Weekly analysis

The US dollar continues to blast higher with brutal momentum as key levels give way in major USD pairs. The momentum is impressive and could be set to continue if longer US yields also become unanchored and rise together with Fed rate hike expectations. But other central banks will be in focus next week as we look for whether hawkish surprises can offer any counterpoint to the strongest weekly surge in the US dollar since the panic phase of the pandemic outbreak.

The US dollar continues to track Fed rate hike expectations higher, with the USD back on an aggressive strengthening path today from the get-go, perhaps as long US treasury yields are back higher  an un-anchoring of long US yields and the yield curve steepening somewhat from here could take the USD move farther than if the long end of the US yield curve remains tame. In my portion of our quarterly outlook that was released this week and written some two weeks ago, Forecasted that the US dollar “could prove resilient for some of the early part of 2022 against the usual pro-cyclical currencies”, as assumed that risk sentiment could crater for a n extended period this quarter as asset markets continue to suffer under the weight of the Fed’s hawkish shift. Assessed that a “broad, aggravated extension of the [USD] strength we saw in late 2021” is unlikely on the assumption that those longer US treasury yields remain anchored. That is an important caveat, and long US treasury yields are creeping back toward the cycle highs. A quick move here significantly above 2.0% for the US 10-year treasury benchmark together with even higher Fed expectations could extend this USD move higher than I would have thought likely when writing the outlook or even after the FOMC meeting. If long yields stay tame, I have a hard time seeing the short end Fed expectations extending much further now that we have effectively already priced in five rate hikes for this calendar year.

Another important factor as 2022 wears on is that the US Federal Reserve is not the only central bank in town and if the Fed is moving in determined fashion to get ahead of inflation, we can expect other central banks to do the same  eventually even the ECB, especially as global prices are generally in US dollars and the price levels could rise even faster elsewhere. 

The RBA is certain to end its QE purchases as it has pinned the February meeting for a review of this stale policy after the embarrassing breaking of its prior commitment to the 3-year yield control. And after the hefty Q4 CPI surprise, together with ongoing inflationary risks that are aggravated by a weak currency, it is time for the RBA to wax far more hawkish, even though it has focused a considerable portion of its rhetoric on needing to see rising wage levels before raising rates. The market is looking for rate liftoff in April or May – this looks tardy and could be brought forward.
The AUDUSD has collapsed through 0.7000 and below the December pivot low just south of that level after the significant repricing of Fed expectations higher this week. Next week, we have the chance to witness the degree to which signals from other central banks are able to counter the USD strength, for example, if the RBA waxes far more hawkish than expected. This 0.7000 area is a major one and argue the last-ditch bull/bear line as we watch how the pair treats the RBA developments and the status of the USD rally next week. The next major downside area is perhaps the pre-pandemic major support zone near 0.6675.

The most consistent trending pair in G10 FX of late has been the slide in EURCHF, which has even slipped below the prior six-plus-year low near 1.0500 over the last week. Remarkably, the pair has maintained its consistent ride lower through some remarkable jolts in the background, including the more hawkish shift from the Fed and the omicron news. This may suggest that the move is not being driven by strong speculative flows  which might have shown significant volatility in line with other currency pairs recently, but rather by consistent flows as the Swiss National Bank has apparently stepped away from the assumed stout defense of the 1.0500 level. The last two weeks of sight deposit data have shown no growth, no signs that the SNB is leaning against this move after doing so the prior four weeks. Also, when inflation fears dominate as they have at times recently, CHF strength is an easy way to avoid importing inflation without rocking the boat with monetary policy signals, while CHF strength is also a natural safe haven play when volatility spikes as it has in recent weeks. The consistent trend may be set to extend here, with parity in EURCHF a natural target.

EURCHF has weakened steadily since mid September in line with the weakening in EURUSD, but far more steadily than the latter, as this trend has managed to sustain through recent volatility elsewhere and shifting focus. The technical situation is without remarkable variation and there are no signs that the SNB is leaning against the move of late. 

The USDCAD pair has gone far and fast to the downside since the crude oil market recovered swiftly from its December post-omicron breakout nadir and is now interacting with the psychologically significant 1.2500 area that slow happens to also be the 200-day moving average. Coming up next for the two currencies are signals from their respective central banks, with a hawkish raising of the bar from the Fed likely requiring, for example, calling an early end to QE already at the Jan 26 meeting and possibly indicating that “larger than 25 basis point” hike increments are under consideration.  The Fed is priced to hike to about 1.0% through the December meeting, depending on the barometer. The pricing for the Bank of Canada is less reliable, but it is certainly priced to lead the Fed in hiking this year by around two hikes even if the spread for 2-year yields between the two countries has been relatively flat for over a month, so little new has been priced in on a relative basis recently. On that account, the move lower in USDCAD looks a bit over-extended without new signals from respective central banks. Other factors influencing the exchange rate will include whether oil continues to march to new highs or corrects and risk sentiment, where I suspect extended weakness will begin to offer more safe haven support for the US dollar if long US yields are also on the rise.

The decision to reappoint Powell was made easier by Quarles stepping down from the Fed Board of Governors ahead of schedule after his position of Fed Vice Chair for banking supervision ended in October. It allows Lael Brainard, who the progressives had favored for Fed chair, to step into that vice-chair role and roll back some of the changes introduced by Quarles without the awkwardness of him sitting across the table.
This decision also removes uncertainty with Powell’s current term ending in February. Had there been any delay in appointing a new Chair due to a lack of political support this could have caused significant financial market nervousness, particularly if we are right and the economy is soaring, inflation is above 6% and the Fed is still stimulating the economy with QE.
The Fed will still taper, and will likely hike in 2022 and the rates market will remains in a state of anticipation for tighter policy and a higher rates environment generally.

Moreover, with two vacancies on the Fed Board of Governors now that Quarles is departing, Biden has the opportunity to shape the Fed further to ensure that monetary policy is truly focused on achieving the “broad-based and inclusive” goals as set out in the updated Fed’s 2020 policy framework. 

In US treasuries, this has mean a sharp drop along the entire US yield curve, giving the euro and the yen a strong boost, as the euro in particular was headed south and fast on the policy divergence theme of the ECB seen likely to maintain zero rates and even some level of QE out over the horizon while the market had priced in three full Fed rate hikes by the end of next year before this sudden reversal. On the weak side, while the US dollar has fallen within the G3 and is approximately flat against sterling, the smaller currencies are sharply lower against all of the above, and EM.

In December, European inflation reached a record high, up 5% over the year before. The US Federal Reserve has pointed to more aggressive measures to contain inflation.
There were a few surprises in the first week of 2022 for the EUR/USD pair, but it remained largely unchanged. Among the biggest shocks was when the American central bank released minutes of its December meeting, which showed policymakers were considering cutting their bonds.

According to the Fed, if the current improvements in the labor market persist, the conditions for a rate hike are likely to be met relatively soon. Next came the December nonfarm payroll report. The US created 199,000 new jobs in December, half of the market expected. On the other hand, the unemployment rate improved and fell to 3.9%. While the numbers were not impressive, market participants still considered them acceptable.
In December, the euro area’s inflation rate grew by 5%, a new record high after the last month at 4.9%. Also, German consumer prices rose 5.3% compared to the forecast of 5.2%. Inflation is pushing the European Central Bank to reconsider its conservative stance.

The hawkish FOMC minutes from Wednesday have so far proven not hawkish enough to trigger more than the one-off adjustment in the US dollar that seems to be fading quickly as we look toward today’s US December jobs report (more on that below). At the same time, risk sentiment remains broadly stable, speculative- and highly interest rate-sensitive US equities generally aside. This is intriguing as the implication is that as long as US yields and Fed expectations are able to march higher without spooking asset markets, the US dollar may fail to rally and could even weaken, though we need to get EURUSD up out of the sub-1.1400 range for a more interesting signal on that front.

Additionally, for the cycle we have to wonder if the Fed is the cart or the horse here, something that it may itself not understand, as it has already shared its lack of understanding on how its balance sheet affects the economy (though we seem to have a good idea how it affects financial markets – and the standing repo facility of some $1.5 trillion offers the Fed quite a large safety valve for how tapering and possibly a quick move to reducing the balance sheet will affect treasury market and asset market dynamics). Put another way, the economy will pull the Fed this way or that on interest rates more than Fed policy will impact the data, as policy moves only hit with a significant lag of 9-12 months.

Speaking of data, the next step for the USD and market is the December jobs report later today, with the market likely leaning now for quite a strong figure, given the six-month high ADP December private payrolls change number released on Wednesday at +807k. That puts the two-month total for the Nov-Dec ADP private payrolls change at over 1.3 million, while the official BLS nonfarm payrolls change total was a tepid +210k in November. Today’s December tally is expected to show about +450k of payrolls growths. But note: the “two-month net revision” number bears watching, as the US Bureau of Labor Statistics has had difficulty collecting data over the last year and has consistently underestimated the pace of jobs growth, with every month since July seeing growing positive revisions, from a +119k revision in August to a +235k revision in November.

Another week of strong gold buying has now raised the alarm bells given the risk of long liquidation should the yellow metal fail to hold onto its US CPI price boost above $1830. Last week the net long in gold reached a 14-month high at 164k lots and the speed of the accumulation, especially the 70% jump during the past two weeks alone carries, will be raising a red flag for tactical trading strategies looking for pay day on short positions should support give way.

Gold extended Friday’s drop below $1850 overnight, before bouncing ahead of key support in the mentioned $1830-35 area. The risk of a quicker withdrawal of Fed stimulus supporting real yields and the dollar has for now reduced gold's ability to build on the technical breakout. Fed expectations and a stronger US dollar might keep a lid kept a lid on further gains for gold prices.

From a technical perspective, spot prices managed to find some support ahead of the $1,834-32 strong horizontal resistance breakpoint. This should now act as a key pivotal point and help determine the next leg of a directional move. A sustained break below would prompt some technical selling and accelerate the fall towards the $1,808-07 region en-route the $1,800 mark.

On the flip side, some follow-through buying beyond the $1,850 level might trigger a short-covering move and push gold towards the $1,865 resistance zone. The next relevant hurdle is pegged near the $1,875-77 area (multi-month highs), above which the XAU/USD could aim to reclaim the $1,900 mark for the first time since June.

As the EUR/USD currency pair hovered around 1.1300 for a fourth straight week, modest gains were posted before the weekend, but no future is apparent. During this time of year, volatility is hit hard by the vacation depression, and the decline towards the end of the year can lead to odd pricing.

The US Federal Reserve and European Central Bank announced their monetary policy decisions last week and released new inflation and growth forecasts. As the markets waited for the release of the results, both central banks responded to the gradual decline in prices, which did not result in any directional movements.

Beginning in January 2022, the Federal Reserve will increase its monthly bond purchases to $ 30 billion from $ 15 billion previously. As a result, the central bank will stop buying government bonds and mortgage-backed securities every month, which means a faster rate hike. The Fed’s scatter chart currently predicts three rate hikes in 2022 and three more in 2023.

Forecasts for 2021 and 2022 have been raised to 5.6% and 2.6%, respectively, from 4.2% and 2.2%. As a result, GDP will grow by 4% in 2022, up from 3.8% in September, while the economy is projected to grow by 0.2% in 2023, up from 2.5 % in September. 

In contrast, the ECB has confirmed that it will complete its pandemic emergency program in March 2022, as expected. Moreover, the governing council decided to increase its bond purchase program to €40 billion per month in the second quarter of 2022 and to €30 billion via PEPP in the third quarter.

Recent macroeconomic data confirmed inflation has reached an overheated level, and economic growth has slowed. The US PPI rose 9.6% year-over-year in November, while retail sales rose a modest 0.3%. Germany’s IFO business climate decreased to 94.7 in December, while the EU CPI rose 2.6% year-over-year. 

Trade accordingly with your risk.

Forward concerns on EU growth have been gathering on the natural gas and power crunch that developed into early autumn and is driving an ugly kind of tightening on the economy before the ECB ever gets around to contemplating a rate lift-off. And now we have the latest wave of Covid concerns, especially in Germany where the case count acceleration has been remarkable, as an additional factor that could hold back confidence and activity. This is all adding to the pressure on the euro after strong US inflation numbers and solid jobs and survey numbers in the US have brought Fed expectations to new highs for the cycle – even if the longer end of the US yield curve remains a conundrum in my book. South of 1.1500 and the trend is the trend, but the pair is getting very cheap at these levels based on traditional fair value calculations.

For this week, the US macro calendar highlights include the first of the regional November US manufacturing surveys, the Empire and Philly Fed surveys on Monday and Thursday, respectively, while the data highlight of the week is perhaps the US Oct. Retail Sales figure on Thursday. But from one moment to next during US waking hours, the overhanging risk for short term volatility will be on President Biden’s Fed Chair nomination announcement, with the algos primed to jump on the Brainard-or-Powell headline, even as it is unlikely that this changes the Fed policy outcomes. I would also like to highlight an intriguing speech up next Friday from Fed Vice Chair Richard Clarida, who is scheduled to speak on Friday on “global monetary policy coordination, cooperation and collaboration” with a Q&A. If this US dollar is set for significant further gains, global central banks will have no choice but to coordinate policy to send it back lower. 

The weekly forecast for the USD/JPY remains mixed as the fundamental scenario is bullish bias, while technically, the retracement seems due after a bull run.
US credit markets and the Federal Reserve System hold USD/JPY hostage. US inflation cannot be contained in the short term unless US Treasury bonds rise. The Federal Reserve does not need to raise interest rates, as the credit market will do all the work
In contrast, the Bank of Japan is moving in the opposite direction. Prime Minister Fumio Kishida has pledged fiscal and monetary policies to stimulate the Japanese economy. A new budget for additional government spending will be proposed, and the Bank of Japan may increase purchases on the credit market. Japanese 10-year government bonds yielded 0.056% last week and 0.051% last week, largely flat.

Despite peaking at 1.764% on March 31, the US government bond yields have risen multiple times this year. The Fed may be willing to encourage higher Treasury and trading rates, but credit traders want proof, not rhetoric, after many false starts. 

Japanese data were mixed. Household spending declined from -1.9% to -0.6% in October, but it remains the third consecutive decline and the fourth over the past six months. In October, the rise in wages was 0.2%, which is within the forecast range of 0.7% and in line with September.  Producer prices rose by 0.6% month-over-month and 9% year-over-year in November, faster-than-expected. Japan is facing a deflationary environment.

Likewise, American data was different. In October, the trade deficit improved, and the number of initial jobless claims fell to 184,000, the lowest level in 52 years. In November, consumer inflation is expected to reach 6.8% in the headline, a 39-year record, and 4.9% in the core, also a three-year record, following 6.2% and 4.6% in October. After a 1.2% CPI increase in November last year, inflation jumped 5.6% last month, the fastest in 69 years.
The US Federal Reserve and Bank of Japan (BOJ), which meet on Wednesday and Thursday, will hold back and order markets. Expect quiet trading after the Fed announces and tightens rates at 2:00 pm ET. US interest rate hikes are almost certainly due to rising consumer prices and concerns expressed by the Fed itself.

Due to the differences in concerns and interest rate policies between the Federal Reserve and the Bank of Japan, the USD/JPY pair is expected to rise. The Fed’s willingness to take inflation seriously will determine how quickly and how far this goes. 

The USD/JPY price fell below the 20-day and 50-day SMAs while the volume is inclining. Such a condition usually forecasts a bearish scenario. On the downside, the 111.80 – 112.00 band may provide strong support amid the 100-day moving average and the round number effect.
On the upside, 114.00 remains a stiff resistance to break ahead of swing highs at 114.75 and 115.50. The path of least resistance lies on the downside. 

Trade accordingly with your risk.

USDCHF slipped below its 200-day moving average yesterday and that the EURCHF pair is now working down into the last bits of its range ahead of the cycle low near 1.0500, where the defense against further CHF strengthening is likely to stiffen significantly from the SNB. Such a persistent move lower suggests either some loss of faith in the real rate outlook for the EU relative to Switzerland or some safe  haven seeking under the radar. 

Trade accordingly with your risk.