The Daily Fix: USD looking vulnerable, but only on a select basis

There is certainly plenty for traders to digest over the past 24 hours or so, and the good news is there is just one last trading session to come before the weekend. Where we can take a step back, catch our breath and look at the financial world with a fresh mindset.

While this is largely in the rear-view mirror, there is still much being made about Fed governor, Lael Brainard’s, speech to the Detroit Economic Club on Wednesday. If you haven’t read it, it is a must-read, as it is arguably far more important than any other speech this year from a Fed member. The crux of the rhetoric is that Lael Brainard, who has been the architect in altering Fed policy in other occasions, has given us a roadmap by which the core of the central bank will use to move the fed funds rate from here – that being higher. There is now clear separation around their focus of both short- and longer-term neutral rate and not only has Lael Brainard highlighted that we need to focus on the short-term neutral rate, which sits closer to 3%, but this rate is dynamic.

This is key as it makes us feel the Fed now have free reign to lift the fed funds rate up to 3% without any real hesitation when regional presidents have argued we should be looking at the long-term natural rate, which is closer to 2.1%. We can look across the full-fed fund's future curve and see this peaking at 2.8% in 2020, suggesting rates traders are not yet buying into this view. What this means in layman’s terms is that the fiscal stimulus, which still needs to fully feed through to the data, gives the Fed the green light to hike in September, December and likely a number of times in 2019 and, if we look at the Eurodollar strip or fed funds future curve, this message from Brainard is not priced in.

One would assume this is a clear USD positive. And, on the face of it is and this may help explain why USDJPY came off its low of 111.38 after the below-consensus US core and headline CPI print, with traders bidding this pair into the figure. We still need to assess tonight’s US retail sales report, and while most will focus on the headline print (consensus 0.4%), more importantly, perhaps, is the ‘control group’ element, which is the basket of goods that feed directly into the Q3 GDP calculation. With US Q3 GDP tracking close to 3%, a number above 0.4% will cement these GDP expectations and should inspire USDJPY, with the set-up on the daily chart looking progressively more bullish. 

Here, we see price smashing through the top of the cloud and also the 61.8% retracement of the July to August sell-off at 111.88. A move through 112.00 looks a high probability here, and it would not surprise if price started to hug the upper Bollinger band and begin a slow steady creep higher in the coming days.

So, we can see bullish positions building in USDJPY. However, against the basket, the USD is looking more vulnerable. The USD index has now closed through the neckline of the multi-month head and shoulders and looks ominously poised to break below the 28 August lows of 94.43. A break here would suggest turning more cautious on the broad USD and would suggest a technical target of 92.00 on the USD index. Naturally, one could argue EURUSD, which holds a 57% weighting on the USD index, will need to break supply at $1.1740 and into $1.1800 (the June swing highs) for this to materialise. My preference is long EURJPY and feels this pair has legs for a move here to test the 132 level, but I have no issue being long EURUSD in small size here either.

The overnight ECB meeting failed to move the EUR, Euribor or German bunds, and while the bank modestly cut its growth expectations, while confirming that the APP program would be reduced to €15b p/m by the end of September, this was all expected. Any move in EURUSD overnight was driven by the weaker US CPI print and also reports that the UK may be eyeing concessions in the Irish border debate.

EURAUD has been a key trade of late and one questions if the pullback from 1.6354 has run its course here and its time to buy back in. At this juncture, the AUD is simply a vehicle for expressing a view on China-US relations and is a key barometer here. Chinese mainland and offshore (Hang Seng) had a decent relief rally yesterday, but the good-will stops here and Trump has made sure of that tweeting overnight that ‘we are under no pressure to make a deal with China; they’re under pressure to make a deal with us’. This could partially explain the bid off the lows of 6.8228 in USDCNH, and as we have seen time and time again, where USDCNH goes, AUDUSD will follow.

So, it promises to be an interesting Asian trade, notably whether yesterday’s bullish equity move was a dead cat bounce or something more sustainable. Equities around the traps should feed off the 0.5% gain in the S&P 500, as well as the five-basis point narrowing in high yield credit spreads. Although the question is whether the buyers step in on the open and further push prices higher or whether they fade the early strength – it will reveal a lot about sentiment. AUDUSD should track this move, and I would specifically focus on the Hang Seng.

On the day, the 15 August (doji) low of $0.7202 looks like a key line in the sand and we can watch trader behaviour here, as it feels as though downside risks prevail and the short covering rally we have seen in the last couple of days could offer more compelling levels to re-apply shorts.

China’s retail sales (consensus at 8.8%yoy), industrial production (6.1%yoy) and fixed asset investment (5.6%yoy) shouldn’t be too influential on trade, but that view is largely premised on the idea that the data doesn’t miss expectations by any great degree.

 (AUDUSD has reverted to the line of best fit, suggesting short positions could work here)

(Source: Bloomberg)