Forex Traders Weekly Outlook – Pound at 1985 Lows Heading into FOMC, Bank of England and BoJ

Forex Weekly Analysis and Outlook – US Dollar, Euro, Japanese Yen, British Pound, Swiss Franc, Canadian Dollar, Australian Dollar, New Zealand Dollar, Turkish Lira, Mexican Peso. Currency dynamics are complex. There are myriad facets to analyze and contemplate.

Heading into a week saturated with central bank decisions the US dollar continued another week higher over major and minor currencies globally fueled by rising US interest rates. The yen and won fell to fresh historical lows against the dollar with verbal BoK and BoJ intervention did little to slow the selling. China’s yuan, nears the psychological 7 barrier with the PBoC attempting to hold the slide. The pound dropped through $1.14 for the first time since 1985.

To say central bankers, have issues is an understatement. Already grappling with the quickest inflation in decades they now have these decisions to make, forcefully raise borrowing costs to defend currencies and risk hurting growth, spend reserves that took years to build to intervene in foreign exchange markets, or simply stand aside and let the market play out.

Weekly Recap and Outlook

How Foreign Exchange Prices Finished September 16, 2022

  • For the week, the U.S. Dollar Index gained 0.6% this week, traded toward its high from last week in early Friday trade but eventually returned to its flat line at 109.72. (Up 14.7% y-t-d)
  • For the week on the upside, nil
  • On the downside, the Norwegian krone declined 2.6%, the New Zealand dollar 2.0%, the Brazilian real 2.0%, the Australian dollar 1.8%, the Canadian dollar 1.8%, the South African rand 1.7%, the British pound 1.5%, the Swedish krona 1.1%, the Mexican peso 0.7%, the South Korean won 0.6%, the Singapore dollar 0.5%, the Swiss franc 0.4%, the Japanese yen 0.3% and the euro 0.3%. The Chinese (onshore) renminbi declined 0.87% versus the dollar (down 9.03% y-t-d)..
Major and Minor FX Rates

Central Bank Rate Watch:

A big week for central banks:

  • First Tier: Fed FOMC, Bank of England, BoJ
  • Second Tier: PBoC, Norges, SNB, Riksbank, SARB, Brazil, BSP, BI, Turkey

The dollar came back with a vengeance after falling the first few weeks of August. What we focused on in the fundamental backdrop was the selloff in the euro and yen was linked to soaring natural gas prices and the threat that Russian supplies might be cut off altogether hitting big energy importers and machinery exporters, Japan and Germany hard. German gas giant Uniper SE is saw the government come to the rescue with bailout package of over 9 billion euros.

The surge in interest rates and the de-risking of the world is one factor but there are other particular influences. With regards to volatility in currency markets, these huge moves act like rubber bands when its crowded. The more stretched an exchange rate is, the bigger, faster and more painful the eventual correction. What is the catalyst? There is the obvious, a peace deal in Ukraine or a dovish Fed, which after Chairman Powell’s speech at Jakson Hole that appears to need a dramatic change.

“The Federal Open Market Committee’s (FOMC) overarching focus right now is to bring inflation back down to our 2% goal. Price stability is the responsibility of the Federal Reserve and serves as the bedrock of our economy. Without price stability, the economy does not work for anyone.”

“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-trend growth.”

“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.” Jerome Powell’s Jackson Hole speech

. However, it is usually something not expected that creates major shifts

The reality is the recovery from the pandemic is not yet complete and we have the specter of a US recession darkening the scene. The strong dollar adds to the pressure to tighten as weak currencies exacerbate imported inflation.

John Maynard Keynes, 1920: “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction and does it in a manner which not one man in a million is able to diagnose.”

US Yield Watch:

U.S. Treasuries underperformance in shorter tenors with continued speculation about aggressive rate hikes from the Fed, compressed the 2s10s spread by another 15 bps to -40 bps. Two-year Treasury yields surged 17 bps on CPI Tuesday and rose 31 bps for the week to the highest (3.87%) since October 2007. Market expectations for the Fed funds rate at the December 14th FOMC meeting spiked 31 bps this week to 4.19%. Benchmark MBS yields jumped 26 bps to 5.07%, the highest since November 2008.

Yield Watch

  • 2-yr: -2 bps to 3.85% (+28 bps for the week)
  • 3-yr: -6 bps to 3.80% (+18 bps for the week)
  • 5-yr: -5 bps to 3.63% (+18 bps for the week)
  • 10-yr: -1 bp to 3.45% (+13 bps for the week)
  • 30-yr: +4 bps to 3.52% (+6 bps for the week)

Highlights – European Bonds last week

  • Greek 10-year yields were unchanged at 4.26% (up 295bps).
  • Spain’s 10-year yields rose five bps to 2.91% (up 235bps).
  • German bund yields gained six bps to 1.76% (up 193bps).
  • French yields increased four bps to 2.31% (up 211bps).
  • The French to German 10-year bond spread narrowed two to 55 bps.
  • U.K. 10-year gilt yields added four bps to 3.14% (up 217bps).

Highlights – Asian Bonds last week

  • Japanese 10-year “JGB” yields were up slightly to 0.26% (up 19bps y-t-d).

Europe

The Euro’s attempts to rally have disappointed all year and have been impacted by surging inflation. Record-breaking natural gas prices have plunged Europe into a crisis with energy rationing this winter. In Germany, the cost of imports relative to exports has jumped to levels last seen in the 1980s. The weak euro in turn exacerbates a surge in energy costs. The EURUSD has depreciated over 12% since the start of the year and is currently trading below parity.

“We can be gradual, but we should not be slow and delay normalization until higher inflation expectations force us into aggressive interest-rate hikes,” ECB’s Villeroy said Saturday. “What remains essential, however, is to be orderly, in order to avoid undue market volatility and ultimately economic volatility.”

EURUSD recoveries have all lead to failure, the July attempt at a bullish breakout above previous resistance at 1.0270 failed and from there the Euro tumbled. EUR/USD bulls were unable to push the pair meaningfully above the long-term previous-support-turned-resistance level at 1.0350. That comes in from the low set at the start of 2017 and overlaps the 50-day EMA which has defined the downtrend over the last six months within the downtrend channel.

The Euro did finally breach parity in July, if you recall the first attempt recovered off lows earlier this year after Dutch central bank chief Klaas Knot said if inflation continues to climb then rates may need to be raised 50bp, this was the first time such an aggressive shift has been suggested. However, it gave all those gains back. The low just over 1.5% away from reaching parity with the dollar.  It was all the way back in 2002 that the euro and dollar last reached parity. The Euro reversed off the lowest closing rate since 2017 at the outer channel extended gains to above $1.07 before settling back lower again. The short covering rally enabling a reloading of US dollars. From there we got the sharp lows below parity which we are now correcting.

Bloomberg reported Goldman Sachs Group Inc strategists see the euro falling to $0.95 in the event of a deeper and more prolonged cut to gas flows. A prolonged adjustment to the region’s terms-of-trade is not yet in the euro’s price, according to Karen Fishman, strategist at Goldman Sachs. The currency is trading at levels that are in line with the investment bank’s base case scenario of a mild euro-area recession later this year.

The European Central Bank continues to lag behind the Fed in tightening monetary policy, ECB President Christine Lagarde said earlier this month, noting that the euro area’s economy is likely to absorb a greater blow from the war in Ukraine.

In a nutshell the Euro have been undermined by crisis after crisis, the energy crisis is devastating Germany in particular. German reports like trade, GDP and the Ifo business climate underscore who difficult the situation is. The Ukraine war and Russia threats with Nord stream 1 pipeline continue to cruel growth prospects.

Another headwind is the higher energy prices and supply disruptions stemming from the war to depress growth in Europe. Any kind of weakening demand in China for European goods could also weigh heavily on the region.

“The European Central Bank is determined to nip ‘in the bud’ any fragmentation in borrowing costs between eurozone countries, its president Christine Lagarde said…, warning anyone doubting this was ‘making a big mistake’. Appearing before EU lawmakers in Brussels, Lagarde defended the ECB’s decision, made at an emergency meeting last week, to accelerate work on a new policy tool to counter a recent surge in the borrowing costs of more vulnerable countries. ‘You have to kill it in the bud,’ the ECB president said… ‘Fragmentation will be addressed if the risk of it arises; and it will be done so with the appropriate instruments, with the adequate flexibility; it will be effective; it will be proportionate; it will be within our mandate and anybody who doubts that determination will be making a big mistake.’”

June 20 – Financial Times (Martin Arnold)

Euro – EURUSD

For the week EURUSD closed up 0.93%

The Euro back tested the 1/8 after its first sweep of parity with the sharp selloff fueled reversal off last month’s correction off the Tenkan which was fast and furious to the lowest closing rate since 2017 spitting the outer channel. Euro continues to cascade in what seems like eternal flags in the channel as it spits the Tenkan. We watch if Kijun (pink) reflecting Tenkan (orange) creates any impulse as EURUSD develops in the channel. Watch 3 waves to see development for continuation. Again, governed by EURGBP and Bund volatility

British Pound – GBPUSD

For the week GBPUSD closed up 0.59%

PM Truss wasted no time in addressing the energy crisis, she announced that a fracking ban will be lifted and that household energy bills will be limited to GBP2,500 per annum for the next two years. UKs Government regulator OFGEM last week announced the typical household energy bill will see an 80% increase from the current energy price cap to GBP3,549.

Germany also announced energy subsidies for households and businesses, though Germany’s economy minister said that subsidies can’t continue forever.

Cable parity is now doing the rounds, with the British Chambers of Commerce forecasts the UK is already in a recession with inflation to hit 14% later in the year.

It is still hectic for Sterling. Above we have channel and Tenkan confluence and sliding Kijun. GBPUSD reversed after 1985 lows and spat the fib extension 1.618 level around the 1.1432. British pound continues to have difficulty since it’s vicious move down in July that reversed to unchanged by the end of the month. Cable lost all of the steam from its biggest weekly gain since December 2020 against the dollar to above $1.26 to be smashed to the bottom channel under -1/8 and 1.1500 after retesting the channel and Tenkan.

Euro Pound – EURGBP

For the week EURGBP closed up 0.16%

EURGBP had been in the doldrums since it back tested 50wma and cloud which broke and advanced significantly this week to the top of the channel and immediate level of resistance at 0.8670. EURGBP support under Kijun with Tenkan.

Asia

The yen has been the worst performing major currency in 2022, sliding against the US dollar though it has corrected some in recent weeks. Relative to a basket of trading partner currencies and adjusted for inflation, the yen fell to levels last seen before the 1985 Plaza Accord.

Asian currencies have had a dismal year. The Japanese Yen and South Korean won have been falling sharply lower in 2022. The won has weakened more than 8% this year, following an 8.6% drop in 2021, which was the fastest annual fall since 2008. The Won fell below the much talked about psychological threshold of 1,300 per U.S. dollar for the first time in 13 years

Also factor in that Asia is the epicenter of technology manufacturing – with the global “tech” Bubble in grave jeopardy. The confluence of China’s bursting Bubble, Japan’s foolhardy monetary policy gambit, and highly levered systems puts Asia today on a Collision Course with rapidly deteriorating macro and micro fundamentals. I’ll assume mounting hedge fund and derivative issues.

Japanese Yen – USDJPY

For the week USDJPY closed down 0.88%

The yen has seen some recent strength after a trifecta of sell-the-yen trade have come in. We have seen a reversal in the widening US-Japan interest-rate gap, soaring oil prices and the loss of the currency’s safe haven status. Growing recessionary fears and lower than expected inflation, though still near record levels, keep a cap on yields, and pressured oil prices. We have also seen investors back into traditional safe assets, gold and the yen. Dollar-yen, which soared 38% from a March 2020 trough to mid-July this year, is in retreat. For how long, or was that the peak?

The yen on track for its worst year on record falling to 144.99 per dollar, a 24 year low, fueled by the selloff in Treasuries widening the yield gap between the US and Japan.

The BoJ has said Japan’s cyclical position with low core inflation and a more limited rebound in economic output warrants an easier monetary policy stance compared with its G10 peers. A strengthening dollar also tends to weigh heavily on emerging markets currencies, a rising dollar makes dollar-denominated debt more expensive for emerging nations to repay. The Bank of Japan chief Kuroda speaking at the G7 said BOJ will patiently continue with powerful easing announcing no change to monetary policy.

A former top Japanese currency official said that the yen could weaken to 150 per dollar due to a deepening divergence in monetary policy. Veteran economist Jim O’Neill said “The yen’s slide may spark turmoil on the scale of the 1997 Asian Financial Crisis if it declines as far as 150 per dollar”

The USDJPY pushed to a new high at levels last seen in 1998. Prices confirmed a breakout above 139.391, the previous 2022 peak from July. This move was fueled after it corrected to the weekly Tenkan at 125.88 which held and fueled a swift return higher and has rallied dramatically. USDJPY traded to 144.99 above the 78.6% Fibonacci extension at 140.636 and 100% level at 143.425. Above here is the 1998 peak at 147.65. Key support is the Tenkan and 8/8.

On the way up the price accelerated after the close above the Tenkan over 114 hence the pull for it to correct to the Tenkan which it did to ignite this rally a month ago. The Murrey Math level should remain massive support for dollar-yen. Any change will come from the weekly Kijun as it breaks through the old channel.

Use your USDJPY Murrey grid for now. EURJPY AUDJPY will determine risk on/off. The Tenkan is the natural balance of support ahead.

The Bank of Japan reinforced its commitment to low interest rates despite the rising inflation. The BoJ said it would purchase 10-year Japanese government bonds at a yield of 0.25% every business day to ensure that the yield doesn’t exceed that level. That sent the yen weakening to more than 130 to the dollar for the first time since April 2002.

Yen weakness places Chinese manufactures at a competitive disadvantage, which has emboldened Beijing to play the currency devaluation card in an attempt to mitigate mounting economic woes and dumping of Chinese assets. Higher-yielding Chinese debt securities are losing their relative appeal (in a rising yield world), and now even the perceived stability of the Chinese currency is in question.

A slump of that to 150 may convince China to intervene in the currency market to protect its own flagging economy and it would be perfectly rational for it to do so, former Chief currency economist at Goldman Sachs Jim O’Neill said:

‘If the yen keeps weakening, China will see this as unfair competitive advantage so the parallels to the Asian Financial Crisis are perfectly obviously,’ ‘China would not want this devaluing of currencies to threaten their economy.’”

China

  • USD/CNY is the onshore yuan and is permitted to trade plus or minus 2% from the daily reference rate.
  • CNH is the offshore yuan. USD/CNH has no restrictions on its trading range.
  • A significantly stronger or weaker rate than expected is typically considered a signal from the PBOC.
  • The IMF lifted the yuan’s weighting in its Special Drawing Rights currency basket in May

For the week USDCNH closed up 0.26%

Yuan weakness continued with the dollar’s rally gathering pace in the fallout from Jackson Hole. China’s Yuan, Japanese Yen and the Euro have seen significant moves given their geopolitical dynamics. The Yuan slipped to a two-year low of 6.923 Monday and ended August with a decline of 2.2%, a sixth month of losses with its real estate crisis overhanging.

Last Tuesday morning, the PBoC set the midpoint fix at more than 6.85 yuan to the dollar. It is likely to depreciate further as the country’s central bank moves to combat a slowing economy and a deep housing downturn. China took steps to support the weakening yuan Thursday, after hitting fresh two-year low. The People’s Bank of China set its yuan reference rate at a stronger-than-expected level for the managed currency. The move signaled the PBoC wants to slow the pace of yuan depreciation..

The latest selloff in the yuan, or the renminbi accelerated as the U.S. dollar marched higher. Recent data releases also show China’s economy in rude health. Factory output, investment, consumer spending and youth employment numbers in July all pointed to broad economic weakness. China’s economy contracted by 2.6% in the April-to-June quarter from the first quarter of the year, official data released last month showed.

The yuan is set to slide past 7 per dollar with scarcely a murmur as a range of metrics show the currency would still be relatively expensive against its non-dollar peers, analysts say. The authorities will allow the currency to weaken past that key psychological barrier and merely seek to prevent a rapid decline that may cascade into a disorderly selloff, according to Societe Generale SA and Barclays Plc, among others. 

“I don’t think the People’s Bank of China aims to defend seven,” said Wei Yao, chief China economist at Societe Generale in Hong Kong. “It’s the speed that matters. The yuan will still be expensive even after dollar-renminbi breaches seven,” she said,

Bloomberg Sep 1

During July the PBOC cut the 5-year loan prime rate to 4.45% from 4.6% to boost the economy and cut short term rates further this past week. Beijing has warned against criticism of its dynamic zero-COVID policy. The zero-tolerance approach, which depends on strictest lockdowns and mass testing, has weighed heavily on the already slowing economy and raised the need for further policy easing.

On Aug. 19, the central bank also signaled its preference for a weaker yuan by setting its daily midpoint fix for onshore trading at more than 6.80 against the dollar. This was the first time it had crossed that level in 23 months. The PBOC allows the currency to trade within a daily range of 2% up or down against the dollar from its target level. The market is asking where the upper band is now?

The forward margin between the Yuan and the USD has widened as the PBoC’s rate cuts have been made it less attractive to hold the yuan against the dollar because the U.S. Federal Reserve has gone in the opposite direction.

 April 28 – Bloomberg (Sofia Horta e Costa and Tania Chen): “When China’s tightly managed currency depreciates dramatically against the dollar, it can be hard to stop. More than six years after China’s shock 2015 devaluation roiled global markets and spurred an estimated $1 trillion in capital flight, the yuan is weakening at a similar pace. Onshore it’s lost nearly 4% in eight days, while the offshore rate is heading for its worst month relative to the greenback in history. Selling momentum is the strongest since the height of Donald Trump’s trade war in 2018.”

China Foreign Exchange Trading System

While the yuan has tumbled about 8% versus the USD this year, it has strengthened against the currencies of major China’s export rivals such as Japan and South Korea. The yuan’s trade-weighted basket is just about where it was at the end of December.

China Foreign Exchange Trading System August 2022

The Fed’s tightening cycle has triggered a widespread selloff in Asian currencies this year, including more than 10% declines for the Japanese yen and the Korean won. China’s central bank last let the yuan depreciate past 7 to the dollar in August 2019, during the trade war between Beijing and Washington.

The yuan however has held up better against other currencies this year. China Foreign Exchange Trading System, an arm of the central bank, measures the performance of the currency against a basket of 24 currencies, including the dollar, yen and euro and lesser-traded currencies such as Polish zloty and Russian ruble the WSJ reported. That yuan index was roughly at the same level it was at the start of 2022, according to the most recent data published on Aug. 19.

Australian Dollar – AUDUSD

For the week AUDUSD closed up 0.43%

The Aussie dollar reversed off an eight-week high, trading over US71¢ with the revitalized hawkish Fed. The Reserve Bank of Australia has hammered on stagnant wage growth as a problem within the Australian economy. In June, the government raised the minimum wage by 5.2%. Keep an eye on the effect on bonds and the dollar here.

To reflect potential upside, we look at the way down AUDUSD with cloud, Kijun and channel confluence over $0.7250 it reversed lower to 4/8 just over .66. This week we closed under the Tenkan around the channel midpoint. Since completing a 5 at the psychological 80 level it had fallen & corrected under the weekly cloud in emotive fashion

China lockdown fears overhang and AUDUSD forwards support with bonds and RBA raising. Support is the Murrey Math Levels. Resistance the Cloud and Kijun like many commodities. It was the strongest major currency against the USD in July after the Yen correction and has continued in that fashion.

New Zealand Dollar – NZDUSD

For the week NZDUSD closed up 0.25%

The Kiwi outran the Aussie lower this week after it mirrored the AUD spitting the lower channel wing to recover through Tenkan after momentum failed and reversed from there. NZD/USD threatens the yearly low (0.6061) after failing to test the June high (0.6576), and the exchange rate appears to be tracking the negative slope amid the string of failed attempts to push back to the Kijun resistance. We closed back at 1/8 and well under the old 61.8% break. The RBNZ Policy Announcement has had 7 consecutive rate hikes which has been supporting the forwards.

Canadian Dollar – USDCAD

For the week USDCAD closed down 0.81%

The USDCAD popped through 1.3000 on the hawkish Powell comments, while the liquidity zone below 1.3100 could limit upside price action. The high of 1.3223 on July 15 is back in focus. That was the highest level since November 2020. It has recaptured the Tenkan led by the AUD and NZD as it spat the weekly flat-topped triangle. Watch flat Kijun and Tenkan. Use Fibs for support and resistance. Eyes are on Canadian CPI, the recent decline in energy prices should help alleviate some of the broader pricing pressures. The BoC have been quiet since their 100bp hike in July after it was accompanied with the removal of language about acting in a “forceful” manner, but it did signal rate hikes are to continue with the path being decided by its ongoing assessment of the economy and inflation.

Emerging Market Currencies

Key EM currencies suffered additional losses this week. The South African rand declined 2.4%, the South Korean won 2.3%, the Brazilian real 2.1%, the Thai baht 1.9%, and the Colombian peso 1.8%.

Since the depths of July, we saw a dramatic squeeze. Emerging and developing nations’ foreign reserves have shrunk by $379 billion this year through June, according to data from the International Monetary Fund. Excluding the effects of exchange-rate fluctuations and the large foreign-exchange holdings of China and Gulf oil exporters, emerging markets are seeing the biggest drawdowns since 2008 according to JPMorgan Chase & Co.

The Run-on EM markets is unleashing a dangerous dynamic. When global liquidity flows abundantly, financial flows originating from U.S. trade deficits and leveraged speculation often find their way into higher-yielding EM securities. These flows end up at EM central banks, where they are conveniently “recycled” back into U.S. markets through (chiefly) purchases of Treasuries, agencies and other debt securities.

EM tightening cycle fragility (aka “taper tantrum”) is not a new phenomenon. This is, however, the first episode of highly levered (securities markets and real economies) EM systems facing global de-risking/deleveraging without a clear Fed and central banking community “put.” With the global liquidity backstop now nebulous, there is every reason for the leveraged speculators to move more aggressively in exiting levered EM “carry trades.” And resulting outflows lead to only weaker currencies, more EM central bank Treasury (and sovereign debt) sales, and greater stress on global financial stability.

Mexican Peso USDMXN

For the week USDMXN closed down 0.39%

The Mexican Peso held its triple bottom to rally back to the Tenkan as rates rose in the US. It continues in the long sideways pattern and consolidates despite outside uncertainty from oil and high rates. The recent high near 19.5 per USD was the highest level since March of 2020 and tracked general strength in Latin American currencies which has since reversed. Use the Gann octave and the extension fibs to help measure the noise.

Turkish Lire USDTRY

For the week USDTRY closed up 0.23%

The Turkish Lira slow decline continues as it rides the median in the corrective channel tier spitting 17 against the dollar. We are still in spitting distance of that all-time low of 18.4 hit in December. The Turkish Central Bank last cut its Weekly Repo Rate to 13.00% at its meeting. Turkey’s recent monetary policy decisions have not been based on economic fundamentals, with since late 2021 seeing a cumulative 600bps cut in rates in a matter of months to current levels.

The background is the same with President Recep Tayyip Erdoğan vowing to cut interest rates despite spiraling inflation. In December last year, the Turkish Central Bank introduced a “Lira deposit scheme” to stem the decline in the currency. The Turkish president said that the country had ‘wasted years’ with the misguided view that prices should be controlled by using higher borrowing costs to suppress consumption. Such policies, he said, benefited only ‘those living a charmed existence and filling their pockets with [the proceeds of] high interest’, including foreign investors.”

To recap the wild 18-10 USDTRY swing last year reversed after falling in 3 waves to explode over the Tenkan, weekly cloud Kijun and 50wma below. The Murrey Math and Fib targets with last year’s Lire all-time lows in a hyper inflating collapse. So far this year the lira is the worst performer in emerging markets, raising concerns that the country could be heading for a repeat of the FX crisis seen at the end of last year.

Watch Central Banker and Geopolitics speeches, reports and rate moves. 

Sources: TC WSJ

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