FX Focus: Happy to carry the USD

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

As the headline suggests, traders and investors are happy to hold onto the US dollar (USD) in the current climate. It is clear that as both a yield play and safe haven, US Treasuries are popular at the moment in what is effectively seen as a no-lose situation. In a climate where the trade wars show no signs of abating, stock markets continue to brush off the risks to global trade and the message seems to be - stick with the carry trade.

Whether this is a product of risk complacency in the modern day has yet to be seen, but what is clear is that the USD remains a buy and an anticipation of a deeper correction amid strong economic performance is looking more unlikely by the day.  

Friday's employment report was somewhat of a mixed bag as the headline number fell short of the 213k gains expected. Coming in at 157k over July, the revision in June took some of the negative bite out of the miss with earnings growth coming in as expected at 0.3%.

We did however see June earnings revised back down to 0.1%, so there are signs that despite low unemployment - now 3.9% - wages are not picking up with enough pace to match the economic expansion reflected in the other data metrics on offer.  

Later this week we will get the CPI numbers for July - indeed this is the only major US data on offer. Inflation is expected to grind up to 3.0%. Fed tolerance for an overshoot has been widely acknowledged, though nevertheless underpins the rate hike expectations for this year which put a September hike firmly on the table as well as December at a little over 50% at this stage.  

There are still no signs that the tariff exchanges are having an impact on US growth, though we did see the trade balance widening out a little on Friday. Given the momentum in demand for US assets and the USD, it’s worth remembering that at the start of the year the twin deficits were a major detractor for US Treasuries and the USD in tandem, and we continue to point to the risk of this narrative returning later in the year.

As much as currencies move on yield differentials, current accounts will also dictate flow and speculation, and this narrative can bite at any time. 

For now though, the USD index is looking to push for new highs. In recent weeks we have highlighted the lack of progress through the 95.00 level (DXY) but at the end of last week we managed to close above this level.

Technically, this may well encourage speculators to revisit the highs seen closer to 95.65, and we point to 95.80 and 96.20 as potential resistance points which could lead to exhaustion and/or profit taking at the very least.

Past performance is not a guide to future performance

For EUR/USD this would mean we finally take out the 1.1500 level which has been stubbornly resilient in recent weeks - so much so that moves under 1.1600 have been reluctant and somewhat nervous. Again, the market seems to have shaken off fears of a short squeeze as Euro wide econometrics point to the soft patch lasting a little longer and the ECB staying on the sidelines until after next summer as recent meetings have stated. 

Past performance is not a guide to future performance

Europe's wait and see approach

At the start of the week, June factory orders in Germany fell by 4% in what should be a worrying sign for Europe's leading member state. Certain members of the ECB are concerned that the timetable for rate normalisation is a little too far out, though based on numbers such as above, it is hard to argue against the consensus 'wait and see' approach within the governing council.

German industrial production data on Tuesday will shed further light on output levels and perceived demand. We also have Italy looking to challenge the EU's rulebook as the deputy PM Di Maio has cranked up rhetoric in saying that fiscal rules are not the priority in the next budget.

This simmering backdrop is not wholly ignored by the market, though we have to consider just how much of this political risk is factored in to the exchange rates.

Given EUR/GBP is pushing up towards 0.9000 again on UK Brexit woes, comparative risks of no deal between the UK and EU is also worth considering at these elevated levels.

Real money flow is also likely to diminish the buy side if no trade agreement is reached, so once again, we look for this to develop into a more balanced view on what the consequences will be for both sides in the negotiations.  

Q2 GDP is at the end of the week in the UK, and by all accounts, we are very likely to see an improvement on Q1, which formed part of the basis of the rate hike seen last week. 

Cable is currently probing under 1.3000 again, where support levels at 1.2920 and 1.2800 look the more prominent. A move back towards 1.2500-1.2600 is not out of the question, but longer term buyers are said to be ready to step in well ahead of this. 

Weakness in GBP at the start of this week is down to comments by the trade secretary Liam Fox who has said the chances of a no deal outcome have risen to 60-40%.  This is along similar lines to Bank of England governor Mark Carney's comments that the probability of this is uncomfortably high, so headlines from any developments will naturally impact on the exchange rate.  

Past performance is not a guide to future performance

There's a plethora of data out of Japan to look forward to as we focus on household spending on Tuesday, the current account on Wednesday, machinery orders and foreign investment in Japanese stocks on Thursday and the Q2 GDP on Friday.

Given the BoJ's policy stance is unchanged and will remain unchanged for some time, traders will still be wary of any developments (such is improving data no less) which can reinforce expectations of any consideration towards an exit strategy. It will happen at some point and we have had numerous instances of trying to second guess the timing - indeed as recently as a week ago ahead of last week's BoJ policy meeting. 

JPY weakness ahead continues to be the consensus view based on the ongoing asset purchasing program, but the price action shows caution in this trade as USD/JPY struggles for traction back towards the highs seen above 113.00 a few weeks ago. 110.50 is immediate support. 

Loss of this level brings 109.20-25, if not 108.00, into focus with the cross rates following in kind based on the steadfast USD relationship with the rest of the majors.  

Past performance is not a guide to future performance

Staying in the region, China's trade balance will be keenly eyed in light of US actions aimed squarely at the exporting powerhouse. We have seen USD/CNY pushing higher in recent weeks with 6.90 and 7.00 upside targets amid speculation of deliberate devaluation.

Despite fresh highs last week, there were no comments from President Trump last week, though it is hard to expect the US administration is not watching closely.