By Stephen Innes, Chief Global Market Strategist at Axi,
The US Federal Reserve is doing the darndest to quickly kill off any premature discussion of when tapering might happen. The US dollar continues to get held at bay despite soaring US bond yields that have historically led to US dollar strength.
But US exceptionalism is gradually seeping into the narrative with some dollar bulls thinking that the US is entering a super growth cycle. A view that that was echoed by St. Louis Fed president James Bullard when he said the US rebound has the potential to outpace China.
And while the US dollar remains to trade on an even keel while the equity market rally pauses for breath, February’s breakdown in the relationship between the US dollar and equity markets is already fostering thoughts of a new paradigm for the Forex market.
For me, this seems far too premature of a judgment given the US dollar moves in the opposite or same direction as US equities have been a 50:50 call so far this year.
Multiple themes have emerged in FX markets—USD weakness has become narrower, the Euro is lagging, and Emerging Markets (EM) high yielders are outperforming, thanks to dovish US Fed and investors’ insatiable appetite for yield.
There is lots of dispersion in the macro outlook, so traders and investors alike are preferring the high-quality G-10 commodity currency and risk betas like the Australian and Canadian Dollar.
But the Malaysian ringgit is benefiting from higher commodity prices and could be a shining star in the Asia FX basket if we enter the super commodity cycle some are predicting.
Markets in China will be open again today after the Lunar New year holidays. Fundamentals still support the RMB amid China’ steady economic recovery. Of late the People’s Bank of China (PBOC) has consistently set the daily USDCNY to fix slightly weaker than market expectations trying to take some wind out of the rally sails.
Still, the pushbacks haven’t been aggressive enough to stop the RMB from extending its rally, suggesting that the central bank is not necessarily uncomfortable with a stronger currency. All of which should benefit the regional currency backdrop.
AS for the EURUSD which is always at the centre of discussion, I believe it is mainly a US dollar story. Indeed the Euro has weakened against virtually every currency of late which makes sense given the heavy vaccine divergence, and even the Swiss franc, despite a massive repricing of Italian sovereign risk.
I continue to expect the US Treasury curve to steepen further with 10-year yields going towards 1.50 percent if not 2 percent this year. But even if that happens, as long as the Fed stays on its ultra-dovish message, I think risky assets can keep performing well.
On the FX side, this suggests that carry remains a crucial driver with EURUSD probably remaining in range though with a downside bias through Q1.
As we move back into the “look through” trade environment supported by monetary and fiscal puts, investors are quickly rediscovering that not all growth assets are created equal in a Covid-19 downtrodden economic climate, and the forever fickle FX market is testament to the thesis that nothing goes up in a straight line.