Market Outlook: FX - Consolidation the name of the game

Currency markets

This week has been mostly a consolidation one, with no apparent new theme emerging and market participants mostly sticking to existing positions. 

The dollar straight up against the EURO is incredibly challenging to forecast within a 3-5 day frame, let alone one month. Still, FX traders are more than happy to ignore the highly confusing and flippant dollar analysis on offer and go about their merry way while trading the least resistance.

The Euro remains supported by the fall in its existential risk premium, which placated market fears about EUR fragmentation; how long that last will very much depend on the data. And with the recent run of EU zone economic data highlighted by Friday’s Eurozone employment underscoring a path to EUR divergence (and not in a pleasant way), is it time to float back under the umbrella of the US dollar?

Still, the EUR is holding up above 1.1800 despite the pick-up in Covid-19 cases raising questions about the pace of recovery from the record GDP drop in Q2. This suggests the EUR has merely wrestled the title away from the US dollar as the "Cleanest Dirty Shirt in the Laundry Basket." as traders continue to hedge top side EURUSD risk around the November election date and hedge for what once was expected to be a Fed policy bazooka in September. 

With ten-year US bond yields backing up +.20 bp above .70 % this week and financial market conditions holding steady – with the best signpost the S&P 500 closing in on record territory – there’s no reason for central banks to lean against the bond markets repricing. If UST 10Y yields back up another +.30 % closing the valuation gaps to US equities, the dollar goes higher and gold goes lower initially 

Misses for China's July retail sales and industrial production data dampened enthusiasm Friday, despite another decent US equity session Thursday. FX has traded OK though, helped by White House economic adviser Larry Kudlow's comments that the Trump administration is satisfied with China's progress in meeting its commitments in the 'phase one' US-China trade deal. 

USDCNH traded lower. I've received some questions about the pick up in short USD/Asia interest and whether the positioning is an issue. The move started to pick up speed last Thursday/Friday when the US administration offered up a friendly olive branch to China around the trade talks, and volumes haven't been that large, so I don't think it's an issue yet, and this price action should support that – after all, we only closed out at 6.94 USDCNH. 

The Trend is your Friend 

Path of least resistance (AUDNZD) 

AUD/NZD rallied above 1.09 last week for the first time since October 2018, continuing its sharp trend higher since July 10. And when you combine clear cut policy divergence between the RBA and RBNZ and that the critical technical break would predictably attract the systematic trading community and CTA, it would suggest we could see 1.10. Especially if Governor Lowe walks down some of his panicky comments from Friday as the RBNZ was even more surprisingly dovish than even those betting against the Kiwi thought after the RBNZ turbo-charged their bond-buying program.

The two keys to + 1.10, assuming the market went all in long at 1.09 (my call post-RBNZ London open note) are:

• CTA and systematic trading influence 
• RBA Governor Lowe walking back some panicked comments of Friday and RBNZ governor Lowe reaffirming his dovish stance next week