USD flows may slow. The dollar continued to see solid flows last week, but not so much due to strong fundamental underpinnings directly related to the dollar. The Eurozone, Japan, Australia, and emerging markets are all on their heels right now with the coronavirus continuing to only make matters worse. As anticipated, the dollar finally notched new cycle highs last week against developed market currencies, with the US Dollar Index (DXY) rising to its highest levels since April 2017. There may be some near-term weakness, but overall the trend and backdrop favours firmness for the greenback.
Last week, euro selling stalled at a 20-year trend-line. It may be something to build on in the near-term as selling and sentiment became saturated around long-term support in the 1.07-area. On Friday, we saw upbeat German/Eurozone Markit services and manufacturing data. ECB president, Lagarde, will be speaking in Germany on Wednesday. German unemployment and inflation data via CPI are due out on Friday. Can more positive news flow stack up to help fuel a near-term recovery? Perhaps so, but structurally headwinds are seen as keeping the single-currency pointed lower in the long-run.
EUR/USD bouncing off 20-year trend-line
GBP continues to hold its ground. Look for positive economic data to remain supportive. While GBP/USD has been trending lower since the general election, it is doing so in supportive fashion with cable still trading around the same level it was at two months ago. There remains near-term risk down to 1.27/24, but broadly speaking we view risk as asymmetrically skewed higher towards the 1.40s.
Sterling working on a breakout versus the euro. Last week we went over the potential for GBP/EUR to further itself along in a meaningful way should it break above 1.2081. The backdrop is there with the two currencies generally pointed in opposing directions. A sustained break above the 1.2081 level gets the pair out of the jostling range of the last 3.5 years. A breakout might take some time to develop, but probability appears skewed favourably towards much better levels for sterling versus the euro.
The dollar went wild against the yen on strong flows out of the Japanese currency as concerns rose regarding how bad things could get for Japan’s economy. But that move is currently being reversed as coronavirus-induced risk-off is taking its toll on risk trends and putting a bid in the yen. At the time of this writing the DAX is down nearly 4%, and US stocks, which have been incredibly strong, are off by 2.6% per the S&P 500. The fierceness of last week’s move in USD/JPY (and now subsequent reversal) may have come as a surprise to many. But as we have been warning in recent weeks, record low volatility in the FX market in a growingly uncertain environment has put us on high alert for an increase in volatility. USD/JPY laid dormant all of last year, so much so that it carved out the smallest annual trading range ever, and ended the year with the smallest quarterly range since 1983.
The volatility compression hasn’t been isolated to USD/JPY of course. We’ve seen broad-sweeping compression in price activity across the FX spectrum. Just recently the euro also hit record low levels of volatility. Price behaviour in EUR/USD this month has been some of the cleanest we have seen since at least early 2018, and when coupled with the sudden price swings in the yen, it hints at the notion larger fluctuations in the FX market lie ahead.
Aussie broke to fresh cycle lows. Support is lacking both fundamentally and technically. There isn’t any substantial price support until near the 60-cent figure. The market is pricing in potential for a couple of rate cuts between now and the middle of the year.
In summary, the dollar may pull back a bit here but remain generally firm. The euro could stabilise in the near-term, but the long-term outlook isn’t changing anytime soon. Sterling isn’t backing down versus ‘King Dollar’; GBP/EUR is threatening to break a 3.5-year trading range. Aussie is flirting with 2008/09 levels as backdrop remains poor. The sudden explosion in Japanese yen activity highlights how quickly things can change. Volatility is anticipated to tick higher in FX.