Is a USD bull market emerging?

The USD is king again, with the USD index (a basket of currencies comprising predominantly made up of EURs) currently at the highest since 2013.

Source: Bloomberg

We are approaching key support on EUR/USD, with the 38.2% retracement of the July 2013 to May 8 rally in focus at 1.3227 – a break here would naturally bring the 1.30 handle into play. USD/JPY has really blown expectations out of the water, and while I was expecting a move higher in the pair earlier in the week, I certainly wasn’t expecting a test of the 104 level. It’s worth remembering that the last time the US dollar index was at these levels, the US ten-year yields was testing 3% - it is now at 2.43%!

It seems consensus that the FOMC minutes were modestly hawkish and confirmation of this was the five basis point move (in yield) higher in the US two-year treasury. Certainly the market picked up that job gains, which might bring rate rises sooner. However, those who really hone into the deeper thematic and rhetoric would be most interested in the more extensive discussion into the potential exit strategy and at what stage the central bank stops re-investing proceeds from the upcoming maturing assets it holds on its balance sheet.

The start of a multi-year USD bull market?

Stage one of the multi-year cyclical bull market in the USD has begun in my opinion, with the market altering positioning in anticipation of an end to the tapering process and the potential for short-term rates to increase. The second leg should come when the Fed starts to lift rates and subsequently stops re-investing the proceeds of maturing assets, which in turn will cause the balance sheet to contract. The final catalyst could occur around 2016 when we potentially see a positive ‘real’ Fed funds rate, i.e. when the short-term Fed funds rate moves above the level of inflation.

What was interesting though was that while the FOMC minutes put a bid in the USD and brought out gold and bond sellers, it wasn’t enough to derail the equity story. The NASDAQ continues to perform well and I wouldn’t rule out a new all-time high in the S&P 500 this week, especially as the futures already achieved new highs yesterday.

Perhaps the key concern for USD bulls comes from China, although the risk of short-term profit taking is high as we go into Janet Yellen’s Jackson Hole speech on Friday. We’ve already seen Chinese house prices falling in 64 cities in July (the highest level since the inception of the series in July 2005), however today’s HSBC manufacturing PMI missed consensus by some way at 50.3. We’ve seen some of the heat come out the CSI 300 (-0.7%) and Hang Seng (-1%), although both have had exceptionally strong moves of late. However, the 52 point ‘fix’ higher from the PBOC in USD/CNY is also of interest.

Watching the USD/CNY cross

The 2% appreciation in the CNY over the last couple of months has certainly been noted and reflected the better trend in Chinese data. What’s more, global markets have not really been overly fussed by this move. Generally when we see bouts of engineered CNY  weakness, we see China’s FX reserves increasing, in turn pushing developed market bond yields lower, which as we know increases the relative attractiveness of carry trade, i.e. being long AUD, NZD and TRY. Still, despite USD/CNY breaking above the July downtrend, we haven’t really seen much selling of USDs against higher yielding currencies today.

There has also been minimal selling in the copper (CME) market, although London traders may become more active. CME copper is one to watch over the coming weeks and while iron ore futures have fallen to new contract lows, with rebar futures now firmly below the CNY3000/mt level, copper has held firm. As you can see from the weekly chart, the trend is lower and it seems key that the metal stays supported above $3.00.

European markets should find a firmer footing on open, helped by a new high for the year in the ASX 200 and a good bid in the Nikkei. US futures are up modestly, with FX seemingly the livelier asset class in Asia.

On the data front we get flash manufacturing and services PMI in Germany, France and the eurozone (aggregate), with the market expecting a slight decline in the surveys.  We also get flash (Markit) manufacturing PMI in the US, with July existing home sales and Philly Fed manufacturing also in focus. UK retail sales could trigger some short covering in GBP/USD if we see the ex-auto print above 0.4%; recall the pair has fallen 3.5% since late July, with any rallies being faded fairly aggressively.

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