FX Update: US CPI reaction: follow through after the kneejerk?
Summary: The US October CPI data came in far hotter than expected at new multi-decade highs, jolting markets across the board as Fed rate hike expectations were brought forward. The US dollar strengthened across the board, and so did gold as real yields plunged on the market figuring that the Fed will remain behind the curve on inflationary risks. On that note, will the initial move higher in the US dollar eventually prove a red herring?
FX Trading focus: The proof in the USD kneejerk rally will be in the follow-through
A couple of things make me uncomfortable with the idea that the USD move can extend much higher from here – at least on the notion that the Fed will ever get serious on the hawkish side relative to other central banks. First, while further hot inflationary prints can yet get the Fed to shift its guidance for a faster taper pace already at the December 15 FOMC meeting (we get the November jobs and CPI report and the October PCE inflation data before then) the Fed is unlikely to “get ahead” of inflation and is instead more likely to stay behind the curve, certainly relative to other central banks that are moving more rapidly to address rising inflation risks, even if the ECB and BoJ will always try to lag, but have the tailwind of current account surpluses.
Rather, any further move higher in the US dollar in the near term would far more likely be down to reduced liquidity and weak risk sentiment in global markets rather than a accelerated pace of Fed tightening. The still low yields at the long end of the US yield curve (despite yesterday’s chunky move in the wake of the very bad 30-year T-bond auction and the prior day’s weak 10-year auction) do indeed suggest that something is amiss with the US Treasury market. Are these low yields really a rational assessment of concerns that the forward growth outlook is dire, with near term inflationary outcomes eventually leading to a sharp tightening that kills growth? Or are they simply a reflection of poor liquidity and dysfunction in the world’s most important financial asset – US treasuries? Indeed, Bloomberg ran an article on this very topic in late October (linked to wild volatility at the short end of the curve) and I found a small update on the Bloomberg platform this morning that their measure of liquidity in the bond market is the worst for the cycle. Would not a more aggressive tapering of QE help to ease the liquidity concerns and help improve liquidity and are the odd developments in the US yield curve of late perhaps linked to massive macro bets on yield curve steepening gone awry?
Bottom line: The “Fed catching up” narrative doesn’t work for me as a driver of notable further USD strength, and further USD strength from here for any reason, including the possible one noted above, rapidly becomes destructive and something that must be addressed – via a Plaza Accord-type arrangement if the Fed can’t restrain the USD from strengthening – although we’re not quite at that pain level any time soon.
As noted in this morning’s Saxo Market Call podcast, the most interesting move yesterday was in the gold price, which soared through resistance despite longer yields rising yesterday, as inflation fears accelerate more rapidly, dragging real rates lower – that is an interesting macro signal, to the say the least, and the JPY weakening despite the sharply lower US real yields is likewise interesting if it can be sustained. Worth noting yesterday that the Kishida government announcing plans to offer cash stimulus for lower-income households to the tune of JPY 100k (just under $900) in a plan that will cost “tens of trillions of JPY”. JPY 10 trillion is about $88 billion, or about 1.8% of Japan’s GDP.
Chart: EURUSD
EURUSD dumped through the lows and through the psychologically significant 1.1500 level all in one swoop yesterday as hot US inflation data made its mark. The next level of import is the 1.1290 area, the 61.8% retracement of the rally from the post-pandemic lows as the US dollar is now in a new rally phase until proven otherwise with this move. Of course, a rapid reassessment of the break and rally back above 1.1550 or so is all that it takes to reject this latest development.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
FX Trading focus: The proof in the USD kneejerk rally will be in the follow-through
A couple of things make me uncomfortable with the idea that the USD move can extend much higher from here – at least on the notion that the Fed will ever get serious on the hawkish side relative to other central banks. First, while further hot inflationary prints can yet get the Fed to shift its guidance for a faster taper pace already at the December 15 FOMC meeting (we get the November jobs and CPI report and the October PCE inflation data before then) the Fed is unlikely to “get ahead” of inflation and is instead more likely to stay behind the curve, certainly relative to other central banks that are moving more rapidly to address rising inflation risks, even if the ECB and BoJ will always try to lag, but have the tailwind of current account surpluses.
Rather, any further move higher in the US dollar in the near term would far more likely be down to reduced liquidity and weak risk sentiment in global markets rather than a accelerated pace of Fed tightening. The still low yields at the long end of the US yield curve (despite yesterday’s chunky move in the wake of the very bad 30-year T-bond auction and the prior day’s weak 10-year auction) do indeed suggest that something is amiss with the US Treasury market. Are these low yields really a rational assessment of concerns that the forward growth outlook is dire, with near term inflationary outcomes eventually leading to a sharp tightening that kills growth? Or are they simply a reflection of poor liquidity and dysfunction in the world’s most important financial asset – US treasuries? Indeed, Bloomberg ran an article on this very topic in late October (linked to wild volatility at the short end of the curve) and I found a small update on the Bloomberg platform this morning that their measure of liquidity in the bond market is the worst for the cycle. Would not a more aggressive tapering of QE help to ease the liquidity concerns and help improve liquidity and are the odd developments in the US yield curve of late perhaps linked to massive macro bets on yield curve steepening gone awry?
Bottom line: The “Fed catching up” narrative doesn’t work for me as a driver of notable further USD strength, and further USD strength from here for any reason, including the possible one noted above, rapidly becomes destructive and something that must be addressed – via a Plaza Accord-type arrangement if the Fed can’t restrain the USD from strengthening – although we’re not quite at that pain level any time soon.
As noted in this morning’s Saxo Market Call podcast, the most interesting move yesterday was in the gold price, which soared through resistance despite longer yields rising yesterday, as inflation fears accelerate more rapidly, dragging real rates lower – that is an interesting macro signal, to the say the least, and the JPY weakening despite the sharply lower US real yields is likewise interesting if it can be sustained. Worth noting yesterday that the Kishida government announcing plans to offer cash stimulus for lower-income households to the tune of JPY 100k (just under $900) in a plan that will cost “tens of trillions of JPY”. JPY 10 trillion is about $88 billion, or about 1.8% of Japan’s GDP.
Chart: EURUSD
EURUSD dumped through the lows and through the psychologically significant 1.1500 level all in one swoop yesterday as hot US inflation data made its mark. The next level of import is the 1.1290 area, the 61.8% retracement of the rally from the post-pandemic lows as the US dollar is now in a new rally phase until proven otherwise with this move. Of course, a rapid reassessment of the break and rally back above 1.1550 or so is all that it takes to reject this latest development.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
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