Currency Market Cautiousness Vs Mild Stock Market Optimism

The US dollar renewed three-month highs against a basket of major currencies last night, but its advance came to a halt after the publication of FOMC minutes.

The minutes note that the Fed is ready to begin discussions on winding down emergency measures at its upcoming meetings. Some representatives also stated that several indicators favour an earlier start to the unwinding than before.

Interestingly, with the FOMC comments reasonably bullish for the dollar, we saw markets "selling the facts", i.e. intensifying dollar selling. Elsewhere, the US S&P 500 managed to gain support on the intraday decline and close at all-time highs.

Taking a step back, however, the broader picture is by no means so optimistic. The daily charts of the currency and commodity markets show persistent bear pressure, indicating a potential trend reversal.

The USD/JPY maintains a downtrend despite the positive equity market dynamics, which indicates the demand for defensive low-yielding assets. This is also evidenced by an active sell-off in high-yielding EM currencies and the Canadian and Australian dollars, with AUD/USD now at 8-month lows. Like earlier this week, the main interest in the dollar forms at the start of the US session, suggesting a push to the safe-heavens in the debt markets.

Thus, the market is in a relatively contradictory situation with positive stock market trends and wariness on the debt and currency markets. The stock market is now full of small retail investors, which is why we believe the dynamics in debt and FX are most illustrative.

Retail investors should be wary that the big players in global markets are already closing the reflationary trade, selling stocks gently on the upside, as they bet that the peak of the recovery has passed.

A persistent strengthening of the dollar sooner rather than later could pull the stock market reversal triggering a correction. This is especially true when one considers that retail investors are being cut back on external support (unemployment programmes are being wound down, and no new cheques are being paid) and that inflation and softening lockdowns are bringing back the relevance of spending on many services and commodities.

The RSI index on the daily charts of the NASDAQ 100 was at its highs since last August yesterday, marking an impressive local overbought situation. In this environment, short-term buyers of equities may find it more advantageous to watch from the sidelines for a couple of days and not rush to buy out intraday drawdowns.

The FxPro Analyst Team