US Dollar Sliding, Gold At Record Highs

Risk sentiment has turned south and the US stock rotation out of tech into value has gathered pace, with the Nasdaq ending down for a second straight week.  Gold is turning into a star performer, registering a record high today, while the US dollar continues to lose ground.  Economic activity is slowing, second round virus cases are accelerating in places that had previously flattened the curve, while US- China tensions are heating up.  Attention this week will centre on US fiscal discussions while US-China tensions remain a key focal point.

Reports suggest that Senate Republicans and the US administration have agreed on a $1 trillion coronavirus relief package.  This will be the opening offer in discussions with Democrats (who had passed a $3 trillion package in House in May), with less than a week before unemployment benefits expire.  Whether the $1 trillion on the table will be sufficient to satisfy Democrats is debatable and a figure of around $1.5 trillion looks plausible. Time is running out and pressure to reach a compromise is growing.   Further uncertainty will likely weigh on US markets in the days ahead.

US-China tensions remain a key focus for markets. Worries about a dismantling of the Phase 1 trade deal still looks premature even as China has fallen behind in terms of purchasing US imports.  The closure of the US consulate in Chengdu following the closure of the Chinese consulate in Houston will be seen as a proportionate move, that is unlikely to escalate matters.  Nonetheless, a further escalation is inevitable ahead of US elections in November, with a broad array of US administration officials becoming more aggressive in their rhetoric against China.  As such, further sanctions against Chinese individuals and companies could be on the cards.

The week could prove critical for the US dollar given that it is breaching key technical levels against a host of currencies, with the currency failing to benefit from rising risk aversion recently. While not a game changer the European Union “recovery fund” is perceived as a key step forward for the EU, a factor underpinning the euro.  Key data and events over the week include the Federal Reserve FOMC meeting (Wed), US (Thu) and Eurozone Q2 GDP (Fri) and China purchasing managers indices (PMI) (Fri).  US Q2 earnings remain in focus too.  Before these data releases, today attention turns to the German IFO survey (consensus 89.3) and US durable goods orders (consensus 6.8%).

 

Equities weaker, US yields lower, USD softer

The US Federal Reserve’s rejection of capital raising plans by several banks taken together with further confrontation between the US and Russia and a disappointing US durable goods orders report were sufficient to result in a sell off in equity markets, lower US yields and a weaker USD.

Gold failed to benefit in yet a further sign that its bull run has ended, with the metal honing in on its 200 day moving average at 1296.71. On the US data front headline February US durable goods orders beat expectations (2.2%) but core orders (-1.3%) were weaker than expected.

Although the lead for Asia is a weak one markets may still find some resilience due to expectations of policy stimulus from China. Similarly dovish talk from the European Central Bank will offer further support to market sentiment while undermining the EUR somewhat. On the data front today the main releases are US Q4 GDP revision (upward revision likely), and UK retail sales (rebound likely).

Weak USD will not persist, CHF to drop eventually

Risk appetite has deteriorated slightly since the Bernanke fuelled bounce earlier this week but there does not appear to be much of a directional bias for markets either way. Interestingly Treasury yields continue to pull back even while equity markets have softened overnight.

Data has been mixed, with US consumer confidence dipping in March albeit not as much as expected while US house prices also did not drop by as much as anticipated. Data releases on tap today include monetary aggregates in the Eurozone and durable goods orders in the US. The tone will likely continue to be slightly ‘risk off’.

The USD has come under growing pressure since its mid March high, with the EUR in particular taking advantage of its vulnerability. A combination of improving risk appetite and a correction lower in US Treasury yields in the wake of relatively Fed comments have been sufficient to deal the USD a blow.

However, the outlook for the USD is mixed today as on the one hand it will be helped by a reduction in risk appetite but hit on the other by a drop in US Treasury yields overnight. Data today should be a little more constructive for the USD, with a likely bounce back in durable good orders in February.

Overall, I do not expect the weak USD bias to persist especially as it is based on unrealistic expectations that the Fed will still implement more quantitative easing. Indeed, while further Fed easing is possible it may not need to involve an expansion of the Fed’s balance sheet.

EUR/CHF remains pinned to the 1.20 ‘line in the sand’ imposed by the Swiss National Bank while the CHF has strengthened over recent weeks against the USD. Economic data has deteriorated over recent months, with the forward looking Swiss KoF leading indicator pointing to a further weakening.

We will get further news on this front on Friday with the latest KoF release, with a slight a bounce expected. In turn, bad news on the economic front is adding to pressure for CHF weakness. Market positioning in CHF is negative but there is plenty of scope to increase short positioning in the months ahead given that short CHF positions remain well off their all time highs.

Eventually as risk appetite improves and the US yield advantage widens against Switzerland, both EUR/CHF and USD/CHF will move higher.

Risk currencies buoyed

Positive developments helped to buoy markets. Although US durable goods orders were weaker than forecast a jump in US consumer confidence to its highest since February 2011 gave equity markets and risk assets in general a lift. Even in Europe the news was encouraging as Italy managed to auction 10-year debt at a cheaper rate than previously while Portugal passed a third review of its bailout programme and noted that unlike Greece it would need a second bailout.

There was some negative news however, with the European Central Bank (ECB) temporarily suspending the eligibility of Greek bonds as collateral for its funding operations and Ireland calling a referendum on the European fiscal compact. Nonetheless, hopes of a healthy take up at today’s ECB second 3-year Long term refinancing operation (LTRO) will keep markets in positive mood in the short term.

The USD index continues to look restrained when risk assets are rallying. Given the positive equity market mood overnight it is no surprise that the USD came under further pressure while the EUR looks firm ahead of today’s 3-year LTRO by the ECB. Fed Chairman Bernanke’s testimony will give the USD some direction but we do not expect him to deliver any big surprises. EUR/USD will continue to rally if we are correct about a strong EUR 600-700 billion take up at the LTRO but the currency pair will meet resistance around 1.3550.

JPY has lost ground against various cross including USD, EUR and AUD. Much of its weakness is related to widening yield differentials but our models reveal that USD/JPY in particular has overshot its implied value. Unless US yields widen further versus Japan, JPY could even rebound over coming days. EUR/JPY has breached its 200 day moving however, which is a bullish signal for the currency pair. A generally firm EUR tone likely to be maintained in the short term will also be exhibited versus JPY.

Warnings by Swiss National Bank head Jordan reiterating his stance of defending the EUR/CHF floor of 1.20 has done little to push the currency pair higher. EUR/CHF has enjoyed a strong relationship with movements in interest rate differentials. This implies that it will take a relative rise in German yields versus Swiss yields for EUR/CHF to move higher. This is certainly viable given the deterioration in Swiss economic data over recent months. Eventually EUR/CHF will move higher but over the short term it is unlikely to move far from the 1.20 level.

European agreement at last

Following a drawn out period of discussions European officials have finally agreed on a haircut or debt write off of around 50% of Greek debt versus 21% agreed in July. In addition the EFSF bailout fund will be leveraged up to about EUR 1.4 trillion, with the new EFSF scheduled to be in place next month. The haircut for Greek debt is aimed at ensuring that Greece’s debt to GDP ratio drops to 120% by 2012.

The reaction of markets was initially favourable with EUR/USD breaching 1.40 and risk / high beta currencies bouncing. I doubt that the upward momentum in EUR can be sustained, however, with plenty of questions on the mechanics of the deal, especially about leveraging the EFSF fund, remaining. I suspect that the EUR may have already priced in some of the good news.

Data releases, especially in the US are offering markets more positive news. Following on from firm readings for US durable goods orders and new home sales, today’s US Q3 GDP expected to reveal an acceleration in growth to a 2.5% annual rate, will help to alleviate recession fears to some extent. The USD may benefit if the data reduces expectations of further Fed quantitative easing especially given the recent comments from some Fed officials indicating that the door is open to more QE.

In Japan attention was firmly fixed on the Bank of Japan policy meeting and the prospects for FX intervention to weaken the JPY. In the event the BoJ kept its overnight rate unchanged at 0.1% as expected and expanded its credit program by JPY 5 trillion and asset purchase fund to JPY 20 trillion.

The measures are aimed to easing deflation pressure but the real focus in the FX market is whether there is any attempt to the weaken the JPY. I am currently in Tokyo and here there is plenty of nervousness about possible FX intervention being imminent. Speculation of such intervention will likely help to prevent USD/JPY sustaining a drop below the 75.00 over coming days.

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