Chris Weston, Head of Research for Pepperstone offers his weekly analysis of what’s brewing in the Forex markets.
Last week we made the case that the fears of a recession have been somewhat over-cooked by the markets, and that sentiment had swung too far into the negative. We noticed that the markets were slowly turning away from inflation-proofing toward a search for growth.
Nevertheless, the shrill calls from economists that the US is hastening towards recession have remained. With the US adding 372,000 new jobs in June, down from the 384,000 jobs added in May, the bears have jumped on this bit of data declaring that the US is in the first throes of a protracted recession.
However, the reality is that the hard data doesn’t support this narrative. The US payrolls report has US Treasury yields rising again, and the Federal Reserve is very likely to raise interest rates by 75 basis point at its 27 July meeting, as the central bank continues to implement its strategy of getting the fed funds rate to 3% by November at the latest.
This has seen US dollar buyers emerge from the woodwork. The EUR:USD trade lost 2.2% last week to touch 1.0072 and the question remains, when will the euro reach parity with the dollar? Notably, the daily candle chart for EUR:USD (or the DXY) is showing some signs of fatigue and when the trade hit 1.0191 on Friday (8th July) with a potential trade of 1.0279 – the prospect of selling the rally looks compelling.
(Source: Trading View)
NASDAQ:CPI timing
The core driver of risk this week is going to be US CPI. The past 12 months have shown the risk of a move towards the consensus position is high (8.8%). Since August 2021 the NASDAQ100 has fallen by an average of 0.7% in the six hours after the CPI drops, except in January. We’re not saying this is going to happen again, but you make your own conclusions on the odds of an 11-out-of-12 run continuing.
Therefore, don’t be surprised to see an 8.9% to 9.0% move, and if that happens US bond yield should continue an upward trajectory, perhaps providing the catalyst to push the USD:JPY trade through the consolidation range of 136.70. Strong indicators from US CPI could also push the AUD:USD trade lower. This is despite the publication of Australian employment data this week, which will only provide momentary volatility, before the Aussie dollar reverts to being a proxy for global growth and sentiment. Chinese data will also be a potential driver of copper and the AUD.
If you really like the Aussie dollar, get away from the US dollar. You are better off trading AUD:CHF, as long as there is an upside break of 0.6700.
What if…?
But what happens if there is a weak CPI print? Well, what’s weak?
I guess we can only say ‘weak’ relative to consensus, but a fall below 8.5% would see bond yields fall and risk a negative response in the US.
That said, cryptocurrencies and gold will find buyers and the NASDAQ 100 will break out as we head into 2Q22 earnings season.
The UK political situation makes fascinating viewing – maybe not from a market’s perspective, with GBP:USD one-week implied volatility at the 57th percentile of the 12-month range. However, the events that shaped Boris Johnston’s exit will long be remembered.
As the week unfolds, we’ll learn more about the candidates who will run for PM. While we may see some traders targeting EUR:GBP as a political play, unless we see a greater risk of a snap general election, or a far bigger fiscal stimulus than the market has as its base case, then sterling should experience limited political variance.
From the outside, it’s hard to see how any of the candidates can turn HMS Great Britain around anytime soon, although, they may be able to galvanise the Tory party, something that is certainly needed, as we begrudgingly trundle towards what could be a miserable winter for the UK.
For FX traders we have central meetings of the Reserve Bank of New Zealand and the Bank of Canada. One week USD:CAD and NZD:USD implied volatilities are higher than other G10 FX pairs but by no means at extremes – position sizing should be modest, but I have limited concerns holding positions over the meetings.
So, we have built a base for risk, but can it follow through? I guess its eyes-on US real rates, the USD, and earnings – which should drive other markets.
This article is not investment advice. Investors should do their own research or consult a professional advisor.
