'Dark forces' driving dollar rampage

Foreign exchange analyst Rajan Dhall runs through the big issues that will drive the major currency pairs this week.

For a number of weeks now we have been mentioning the unrelenting push higher in the US dollar (USD) across the board, to the point where dips are (in the traditional sense) non-existent. 

Naturally, economic divergence between the US and the rest of the world is a clear fundamental driver of this dynamic, but there are other (dark) forces at play, and you only need look to the USD/CNY (Chinese yuan) rate to see this.  

There was an inevitability to president Trump's outburst last week, when he not only accused the major economic powers of manipulating their currencies, but transgressed into monetary policy independence by criticising the Fed's rate path which suggests there are another 50bps of hikes due later this year.  

The latter has been glossed over to some degree, as many expect Fed chair Powell and the rest of the FOMC to commit to their mandate of maintaining economic stability.  

Past performance is not a guide to future performance 

On the USD, however, the market is expected to be a little less impulsive in pushing on the greenback and there are clear merits to this.  Not only do the short-term metrics suggest that the USD has priced in much of the positive factors at the present time, we also have the impact of excessive currency appreciation in what is a relatively short period of time. 

This will start to impact on things like trade and inflation (primarily) for domestic policy, but also pressure on the emerging (debt burdened) markets which will impact on global equities (eventually).  

This then brings us to the dynamics of investment flow, and with the USD beacon shining bright, we can assume Japanese money is flowing into the US and we have sees this reflected in the strong rise in USD/JPY (Japanese yen).  Equities and fixed income have moved higher in tandem as the traditional safe havens (including gold) are abandoned, and the JPY could gain in the anticipated flight to safety which might follow.  

Past performance is not a guide to future performance 

These however, are not matters which are the direct reasoning of the US president's comments last week.  We are in the midst of a trade war, which is now developing into a currency war if you (as it seems president Trump does) believe China is devaluing its Yuan exchange rate in order to offset the impact of US tariffs.  

In such instances, investors are move likely to head for the sidelines in FX, pointing to gains for both the JPY and the Swiss franc (CHF) in the near term. 

Early action this week shows some fightback in the USD against the usual suspects that are the EUR, GBP and Aussie dollar (AUD), but USD/JPY is looking reluctant to push higher again, as is USD/CHF to highlight a softening in the resilience in the USD.   

The weekly bearish close on USD/JPY now looks set to cause some hesitation on moves towards 112.00, certainly 113.00, which could see the 108.00-109.00 area a target for later on this week.  USD/CHF support in the 0.9880-50 area is now in focus, with the lack of material pick up around 0.9900 noticeable.  

EUR/CHF is expected to be protected by central bank actions - SNB involvement in the currency markets widely acknowledged and accepted in the real sense of the word.  Support ahead of 1.1600 looks to have been eroded in the meantime, so the psychological 1.1500 mark is where we turn our attention to from here. 

EUR/USD traders will have their eye on the ECB meeting this week, but all said and done, few can realistically expect the governing council to change their stance after the previous meeting where forward guidance put an H2 rate move on the map and not before.  

More hawkish members and it is reasonable to believe Germany is among them feel this means that the ECB is falling behind the curve, but when we see the core inflation rate struggling to hold above the 1.0% level, president Draghi will point to the single mandate of price stability, which is anything but stable at the present time.  Indeed, there are headwinds for EU corporates with input price pressures rising from the weaker exchange rate, but exporters will not be complaining about this.  

The question now will be whether this week's meeting can break the 1.1500-1.1800 range we are now entrenched in.  EU wide politics has also taken its toll with Italy set for a run in with the EU bloc on funding while immigration concerns are also bubbling under the surface.  

Longer term, these will likely limit the upside when US metrics start coming off the boil as we expect them too, but the consistent buying ahead of 1.1500 should be a concern for EUR shorts looking for the next push lower.

Past performance is not a guide to future performance 

Friday's all-important Q2 GDP figure will be equally as influential here. Just as will be coming off a potentially lively session in EUR/USD, traders will have to consider whether the latest growth stats are priced in or not - we have suggested they may well be - with median consensus looking for a 4% rise in growth, but can it continue at this pace.  Unlikely with USD strengthening at this current pace.  

GBP, and Cable will be interesting this week as the Brexit saga starts to hot up.  The focus is now on how the EU will take to the White Paper which the UK PM struggled to eventually get through.  For all the media hype of a no deal Brexit, the new Brexit Sec Raab still feels confident that a trade deal can be thrashed out, as he has noted a willingness in his counterpart Michel Barnier to strike an agreement.  

This is nothing more than speculation on his part, just as it is on whether we get a deal or not.  Uncertainty is set to keep the pound in the balance at these lower levels, so any material upturn in GBP - against any pair - is likely to be sold into. 

Past performance is not a guide to future performance 

For cable, valuation overstretch on the downside starts to kick in once we get closer to 1.2900, with last week's drop below 1.3000 stopping well short of this level.  EUR/GBP also took out a band of resistance in the 0.8900-20 area to suggest a move on 0.9000 was forthcoming, but it seems the market will have to decide on this later this week given the EUR based risks we have mentioned above.  

Little in the way of UK data to contend with over the next five days, having come off the back of soft numbers on inflation and spending, while employment remains relatively healthy under the circumstances despite small dip in the pace of wage growth.