Trade idea – The USD is king, but grossly overbought

There is little doubt the USD is in a purple patch and having a fantastic run. Short positions have been squeezed and traders have ramped up their exposure in a massive way.

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Source: Bloomberg

What we have seen in almost every USD pair has been an incredible move. I still can’t get past USD/JPY rallying from ¥101.93 during the pandemonium that ensued when it first looked like Trump could win the election. USD/JPY is now just above ¥110.00 and grossly overbought, and as a result I would advocate buying pullbacks into ¥107.50-¥108.00.

The move has been driven predominantly by the US bond market, where we have seen one of the most intense and most aggressive sell-offs we are ever likely to see. When you see the US 10-year treasury trading from 1.71% to 2.3% in just over a week you have to do a double-take and it’s this move that is causing a wave of capital to flee to US assets from Europe, Japan, Australia and emerging markets. If Trump is going to borrow and build, then traders want USDs because inflation expectations have just skyrocketed in the US.

The fact that Trump’s fiscal plans include increasing the US debt load by over $5 trillion and taking the debt-to-GDP dynamic to 105% is a problem for another time. And it will be a problem for another time.

The more pertinent question then is whether the USD ran too fast, too soon? After all, the markets are not even debating whether a December rate hike from the Federal Reserve is going to happen; it’s now a certainty. We also know the markets are starting to feel we could see two hikes in 2017, which is aligned with the Fed’s own median projections. So how much good news is now in the price?

A lot, it seems, and while the trend is just so powerful, I feel the risk of a short-term pullback before a longer-term bull market rally seems elevated here. Given the fragility in many other economies, the potential political risks in Italy, France, Holland and Germany and what is now shaping up in bulk commodities (iron ore, coal and steel), the USD remains a stand-out currency.

There has been lots of interest in AUD/USD and USD/JPY of late. Specifically, AUD/USD has broken and closed below the September low of $0.7442, helped by a 13% fall in iron ore futures since the start of the week. From a risk-reward perspective, I simply can’t be short here and ideally want to see a rally into the September low ($0.7442) and a subsequent rejection of this resistance to confirm that AUD/USD trades into $0.7300. Price will reveal all, but given the extremity of the sell-off, the chance of a short covering rally seems high. If we do see the market reject $0.7440, I would be short with a stop above $0.7515.

I only want to be in the trade if price rejects the $0.7430 to $0.7442 level. If it breaks above here, it could easily go to test $0.7515.

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