With Fed Chair Powell’s refusal at the FOMC meeting on Wednesday to provide forward guidance and indication that coming rate moves will depend on incoming data, the risk as we noted would be an increased sensitivity to data releases. And we saw that yesterday after the release of the weak first estimate of US Q2 GDP, which had annualized growth falling at -0.9% relative to the prior quarter (so an actual fall of less than 0.25%), led by shifts in inventories, weaker government spending and fixed investment, while personal consumption was +1.0%. Fair or not (and to be fair to observers like the Biden Administration, this does not look like a real recession at all yet) this drove the USD sharply lower, with the USD touching new local lows against the majority of G10 FX pairings and the JPY the highest beta currency to the situation on the sharp move lower in treasury yields. That reaction, rather like the kneejerk reaction to the FOMC meeting the day before, has in turn faded fairly quickly, if not fully, suggesting that the market realizes very well that the next data release could fail to support the trend toward lower and earlier peak Fed funds rates. Today we get the June PCE inflation data, but the busy data calendar through next Friday’s July US jobs report may offer a minefield for tactical USD traders, especially when the next CPI data points roll around on August 10 and September 13. Tactically, an important coincident indicator is the US 10-year Treasury yield benchmark, which finally punched below the 2.70% in the wake of the data release but has not followed through lower – if it reverses back sharply into the old range, that may be the end of this USD move lower for now – also in USDJPY terms (assuming no BoJ shift).
The Fed’s halt to QT and eventual move to cut rates and even resumption of QE was possible as there was no inflation to complicate the backdrop, and it while had softened a bit, there was no whiff of recession in the air. This time, the Fed is only likely to relent on further tightening and to begin ease because the labour market has come under severe pressure, which only happens in recessions. And recessions are historically where the Fed is busy chasing to get ahead of a worsening of financial conditions. And the latter only improve in a recession once the Fed has eased sufficiently to get ahead of the downturn. In short, the market is getting way ahead of itself here and we are likely well ahead of peak financial condition tightness – the point at which “something breaks” as we have phrased it before.
This week has seen a tactical capitulation of the USDJPY bulls after the FOMC meeting and negative US Q2 GDP estimate. Overnight, the Tokyo CPI was a bit hotter than expected as well, although it is unlikely the BoJ will carry out a policy shift unless it is under duress at a time of weaker JPY and higher commodity prices. The Ichimoku level of note in coming days is the bottom of the cloud near 131.50, conveniently near the old cycle high that was retested back in June.
Trade accordingly with your risk
The daily and weekly EUR/JPY charts show a bullish picture for the pair, despite multiple overbought signals flashing a warning. As with all strong moves, traders may be wise to wait for a period of consolidation before entering a trade.
The Japanese Yen remains under pressure due to a series of factors. The Bank of Japan (BoJ) said on Monday that monetary tightening is not ‘suitable’ despite annualized core inflation hitting 2.1% in April. BoJ governor Kuroda believes this rise to be temporary and that the central bank will continue to keep monetary policy loose for longer to allow the economy room to grow.
Some market advisors have even mooted the idea of 50 basis point hikes as the ECB struggles to control runaway inflation. Higher interest rates will continue to boost the Euro’s attraction.
The BoJ continues to lean on loose monetary policies, and the European Central Bank (ECB) is looking to tighten the monetary screws. While a rate hike, from a current level of -0.50% - is not expected to be announced at this week’s policy meeting, financial markets have already priced in a series of 25 basis point increases through the rest of the year.
Trade accordingly with your risk
The pair closed the week slightly higher, with the highlight being Powell’s comments on inflation that drove investors to the safe-haven pair.
“The Federal Reserve will not let the economy slip into a “higher inflation regime” even if it means raising interest rates to levels that put growth at risk,” Fed Chair Jerome Powell said on Wednesday.
These and many more comments emphasized the bank’s commitment to taming sky-high inflation. Powell said the more significant risk was not a slowed economy but rather the failure to restore price stability.
On the daily chart, bears pushed the price to 0.95004, where it found support. The week had been choppy for the pair until the last day when the price increased impulsively. The choppiness is a sign of weakness in the bearish move. Bulls have come in to test the waters and see if it is possible to start a bullish move. However, bears are still in charge since the price is trading below the 22-SMA and the RSI is below 50. The trend will only change if the 22-SMA fails to act as resistance and the RSI starts trading above 50.
USD/CHF picks up bids to consolidate intraday losses, struggles to extend Friday’s downside move. Market sentiment remains positive but US dollar bounce off daily lows as traders recheck hawkish Fed bets. SNB, Fed expected to ease on rate hikes amid recession fears.
Trade accordingly with your risk
The gold weekly forecast is up as a possible pause in rising interest rates could return its appeal as a hedge against a possible recession.
Last week, gold had its second bullish week, closing at 1853.46. The weaker dollar brought on this move, which was also lost for a second week, closing below 102.00. This move was due to poor GDP data from the US, which pointed to a slowdown in the economy.
Gold investors expect consumer confidence in economic activity in the US to drop from 107.3 to 103.9. A lower-than-expected value could push the dollar lower and gold higher. Investors will also be keen on the unemployment rate, which they expect to decrease from 3.6% to 3.5%.
The daily chart shows gold pulled back to the 22-SMA last week, closing on a bullish candle after being supported at the 1800.00 critical level. Gold might either break the SMA to the upside or bounce to the downside.
A break above SMA could see gold get to 1900.00 in the coming week. If prices push lower, then the metal might retest the 1800.00 level. The gold weekly technical forecast remains bullish as RSI has stayed above the 30 level. This bias will only change if RSI can get below 30.
The nearly unprecedented pace of Fed tightening this year has seen the Fed hike rates 150 bps in the space of three meetings, and the market has priced another 200 bps of tightening for the 2022 calendar year. If tightening proceeds as expected, that will be a total of 350 bps in a brief space of a nine months. Consider that it took Yellen and Powell three years to hike 225 bps and Greenspan and Bernanke nearly two years to hike rates 425 bps—and that’s without the quantitative tightening (QT) of the post-global financial crisis (GFC) era. In short, the Fed has not moved at this pace since the early 1980s.
The Fed still tries to push back against over-the-top tightening expectations even after its tardy start to the hiking cycle. At the FOMC meeting on 4 May, Fed Chair Jerome Powell specifically pushed back against the idea of hikes larger than 50 bps, only to hike by that much on 15 June, after what many believe to be the Fed guiding the market via a WSJ op-ed. Then, at the 15 June press conference, Powell tried to float the idea that the July hike might be 50 bps instead of 75. Clearly, the Fed retains the fervent hope that the current high inflation levels will still eventually prove transitory. This is in abundant evidence in the latest Fed staff economic projections as well, where the June FOMC meeting refresh still puts the 2024 expected personal consumption expenditures (PCE) core inflation at 2.3 percent. This is no change from March, although the Fed actually lowered the projected core inflation reading for 2023 and the headline inflation for 2024 by -0.1 percent. As we express in this outlook, the risk is that inflation is a runaway train and the Fed is still chasing from behind the curve, never able to catch up.
One argument for how the US dollar might peak and begin its turn lower despite the Fed’s tightening regime is that many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve. This very development has been behind a few emerging market (EM) currencies like BRL and MXN already posting the kind of resilience one might never have thought possible in an environment of rapidly rising US yields and a stronger US dollar this year. But within a G10 FX context, outside of the important exception of USDJPY, most US dollar pairs haven’t shown much correlation with the developments in yield spreads driven at the front end of the curve by central bank policy expectations or at the longer end of the yield curve. Take a pair like AUDUSD, where the Reserve Bank of Australia (RBA) hiking expectations have now caught up and surpassed Fed expectations for the coming nine months, and where the 10-year Australian government bond yield (as of late June) traded 80+ bps higher than its US Treasury Note counterpart, compared with a range of 0 to 50 bps for the first few months of this year. This leads us to believe that the dominant strong US dollar driver in this cycle is the US dollar’s global reserve status and the simple directional fact of US inflationary pressure requiring the Fed to continue to tighten. This wears on sentiment and global financial conditions. If that is the case, then the USD will only begin turning once economic reality finally flounders, sufficiently reversing inflation via a demand-induced recession. Only then will the US dollar finally roll over after its remarkable ascent to its highest level in more than 20 years.
With the huge fiscal outlays to combat the pandemic in the US in 2020 and 2021—some $5 trillion in total—came strong new fears about the fiscal sustainability of the US government. Fast forward to 2022 and we discover that the booming asset markets in 2020 and especially 2021, as well as record boosts in personal income from the huge pandemic cash splash, brought enormous tax revenues, helping to ease these budget concerns, even if only temporarily. While things don’t look too alarming for this calendar year, the next few years will likely prove a different story. That’s because since the 1990s, tax revenues have become increasingly correlated with asset market returns—and these are looking a bit ugly for this year, to say the least. The brief 1990 recession and bear market saw nominal tax revenues actually rising 2 percent in 1991, but that compares to rises of revenue of 9 to 10 percent in the two years prior. Compare that with the wake of the tech bust of 2000 to 2002, when nominal tax revenues fell for three years running from 2001 to 2003 by a total of 12.3 percent, despite a nominal economy that continued to grow. The 2008 nominal US tax revenues did not recover to a new high until 2013.
The 2022 US budget deficit is forecast to only reach -4.5 percent of GDP this year and maybe even less, up from a projected -6 percent at the beginning of the year. The fiscal turnaround is so vast that the US Treasury may even reduce the size of some of its treasury auctions this year, helping offset some of the pressure on the market to absorb treasury issuance as the Fed actively reduces its balance sheet at a rising pace until reaching $95B/month in September.
So even without a recession, assuming at best that US asset markets trade sideways to slightly up for the rest of this year, next year’s budget balance will deteriorate badly as capital gains tax revenues shrivel and the cost of servicing existing debt skyrockets on all maturing and new Treasury debt resetting to sharply higher yields. Throw in an eventual recession sometime next year and the US Treasury will be in trouble, challenged to fund its spending priorities. In all likelihood, due to the lack of investment to improve the supply side of the economy, inflation won’t have fallen much by then and won’t allow the Fed to ease as forcefully as it has in the recent cycles since 2000. At the risk of getting ahead of ourselves, we will have to consider the next recession policy response. And in that environment, the Fed may be sidelined as the US Treasury reaches for stronger medicine. An example would be implementing capital controls to keep savings at home and/or financial repression through forcing a percentage of private savings into US treasuries that offer savers negative real yields because of caps on nominal treasury yields. In other words, monetary policy is rapidly becoming irrelevant as it can’t keep up with inflation risks. If it did, it would challenge the stability of the sovereign. To watch the Fed is to look in the rear-view mirror.
The USD pair showing the most volatility over the last few sessions is USDCHF, which managed to pull all the way above parity at the peak of the strong USD wave before retreating sharply all the way to below 0.9700 as of this morning before finding support. Surprisingly, that more than 300 pip retracement has only seen the pair testing slightly through below 0.9200. The franc has found support on lower safe-haven yields that have also supported the JPY recently, but also after yesterday saw the SNB President Jordan out with the first firm hint that the bank is concerned about the inflation outlook and the risk of second round effects. No specifics, and Swiss rates haven’t really responded, but the CHF jumped on the news. All of this after the recent EURCHF attempt on 1.0500 has failed and USDCHF posted that parity milestone. Will revisit this if EURCHF Is down through 1.0200 support, for now the CHF move looks a bit of an overreaction.
USDCHF has managed the rare feat of providing significant volatility in recent weeks after a long period of choppy action as both currencies have often been classified as “safe-havens” in recent years. After launching a rocket ride from the sub 0.9200 base, USDCHF rose as high all the way above parity on the extreme Fed-SNB policy divergence story (Swiss short government debt will be some of the last negative yielding stuff standing for this cycle) as well as the disproportionate pressure on all things European in the wake of the Russian invasion of Ukraine. The consolidation has been sharp for the reasons noted above, but is still far above the break-out line below 0.9500. Looks like the pair has staked out the new range above that figure and at least to the old range highs into 1.000-1.0200 for now. Looking cheap here?
Trade accordingly with your risk
From late May through early June, the USDCAD pair broke down through key support and the 200-day moving average on the persistent rise in crude oil and as US equities had rebounded sharply from the lows of May. CAD was the strongest G10 currency for much of this period. Then, things suddenly turned south for CAD and USDCAD launched a sharp rally higher from nearly 1.2520 to 1.3000 when global stocks suffered an ugly rout from June 9-11, accelerated by the US May CPI release on June 10 that send US and global yields soaring in anticipation of a tighter Fed and the WSJ tip-off that the June 15 FOMC meeting would deliver 75 basis point hike. USDCAD peaked (and risk sentiment bottomed) on June 17, two days after the FOMC. Since then, the WTI crude oil benchmark has backed off from highs well north of 120 dollars per barrel to as low as 101.50 before rebound to about 106 as of this writing. That is extremely CAD negative, and yet USDCAD has traded in a tight range over the last week because off-setting that is the USD-negative sudden mark-down in Fed hiking expectations accelerated yesterday by weak flash June PMI data that mimicked the weak EU flash June PMI data. The market has marked the peak rate from the Fed by around 50 basis points and pulled the anticipated peak in the policy rate into very early next year.
As long as yields continue falling and risk sentiment prefers to celebrate that fact rather than fact that this is an expression of the fear of recession, the pressure for the USD to rise fades. But if the next batches of economic data show that the Fed can’t back down any time soon due to persistent inflation readings from services inflation, rising rents and/or a still-tight jobs market, the USD could yet rise on a re-adjustment back higher of Fed tightening anticipation. On the other hand, if risk sentiment begins to falter on recession concerns, the US dollar may trade higher as a safe-haven. Technically, the comeback of the last couple of weeks is remarkable and trend-followers will look for a solid fall of the very well-defined 1.3000 area to indicate and next leg higher toward 1.3500. The tactical situation to the downside is rather more uncertain due to the huge swings in both directions within the range in recent weeks.
The US dollar strength and higher US yields are the one-two punch continuing to drive risky assets into the red as the week gets under way, with US equity markets at new lows for the cycle ahead of the US open today. I suspect now that in the bigger picture, this cycle of USD strength only ends once US long yields begin falling, and falling because the Fed has exercised its put with new yield caps or because US pension- and/or other rules are changed requiring US savers to hold more treasuries, not because market forces at some point decide that long US treasuries are a superior long-term investment. For now, it would seem talk of such eventualities are premature, although if volatility continues at the current level for much longer, it will sharply bring forward the eventual policy response.
A number of USD pairs are at significant chart tipping point as this week gets under way. The most well defined of these is perhaps the 0.7000 level in AUDUSD, although USDCAD in the 1.2950+ area is quite remarkable as well – an area that has seen at least four prior touches, first as support just prior to the pandemic in early 2020 and then as resistance once the pair crashed back down through that level later that year. Oil prices are challenged from the demand side on Chinese Zero Covid lockdowns and budding behaviour change globally from skyrocketing diesel- and jet fuel prices. The range above there and above the psychological 1.3000 level is considerable – all the way to the double top of 1.4600+ from 2016 and 2020, but the bulk of the time, the 1.3650 area capped the action during those years. If oil suffers a more significant setback over this latest risk deleveraging event, that level could quickly come into play. The private debt leverage is far higher in Canada than in the US and one of the more sensitive sectors to rising rates is housing, which represents a far greater portion of the Canadian GDP growth over the last decade and a half relative to the US – interesting to watch the trajectory of the housing market in both countries after the enormous back-up in yields in recent months.
The Bank of Japan continues to swim against the stream of global central bank tightening as it maintained course overnight with its policy mix of negative yields and yield-curve-control, triggering a wave of fresh JPY weakening that was only moderated slightly by a sharp drop in US treasury yields.
The Bank of Japan refused to budge overnight, standing pat on its policy of yield-curve-control and announcing daily operations in the bond market to defend the policy, with no guidance suggesting a change of course, though a brief comment on foreign exchange was inserted into the policy statement.
That suggests that there is some level of JPY weakness at which the Bank of Japan may be forced to revisit its policy commitments, but that we aren’t there yet.
Sterling rallied hard yesterday in the wake of the Bank of England meeting yesterday, with UK rates and the currency focusing more on the hawkish guidance the meeting produced rather than due to the small 25-basis point hike. The bank said it would react “forcefully” if inflation doesn’t develop as hoped (which will take some doing – the Bank of England expecting the CPI to hit north of 11.0% before falling back after October) which suggests the willingness to hike by 50 basis points even if the economic outlook is not promising.
Trade accordingly with your risk
The euro boost comes as ECB expectations are rising sharply again on the back of fresh rhetoric indicating more urgency to kick off the rate tightening cycle. The ECB’s Villeroy, Nagel and Vasle today all indicated a strong lean for getting going, with Villeroy saying the case for ECB net debt purchases after June is “not obvious” and that it is “reasonable” to expect rates above zero by year-end. The Bundesbank chief Nagel said the ECB must get on with normalizing policy and that it shouldn’t hold back just because of the difficult backdrop, and Vasle saying it would be appropriate to raise rates before summer which means at the June 9 meeting where the odds remain low for a hike. This has helped the euro higher against the lowest yielding CHF and the JPY punching bag as EU longer date yields also rose to new highs for the cycle. The German Bund yield has touched 1.00% in recent days.
EURCHF is the focus of the day as the ECB earns some respect from the market in signaling more urgency to kick off its tightening regime. The price action has taken the pair above the well-defined 1.0400-area resistance as the yield spread has stretched some 100 basis points in the euro’s favour for 2-year since early March, more than off-setting now, apparently, the existential concerns that are burbling in the background as the Germany-periphery yield spreads widen. The 1.0500 area 200-day moving average is the next area of interest.
Since March 2021, EURCHF is on a legitimate downtrend and since the end of February, the pair was in a symmetric triangle pattern . By the beginning of May, after a series of bullish candles, the price managed to escape from the triangle to the upside. That only encouraged buyers and increased the momentum allowing the price to rise further and break the mid-term down trendline .
Breaking those two resistances is definitely a great sign and an invitation to go long. The buy signal is here and stays on the table as long as the price stays above the horizontal support on the 1.035.
An alternative scenario includes the price coming back below the orange support, which would effectively give us a sell signal. But the chance of that happening are now rather limited.