FX Focus: Panic and fear fuel the USD rally

by from interactive investor |

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

It must be said that the appetite for the US Dollar has been vastly underestimated, and given the benefit of yield, the added lure of the reserve currency as a safe haven destination has extended gains to yet more over-extended levels. 

We do not base this on price action alone, as fair value against some of the major currency pairs is being stretched again - notably the EUR, which has come under fire from the European exposure to Turkish debt, which is a primary focus for markets at the moment.

Last week's escalation of the diplomatic row with the US led President Trump to turn the screws once again, doubling the tariffs already imposed on Turkey to prompt a fresh flight to safety. At the start of the week, the Turkish ministry is promising measures to curb this heavy capital outflow, but confidence is not exactly riding high! 

Traditional safe havens are, however, showing some signs of returning to the party. The JPY has been on the front foot against the rest of the majors away from the USD, and is now pressing for 125.00 against the EUR while GBP/JPY is now eyeing a move below 140.00 again.

Whether this can gain any traction against the USD remains to be seen, though we have seen the key 110.50 base taken out and at the time of writing, US equity futures are heavily in the red. 
 

Past performance is not a guide to future performance

What we now have to consider is when repatriation sets in. Japanese investors have been gunning for yield in the US, but if this flow starts to reverse, we could see sentiment on the USD shift en masse. This would refocus on current account protection and spur a relief rally in the EUR also.

Remember, this was a safe haven also a year back, and traditional economic theory suggests current account surpluses eventually strengthen exchange rates, though these waters have been muddied by the outlook posed by the imposition of tariffs.  

Consequently, this week's economic data is very likely to take a back seat. Currencies will follow the stock markets, and with gold still pressing the downside, this tells you all you need to know about USD prominence at the moment.

US economic data

In the US, the stand out release will be retail sales, which is of some interest given strong job gains and the level of pass through in the tax cuts delivered at the start of the year.

The numbers can be erratic though and tend to have a modest impact on the market unless there is a clear deviation from expectations.

Similarly in production, unless we see a reversal in the expansionary forces at play - and these are just a vulnerable to the tariff wars as anywhere in the world - then it is unlikely to impact on the USD also.

Capacity utilisation may creep higher, but this has been stabilising around the 78% mark as the rest of the data has been improving.  

As above, the EUR/USD rate, where the bulk of USD sentiment is expressed, is now at interesting levels which will really test the outperformance of the greenback.

We can forget about rate differentials and the divergence of monetary policy between the Fed and the ECB in the current climate, though naturally this provides a notable weight for the pair for now.

Past performance is not a guide to future performance

What we now have to consider is when repatriation sets in. Japanese investors have been gunning for yield in the US, but if this flow starts to reverse, we could see sentiment on the USD shift en masse. This would refocus on current account protection and spur a relief rally in the EUR also.

Remember, this was a safe haven also a year back, and traditional economic theory suggests current account surpluses eventually strengthen exchange rates, though these waters have been muddied by the outlook posed by the imposition of tariffs.  

Consequently, this week's economic data is very likely to take a back seat. Currencies will follow the stock markets, and with gold still pressing the downside, this tells you all you need to know about USD prominence at the moment.

US economic data

In the US, the stand out release will be retail sales, which is of some interest given strong job gains and the level of pass through in the tax cuts delivered at the start of the year.

The numbers can be erratic though and tend to have a modest impact on the market unless there is a clear deviation from expectations.

Similarly in production, unless we see a reversal in the expansionary forces at play - and these are just a vulnerable to the tariff wars as anywhere in the world - then it is unlikely to impact on the USD also.

Capacity utilisation may creep higher, but this has been stabilising around the 78% mark as the rest of the data has been improving.  

As above, the EUR/USD rate, where the bulk of USD sentiment is expressed, is now at interesting levels which will really test the outperformance of the greenback.

We can forget about rate differentials and the divergence of monetary policy between the Fed and the ECB in the current climate, though naturally this provides a notable weight for the pair for now.

Past performance is not a guide to future performance

As we have said, the risk of an upside squeeze is likely to come from a bout of EUR repatriation more than anything else, with Europe's fallout with the US as well as internal political squabbles counterbalancing this. 

Technically, we have now hit the 200 day weighted moving average at 1.13665 or so, and this is providing some support in the early week panic which has driven the pair lower.

Now that the long-held 1.1500 mark has been breached, we expect upturns to face some selling pressure which could enforce a later move down to 1.1300-1.1275 beyond the above-mentioned level.

From here, pre 1.1200 is likely to see another bank of support kicking in, so as we can see from the close proximity of these key levels, it is likely to be a steady grind lower if we get some sort of stabilisation in the emerging markets over the next few days.  

Data out of Europe this week will be headlined by growth and inflation data for the EU composite, though these are second readings. However, German flash growth estimates will be a little more emphatic in determining the impact of the trade wars - as will ZEW sentiment surveys.  

We also cannot overlook the possible intervention in EUR/CHF which has now fallen through 1.1300.  The Swiss National Bank are pretty open about their operations in the market, so it is a case of speculating where their buying power can and will have more of an influence and closer to 1.1000 looks to be the obvious call.  

Japanese performance

The JPY is likely to continue to be one of the better performers at the present time, but the question now is whether this will bite a little more into the USD rate which has only just taken out the 110.50 - reluctantly so as the price action suggests.

Japanese investors comprise a sizable chunk of the demand for US Treasuries at present, reversing their flow seen at the start of the year - when they were heavy sellers as the TICS data showed us at the time.  

The BoJ has allowed a little more movement in JGB yields as per their previous meeting/announcement, but this does not seem to be enough to tempt local investors back in and their appetite for US paper continues - again, fuelling USD demand.

Last week we saw Q2 growth coming in better than expected which will raise hopes that monetary policy is working, yet it is the inflation pass through they are monitoring primarily.

This week we get the trade balance for July, which is expected to dip by Y50 billion, and this may unnerve policymakers who are ever wary of the level of the JPY and how the market responds to their policy tweaks.  

Past performance is not a guide to future performance

Industrial production in China alongside unemployment and retail sales are a minor distraction away from the exchange of tariffs with the US, though not to be ignored given the focus on credit concerns within the economy. 

Brexit worries

In the UK it is all about Brexit. Data is having very little impact on the Pound at present as all and sundry focus on the odds of an agreement with the EU. Both sides are hoping for some sort of resolution by the end of the year, but recent comments on the heightened odds of a no deal outcome have prompted the market to go overly bearish on GBP again with focus on Cable back on the 1.2000-1.2500 area.  

Past performance is not a guide to future performance

Earlier in the year, we were surprised at the level of optimism which sent the spot rate through 1.4000, but now we are at crunch time in the talks it is a very different story and we expect very little relent on pressure until the negotiations give the market something to hang more positive hopes on.  

Through the week, we get the employment report on Tuesday, inflation on Wednesday and consumer spending on Thursday, and the BoE along with everyone else in the UK will be looking for signs of economic resilience in the face of projected fear and panic spread through the media.  

Initial support ahead of 1.2700 seems to have stabilised some of the downturn for now, but we are seeing very little aggressive interest to pick up levels based on valuation which was cited as a reason to fade weakness at current levels a little over nine months ago.  

While EUR/GBP stays bid, we can assume the bearish undertones will remain in place and renewed talk of a possible move to parity shows you that longer term GBP buyers trading fair value will have some more pain to contend with over coming months.

The cross rate has strong support from 0.8800, and only EUR pessimism exacerbated by European exposure to Turkey is keeping this pair from returning for another test on 0.9000 levels. 

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