Forex Weekly Outlook – Inflation Adding More Pressure on Euro and Pound

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.

The widening interest rate differential between the U.S. and Europe and the UK is adding pressure on the Euro and Pound which in turn is adding to inflation pressures thereto. 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. UK has the same issue, Government regulator OFGEM announced the typical household energy bill will see an 80% increase from the current energy price cap to GBP3,549. GBPUSD looks vulnerable below the recent 1.1718 low.

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 August 26. 2022

  • For the week, the U.S. Dollar Index hit a one-week low in early trade Friday, but bounced as the day went on, rising 0.3% to 108.79. The Index gained 0.7% this week. (up 13.7% y-t-d)
  • For the week on the upside, the Brazilian real increased 2.1%, the South African rand 0.7%, the Mexican peso 0.7%, the Norwegian krone 0.6% and the Australian dollar 0.3%.
  • On the downside,  the New Zealand dollar declined 0.9%, the British pound 0.7%, the euro 0.7%, the Swiss franc 0.7%, the Swedish krona 0.7%, the Japanese yen 0.5%, the South Korean won 0.4%, the Canadian dollar 0.3% and the Singapore dollar 0.1%. The Chinese (onshore) renminbi declined 0.79% versus the dollar (down 7.50% y-t-d).
Major and Minor FX Rates

Central Bank Rates Moves During July:

The following Banks didn’t meet in July but raised late June:

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 ended the week mixed note with the long bond a modest gain while shorter tenors finished lower. This week’s underperformance in shorter tenors compressed the 2s10s spread by ten basis points to -36 bps.

Yield Watch

  • 2-yr: +1 bp to 3.40% (+15 bps for the week)
  • 3-yr: +4 bps to 3.40% (+10 bps for the week)
  • 5-yr: +4 bps to 3.20% (+8 bps for the week)
  • 10-yr: +1 bp to 3.04% (+5 bps for the week)
  • 30-yr: -3 bps to 3.21% (-2 bps for the week)

Highlights – European Bonds last week

  • Greek 10-year yields surged 27 bps to 3.96% (up 264bps).
  • Spain’s 10-year yields rose 21 bps to 2.59% (up 203bps).
  • German bund yields gained 16 bps to 1.39% (up 157bps).
  • French yields jumped 21 bps to 2.02% (up 182bps).
  • The French to German 10-year bond spread widened five to 63 bps.
  • U.K. 10-year gilt yields rose 19 bps to 2.60% (up 163bps).

Highlights – Asian Bonds last week

  • Japanese 10-year “JGB” yields increased two bps to 0.22% (up 15bps y-t-d).

Europe

The Euro’s attempts to rally have disappointed all year and have been impacted by surging inflation. EURUSD’s 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.

“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.”

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.

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 down 0.75%

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 down 0.77%

It is still hectic for Sterling; it is down to a new leader between Rishi Sukan and Liz Truss with Truss the favorite. GBPUSD structure leaves the recent 1.1718 low vulnerable. 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 1.1800 after retesting the channel and Tenkan. It is still undermined by political risk and recession fears. Above we have channel and Tenkan confluence and flattening Kijun. The upcoming week will be heavy on UK data, which could mean an eventful week for the British pound.

Euro Pound – EURGBP

For the week EURGBP closed up 0.22%

EURGBP has been in the doldrums since it back tested 50wma after breaking it early. 50wma and cloud proved too much and EURGBP failed under Kijun support with Tenkan resistance. The EUR/GBP gave up control.

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 up 0.53%

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 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”

Last month USDJPY corrected to the weekly Tenkan at 125.88 which held and fueled a swift return higher and has rallied dramatically. Dollar yen accelerated higher moving above the May high of 131.342 which was 20-year highs for the USDJPY. It didn’t let up with Murray Math Weekly levels recalculating higher. USDJPY closed at 135.75 last month, traded to almost 140 where it spat 8/8 and reversed lower, it is trading at 133.32 today. The last two trading days of the month saw the reversal from positive to negative and traded at the low for the month on the last day of the month to close at the weekly Tenkan.

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 0.65%

Yuan weakness continued with its real estate crisis overhanging, dropping to its weakest level against the U.S. dollar in two years. On Tuesday, the onshore yuan traded over 6.86 to the dollar at levels last seen in August 2020. The currency weakened past 6.88 in the offshore market, taking its year-to-date decline against the dollar to more than 8%.

On 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.

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

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 down 0.22%

The Aussie dollar has 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%. This week, the Federal government will host a jobs summit and a number of parties have already started media campaigns to push the case for further significant wage increases. 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 down 0.6%

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. Kijun resistance, which is pivotal is a long way off. We closed back over 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 up 0.3%

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

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.

After beginning the year at 295 bps, U.S. high-yield CDS surged to a June 16th high of 598 bps. HY CDS sank 43 this week to 421 bps, now down 177 bps from June highs. The iShares High Yield Corporate Bond ETF (HYG) has rallied 8.2% off June lows.

During July we saw the EM CDS index trade up to 395 bps (up 50bps w-t-d), the high back to April 3, 2020, before easing back. EM CDS hadn’t had a weekly 50 bps jump since September 2020.

De-risking/deleveraging has turned more systemic throughout the global “Periphery.”

  • Indonesia CDS jumped 20 mid-month week to 165 bps, the high since May 2020.
  • Vietnam rose 21 bps to 188 bps (July ’20),
  • Philippines 18 to 148 bps (March ’20),
  • Malaysia nine to 112 bps (May ’20),
  • India seven to 175 bps (May ’20),
  • Thailand six to 73 bps (April ’20)
  • South Korea six to 54 bps.
  • Hungary CDS surged 48 (to 230bps)
  • Romania 39 (to 347bps).
  • South Africa CDS surged 31 to 369 bps (high since May 2020)
  • Turkey CDS 13 surged to an almost 20-year high 883 bps.

“Frontier” markets appear to suffer acute illiquidity.

  • Mongolia CDS surged 161 to 604 bps (high August ’20),
  • Egypt 344 (to 1,507 bps),
  • Kenya 269 (1,417 bps),
  • Iraq 131 (798 bps),
  • Namibia 126 (728 bps),
  • Argentina 274 (1,947 bps),
  • Nicaragua 91 (695 bps).
  • Colombia CDS surged 45 (332 bps),
  • Brazil 37 (331 bps),
  • Costa Rica 31 (335 bps),
  • Uruguay 30 (167 bps),
  • Peru 29 (158 bps),
  • Guatemala 25 (332 bps),
  • Panama 25 (158 bps),
  • Chile 25 (141 bps),
  • Mexico 18 (196 bps).

June losses for emerging market currencies were dramatic:

  • Chilean peso dropped 10.3%,
  • Brazilian real 10.0%,
  • Colombian peso 9.2%,
  • Polish zloty 4.8%,
  • South Korean won 4.7%,
  • Philippine peso 4.7%,
  • Argentine peso 4.0%,
  • South African rand 3.9%.

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.

Ominously, CDS prices surged that mid-month USD surge in the Philippines (53bps), Indonesia (38bps), Malaysia (38bps), and India (19bps) – trading to highs since 2020. So-called “frontier” markets are at great risk. This week’s CDS spikes included Ethiopia (588bps), Angola (136bps), Pakistan (125bps), Mongolia (96bps), El Salvador (264bps), Iraq (90bps) and Senegal (80bps) – to name a few.

Mexican Peso USDMXN

For the week USDMXN closed down 0.67%

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 0.52%

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 is expected to maintain its Weekly Repo Rate at 14.00% at its upcoming meeting. Turkey’s recent monetary policy decisions have not been based on economic fundamentals, with late 2021 seeing a cumulative 500bps 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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