Turkish lira continues to lead the major crosses

Simmering trade tensions, interest rate differentials, geopolitical unrest and large G-7 fiscal deficits are all components of how Forex traders determine when to buy and sell currency pairs.

Coming into this week, we can now add the prospects of debt contagion from Turkey to the list of potential drivers of financial assets.

USD

The net result of this confluence of fundamentals saw the USD Index surge to 96.35, its highest NY close since June of 2017. Conversely, the GBP, AUD and EUR have all posted fresh lows for the year against the Greenback.

The only G-7 currency that gained against the USD last week was the JPY, which ended last week about 1% stronger near 110.90.

The fact that the USD Index was able to reach a 14-month high while losing ground to the JPY is largely a function of the composition of the index.

JPY

The JPY has the second highest arithmetic weighting in the index at 13.6%. Combined, the EUR at 57.6% and the GBP at 11.9%, have a weighting of close to 70%, which more than compensated for last week's USD/JPY weakness.

Going forward, we remain bullish on the USD as the FOMC appears committed to two more rate adjustments this year, which will create further divergence between the G-7 monetary policy trajectory.

However, in the short-term, we see scope for some consolidation of last week's move as the market may have exaggerated the credit contagion threat posed by the meltdown of the Turkish Lira.

It's our view that Turkey has been a trouble spot for investors for quite some time. Their sovereign credit rating was downgraded to Ba2 in early March with a negative outlook, the country's macroeconomic posture has been weak for several years, and their central bank does not have much independence from the central government.

In short, global fund managers have had plenty of time to re-calibrate Turkey's financial risk profile before last week's sharp sell-off in the Lira. Still, it's our understanding that the most direct exposure is held by French, Italian and Spanish banks, which could certainly aggravate their already fragile banking networks.

EUR

As such, we see a somewhat asymmetrical risk to the EUR relative to the other major crosses. The EUR/USD has traded as low as 1.1365 in the Asian session and is approaching oversold levels on the daily charts.

The trade flow in the USD/JPY has been in line with traditional "risk-off" protocol. In addition, there has also been the added downside pressure of the unwinding of short JPY hedges tied to long TRY/JPY carry trades.

GBP/USD

It will be interesting to see if this week's high-frequency data out of the UK will have an impact on the Sterling, or if the Lira turmoil overshadows the reports. Later this week will see the release of the UK inflation aggregates as well as retail sales and housing data.

The GBP/USD has been pressed to a 17-month low near 1.2720 during the Asian session and, despite a daily RSI reading of 24.00, doesn't look to have much upside momentum.