiment.
A smart reversal in EURJPY that reversed the most recent rally wave is already fading today, but we could yet get confirmation of this possibly bearish development if safe haven bond buying and the torrid rally in risk appetite fade in the days ahead or after the Powell speech on Thursday. The rally in risky assets of late has mostly been concentrated in US megacaps – European equities have perked up strongly today for the first time in two weeks, with today’s sympathetic bounce-back in this pair underlining the correlation with European risk sentiment).
Scandie watch: the EURNOK chart in particular has been coiling and coiling as oil prices have refused to go higher or lower and the EU is dealing with renewed COVID-19 outbreaks. Any strong sell-off in the oil price (note potentially price-supportive US hurricane activity), reflation and growth narrative and we have a squeeze risk for EURNOK, but one we would be happy to fade at some point. Trigger points on the chart around 10.80 to the upside and 10.50 to the downside versus 10.63 today.
Key developments this week on our radar
Republican National Convention: angles on the USD and risk appetite.
US President Trump and the RNC will launch an all-out offensive to revive his prospects for a second term this week as the Republican National Convention gets under way today and wraps up Thursday with Trump’s acceptance speech. Trump being Trump, he will apparently be speaking on every day of the convention. The Republicans’ platform is one of “renew, rebuild, restore” and stamping the opposition as the party of favouring radical policies that “destroy, defund and dismantle” the country. It is a very divisive message aimed at supporting the Trump base and scaring the suburbanite along the lines of law and order and a “culture war” narrative. We should also expect significant chest-thumping on anti-China rhetoric.
Trump’s approval ratings have been improving from very low levels over the last few weeks and the consensus is that a tilt in the polls back in favour of Trump would be USD positive. The somewhat thin argument supporting this narrative is that the budget deficit outlook might prove smaller under Trump than under Biden because of the latter’s greater inclination to spend for more to fund healthcare and climate initiatives. Another angle on the USD-positive argument is that Trump would more likely pursue a more aggressive “America First” policy aimed at reshoring production that could shrink US trade deficits. But the argument is rather full of holes – recall that Trump’s massive tax cuts for companies already badly eroded the US deficit trajectory well ahead of the COVID-19 crisis.
The only deficit-restraining argument I can think of for either outcome is one in which whoever is president does not have both house of Congress on his side. That current fact is the chief one restraining further stimulus ahead of the November 3 election. The most important takeaway from a Trump surge, even one that only narrows the polls by a couple of percentage points, would be a rise in uncertainty and the risk of a political debacle in the wake of a possibly close election, with Trump refusing to concede and claiming mail-in ballot fraud, etc.
Zoom-ing in on Jackson Hole
Fed Chair Powell will present the conclusions of a comprehensive Fed policy review in a speech titled Navigating the Decade Ahead: Implications for Monetary Policy at this Thursday’s “virtual Jackson Hole” KC Fed Symposium. There is more than enough discussion out there on what this speech will contain, especially the degree to which the Fed is committing to what has already been banged over our collective heads and flagged for months, that it is moving to an Average Inflation Targeting (AIT) regime. Supposedly we are to hold our breath on the intent to use forward guidance as well, but that is a given introduced under Bernanke.
The key impact of AIT is not that the Fed is even able to create inflation, just that it is preannouncing that it will be lax in responding to a rise in inflation (to paraphrase, that it will allow the inflation rate to run hot to ensure that it is achieving a long term average at the target for the PCE core that was never really achieved for any sustained period over the last 10-plus years since the last financial crisis). The key driver for inflation materializing in the months and quarters ahead is fiscal stimulus far more than it is Fed policy, unless the Fed starts to innovate beyond its current legal mandate (only likely in dire situation and maybe not even then). Still, there could be interesting twists in the policy review, such as creating a connection between the inflation tolerance and the unemployment rate – i.e., some version of the logic and policy mix that led to the Weimar Republic hyperinflation.
Then there is the yield-curve-control (YCC) debate. Given the FOMC minutes luke-warm discussion on the desirability of signaling a yield-curve-control regime, I won’t be holding my breath other than signals that it “could be desirable”. But if the Fed clearly outlines the conditions that could make it reach for yield-curve-control (such as long yields backing up despite high unemployment rate), then the market may seize on this as a dovish development and find fresh cause to sell the USD. I suspect wording will be very cautious around this, as YCC should be ready as “we surrender and from now on are merely beholden to the exigencies of funding the government and monetizing whatever deficits it chooses to run”!
Bottom-line for the two key RNC and Powell speech event risks this week: tough for the Fed to make a dramatic surprise relative to the current narrative, which is already pricing in significant financial repression via negative real rates. Still, as long as the policy review fails to add significantly to the consensus read of the Fed’s intentions, the market may be quick to rejoin the trends prior to the speech. The chief caveat to that development is that the market continues to bull higher and display ever more complacency despite the election uncertainty, which may finally start to weigh at some point, particularly if Trump’s odds don’t improve after this week’s RNC. Either way, we look forward to seeing how seasonality affects the picture after the (latest possible) US Labor Day weekend ending Monday, September 7.