The USD has found its mojo and rallied for eight straight days – its longest run of gains since 2016.
The catalyst for this is premised on the idea we're seeing signs of economic, and when the US is performing fairly well, while the rest of the developed world is falling away, we get a re-run of 2018: with the dollar benefiting from economic divergence, and with global savings and capital flows favouring the U.S. as a preferred investment destination. Today's news that House and Senate negotiators have reached an ’agreement in principle’ on border security funding to avert a shutdown is a USD positive, although this outcome was expected.
The idea of economic divergence was the crux of my 2019 thesis for owning gold, where I looked at the precious metal as an alternative currency and one that will be the best house in the neighbourhood through 2019. Gold is working well in AUD (XAU/AUD on MT5) and in EUR terms (XAU/EUR), but with the greenback strong, gold in USD terms is consolidating.
U.S. CPI is important
All eyes now fall on tomorrow's U.S. core CPI (January) print, with calls for 0.2% MoM, which is in-line with the 12-month average. The outcome of this data point will not just influence the dollar, but will potentially have an impact on equities too. Markets quite like the current environment of inflation being ‘not too hot, not too cool’, so a print around 0.2% keeps the gravy train on track.
One interesting point, which is supporting the dollar, outside of the economic divergence theme I mention above, is that of changes in the Fed’s balance sheet. Pantheon Economics noted that the changes in excess reserves (held at Fed banks) relative to the total balance sheet of assets is the equivalent to up to 40bp of additional tightening of the Fed funds rate. This is supporting the USD, but this dynamic will change, and I will explore this in greater depth soon, where I expect a punchy announcement on the future size of the balance sheet between the March to May FOMC meeting.
EUR/USD
There has been good focus on the weaker EUR/USD, which is reflected in the stronger USD (EUR holds a close to 60% of the weight on the USD basket). EUR/USD has closed through the 24 January swing low and hit my 1.1300 target from last week, and now we see price hugging the lower Bollinger band. The lower band, in itself, is widening, showing increased realised volatility, with the price holding the 5-day EMA.
Italy is a concern again, and I guess I’ll be saying that on numerous occasions this year, but comments from Mario Centeno (The Eurogroup President) have suggested the Italian budget could come back on the radar in the period ahead. Recall, rating agency Fitch is also due to hand down a review on Italy’s credit rating on 22 February where they have them on negative outlook. Should Italy get the rating chop, the yield premium over German bunds will move higher again, putting downside pressure on EUR/USD.
One to watch, and certainly the last thing the EUR needs right now is shaky politics at a time of economic fragility.
AUD/USD moves
Through trade today we saw the biggest decline in home loan data since 2015, driven by a big decline in occupier loans. This is data from December and in the rearview mirror. However, a rebound in business conditions offset the fall in housing loans is supporting the AUD, helped by slight positive feel to Asian trade, with S&P 500 futures pushing higher on the shutdown news. Aussie 3-year bonds are up 4bp, while rates pricing is largely unchanged.
One correlation I am looking at is that of AUD/USD (yellow and inverted) and USD/CNH (white). Here, we see as USD/CNH finding buyers of late, with AUD/USD working lower with a strong relationship. USD/CNH requires close attention ahead of this week's high-level meeting in Beijing on trade.
Brexit is a thing again
GBP/USD is back firmly on the radar, not just because of further poor economics (Q4 GDP printed 0.2% QoQ) in the U.K. data flow, but because the odds (Source: Oddschecker) of a no-deal Brexit have increased to 36%, up from 11% last week. I have highlighted the no-deal Brexit betting odds (white) vs GBP/USD (yellow) on the Bloomberg chart.
We should hear more tonight from Theresa May, when she will update the Commons on progress on Brexit. There won’t be any progress though, and the greater focus is on whether we actually get another amended Meaningful vote this week, with the Telegraph reporting it is likely to be held on Feb. 25. Either way, May is cutting it fine and taking this closer to the brink.
