FX price action in the context of global macro developments

The dollar was lifted at the start of the last week by safe-haven demand as China's Evergrande multi-month collapse triggered a sort of panic attack by global markets.  The dollar strengthened after the initial drop following the FOMC meeting.  The Fed's confirmed tapering announcement is likely at the next meeting (Nov), but this has been well tipped.  The market also expected that a few more officials would see a hike next year as appropriate  This too was delivered as expected.  

The real new news was that regardless of the exact start date, the tapering would be completed by the middle of next year. Some Fed hawks (e.g., Bullard) wanted to see the tapering completed by the end of Q1, but that seemed too aggressive for the majority.  The mid-year completion was in line with our expectation because we assumed the Fed wants to maintain maximum flexibility, which means allowing scope for two, not one rate hike next year.  Three FOMC members look for this, up from two in June, and the rotating voting members will bring on a more hawkish contingent in 2022.  The market has nearly priced in a September 2022 hike and has discounted about a 25% chance of a second hike. 

The week ahead promises to be less eventful. The economic diary is less significant with fewer central banks meeting.  Two emerging market central banks, Mexico and the Czech Republic, are notable exceptions,  Banixco is the close call of the two.  The central bank seemed to signal a pause after hiking in July and August.  However, price pressures remain firm, and the bi-weekly measure was higher than expected.  The Bloomberg survey of six economists found unanimous projections for a hike, but the one-month cetes yield of 4.65% suggests it may not be completely discounted by the market.  The Czech move is an easier call.  The central bank has signaled its intention to hike rates, and the market anticipates a 50 bp hike after 25 bp moves in June and August.  Both Russia and Hungary raised rates less than expected earlier this month, but the Czech central bank is more orthodox, and August CPI accelerated more than expected to over 4%. 

Dollar Index:  A range of roughly 93.00 to 93.50 contained most of the price action last week.  The high for the year was set on August 20, slightly below  93.75.  The consolidation looks bullish.  The MACD is gradually moving higher, while the Slow Stochastic is over-extended, and a little weakness will likely see it turn down.  The upper Bollinger Band begins the new week a little below 93.55. The Dollar Index peaked near 103.00 in March 2020 and bottomed around 89.20 at the start of the year.  The (38.2%) retracement objective is by 94.50, which means that DXY is broadly sideways in the trough so far this year.  

Euro:  Everyone and their sister recognize that the Fed is ahead of the ECB in adjusting monetary policy. Yet, Europe's 10-year yields have risen by 20-25 bp over the past month, while the US benchmark yield is up a little more than 15 bp.  The US two-year yield is up about 4.5 bp in the past month, while the German (and Dutch) two-year yield is up nearly six basis points.  Most of the other countries' two-year rates are up 2-4 bp.  In response to the FOMC meeting, the euro broke down to $1.1685 before rebounding, but the $1.1750 area proved formidable. The MACD is grinding lower, while the Slow Stochastic has entered oversold territory and maybe trying to turn higher.  The lower Bollinger Band is around $1.1680.  Recall that the $1.1700 area corresponds to the (38.2%) retracement of the euro's rally from the March 2020 low (~$1.0635) to the early January 2021 high (~$1.2350). The euro recorded the low for the year last month by $1.1665.  Initial support on a break may be seen around $1.16, the low from last November, but the next retracement objective (50%) is a little below $1.15.  

Japanese Yen:  The rise in US yields arguably offers the most compelling explanation of the dollar surge against the yen. The rolling 60-day correlation of US 10-year yields and the exchange rate has been hovering over 0.60 for a couple of months. It has rallied for the past three sessions, the longest advance of the month, and reached almost JPY110.75, just below last month's high.  The high for the year was set in early July near JPY111.65.   The momentum indicators are pointing higher.  The note of caution from the charts is the proximity to the upper end of the range and the close above the upper Bollinger Band (~JPY110.55).  Often when the exchange rate looks like it is trending, it is moving to a new range.  The current range is roughly JPY109 to JPY111.  If it is moving into a new range, last year's spike high was about JPY112.25, and the 2019 high was a little higher, around JPY112.40 may attract.

British Pound: Two notable price developments took place last week.  First, a considerable rise in short-term UK rates following the BOE meeting implied that if the need arose, it would raise rates while it continued to buy bonds.  Less than 24 hours earlier, the Fed's Powell explained why this did not make sense.  Since the BOE is expected to finish its bond purchases at the end of the year, this was seen by many participants as a hawkish signal. As a result, the UK 2-year yield rose 13 bp last week to almost 0.38%. The implied yield of the December 2021 short-sterling futures contract rose five basis points last week, and the March 2022 contract yield increased by about 11 bp.  Second, sterling underperformed last week, falling nearly 0.5% against the dollar.  It was the third consecutive weekly decline. Sterling tested support near $1.36 and bounced to about $1.3750 in response to the BOE but failed to hold above $1.3700. The MACD is moving sideways, and the Slow Stochastic is oversold.  A break of the July low near $1.3570 could signal a test on the year's low set in January around $1.3450.   A move above $1.3750 lifts the tone.

Canadian Dollar:   On the back of the dramatic drop in stocks at the start of the last week, the US dollar rose to almost CAD1.29.  A recovery in stocks appeared to spur a pullback toward CAD1.2635.  Broad US dollar strength and weaker equities saw the greenback gravitate around CAD1.27 ahead of the weekend.  The momentum indicators favor the downside, but the US dollar has held above CAD1.26 for the second consecutive week.  The Bank of Canada warned that the economy may have contracted in July, and the official estimate is due on October 1.  The market is feeling more comfortable with the Bank of Canada rate hike around the middle of next year.  The implied yield of the June 2022 Banker Acceptance futures contract has risen by nearly 15 bp since earlier this month.  

Australian Dollar:  The Aussie had been trending lower since peaking near $0.7480 at the start of September.  The downside momentum faded, and a base was forged around $0.7220.  The subsequent bounce ran into resistance by $0.7315, which is roughly the (38.2%) retracement of this month's decline.  The next retracement target (50%) is closer to $0.7350.  A break of $0.7200 targets the year's low set last month a little in front of $0.7100.  The $0.7050 area corresponds to the (38.2%) retracement of the rally from last year's low of almost $0.5500. The MACD is flat, while the Slow Stochastic appears to be trying to turn higher in oversold territory.  

Mexican Peso: Most of the price action this quarter has been between MXN19.80 and MXN20.20.  In late August, the dollar poked a little above MXN20.4560, but it had re-entered the range within a week or so.  In the first half of September, it based around MXN19.82. The swing in the pendulum of the market's risk appetite helped lift the greenback to MXN20.20 at the start of last week.  It subsequently pulled back and made the low for the week on Wednesday near MXN19.9370.  It returned to test the MXN20.00 level ahead of the week nd and it held again.  In addition to the general dollar direction and the broader risk appetites, there is room for a surprise next week from Banxico.  The lack of a rate hike could see the peso slip in the immediate reaction, but the rate hiking cycle is not over, and at least one and possibly two hikes may be delivered before the end of the year.

Chinese Yuan:  The dollar remains remarkably steady against the yuan. Last week, the mainland's markets were closed for a holiday on Monday and Tuesday, as the market mulled the implications of the demise of Evergrande. However, when everything was said and done, more was said than done, and the dollar finished the week virtually unchanged, slightly above CNY6.4660.  The PBOC has been pumping liquidity into the banking system. While things may change, the liquidity provisions are primarily aimed at the quarter-end and the week-long holiday in early October.  There still seems to be a high degree of confidence that the contagion will be mostly limited to China and the property sector.  The "official" PMI is due next week, and broad stabilization is likely after falling for the past three months.  In fact, the composite PMI has only risen twice this year (March and May), and in August, it fell below the 50 boom/bust level for the first time since February 2020.