FX Update: How high can the USD go after big break?
Summary: Yesterday saw a big US dollar move higher as key support gave way in EURUSD and other currencies likewise came under pressure against the big US dollar. This time, the move was its own phenomenon, not requiring sympathetic weakness in risk sentiment or higher yields. The timing is worth noting as today is the last day of Q3 and end-of-quarter effects may be in play, but the momentum is impressive and would take considerable force to reverse.
FX Trading focus: The USD has broken higher – how far can it extend?
As I argue in the Saxo Q4 Outlook, set for release early next week but penned more than a week ago, the fourth quarter could prove a difficult test for USD bears. And that is already proving the case before Q4 even gets under way tomorrow as key USD resistance fell away yesterday with a bang – with EURUSD below 1.1665 and even below the late 2020 low of 1.1603 while other currencies also dropped like flies against the surging greenback. As noted in the excerpt, the most interesting aspect of yesterday’s move was that it unfolded in isolation from other factors like risk sentiment (mostly stable if leaning slightly lower yesterday but actually recovering today) or US treasury yields (consolidating). One factor besides critical resistance giving way, which likely triggered both stop-outs and new positioning, is the end-of-month and end-of-quarter today, so we still need to see how this move holds in the days to come, but in the meantime must take it at face value and ask both what is driving it and how far the move can extend.
The key driver for the stronger US dollar in the background is likely the anticipation that the Fed is finally set for policy normalization while the chief surplus economies like the EU and Japan are still stuck in perma QE, which is so large there and rates so negative there that surplus savings end up recycled back to the US. Two factors have added a bit of energy of late on that account: the weak result for the center-left in the German election and fading anticipation that a massive EU fiscal programme is on the way. Likewise, the “steady” choice in Japan’s leadership could keep Japan’s fiscal outlook less interesting. On the capital flow front, the huge shift in Chinee policy in recent months has meant a huge reallocation away from China in global portfolios, with the US far and away the largest market for capital hunting a new destination.
Chart: AUDUSD
The US dollar is pressing higher across the board, having cleared 12-month+ lows in EURUSD and taking aim at 1.1500 or lower to the downside there, while elsewhere, the strong greenback has yet to clear major pivot levels established on its previous run higher – for example in AUDUSD, where the 0.7106 level pivot has yet to fall. Note how the recent rally and retreat has created a kind of right “shoulder” after a giant “head” formed from the US election-era timeframe lows to the highs near the beginning of the year. Using the sloped neckline of that head-and-shoulders formation, the key level break level is coming into view ahead of that 0.7106 level. Looking lower, the 0.7000 area was an obviously critical level both pre- and post-pandemic breakout as shown. Then there are the projections lower if 0.7000 falls – anything from the 0.6805 area show (sample EW target) to 0.6550 to even the 0.6210 area (which is the classic approximate head-and-shoulders target area as well as the 161.8% extension of the last sell-off wave from the 0.7478 retracement). One factor that could support the Aussie before the more extreme sell-off extensions is the already crowded short positioning. For now, let’s see if 0.7106 falls.
As to how far the USD move can extend, I suspect it can continue for a while, but will rapidly become self-limiting as USD strength becomes so destructive at anything approaching the current momentum. We are already within about two percent of the levels that triggered Yellen’s abrupt slowing of rate normalization plans back in early 2016, although to be fair, that was after a sustained rally of some 20% from the mid-2014 time frame. Levels of note would include the higher of the sub-0.7000 targets for AUDUSD mentioned above, the 1.1300 area for EURUSD and the 115.00 level in USDJPY. Anything significantly higher than these dramatically accelerates Fed or coordinated central bank action as the USD would be suffocating the global economy. Otherwise, fundamental factors that could help the USD lose speed would be:
Elsewhere, on the US fiscal front, today is critical for the outlook as the House is meant to vote on the infrastructure bill passed by the US Senate. Will the progressive Democrats hold true to their word and nix the bill in protest as the larger social- and climate spending bill has been de-linked from this bill? If so, the fiscal cliff next year for the US looms that much larger, requiring massive consumer dis-saving if the US economy is to continue to expand. The immediate threat of a US government shutdown/default has been averted for now by a stop-gap spending measure that delays that issue until at least December 3.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
FX Trading focus: The USD has broken higher – how far can it extend?
As I argue in the Saxo Q4 Outlook, set for release early next week but penned more than a week ago, the fourth quarter could prove a difficult test for USD bears. And that is already proving the case before Q4 even gets under way tomorrow as key USD resistance fell away yesterday with a bang – with EURUSD below 1.1665 and even below the late 2020 low of 1.1603 while other currencies also dropped like flies against the surging greenback. As noted in the excerpt, the most interesting aspect of yesterday’s move was that it unfolded in isolation from other factors like risk sentiment (mostly stable if leaning slightly lower yesterday but actually recovering today) or US treasury yields (consolidating). One factor besides critical resistance giving way, which likely triggered both stop-outs and new positioning, is the end-of-month and end-of-quarter today, so we still need to see how this move holds in the days to come, but in the meantime must take it at face value and ask both what is driving it and how far the move can extend.
The key driver for the stronger US dollar in the background is likely the anticipation that the Fed is finally set for policy normalization while the chief surplus economies like the EU and Japan are still stuck in perma QE, which is so large there and rates so negative there that surplus savings end up recycled back to the US. Two factors have added a bit of energy of late on that account: the weak result for the center-left in the German election and fading anticipation that a massive EU fiscal programme is on the way. Likewise, the “steady” choice in Japan’s leadership could keep Japan’s fiscal outlook less interesting. On the capital flow front, the huge shift in Chinee policy in recent months has meant a huge reallocation away from China in global portfolios, with the US far and away the largest market for capital hunting a new destination.
Chart: AUDUSD
The US dollar is pressing higher across the board, having cleared 12-month+ lows in EURUSD and taking aim at 1.1500 or lower to the downside there, while elsewhere, the strong greenback has yet to clear major pivot levels established on its previous run higher – for example in AUDUSD, where the 0.7106 level pivot has yet to fall. Note how the recent rally and retreat has created a kind of right “shoulder” after a giant “head” formed from the US election-era timeframe lows to the highs near the beginning of the year. Using the sloped neckline of that head-and-shoulders formation, the key level break level is coming into view ahead of that 0.7106 level. Looking lower, the 0.7000 area was an obviously critical level both pre- and post-pandemic breakout as shown. Then there are the projections lower if 0.7000 falls – anything from the 0.6805 area show (sample EW target) to 0.6550 to even the 0.6210 area (which is the classic approximate head-and-shoulders target area as well as the 161.8% extension of the last sell-off wave from the 0.7478 retracement). One factor that could support the Aussie before the more extreme sell-off extensions is the already crowded short positioning. For now, let’s see if 0.7106 falls.
As to how far the USD move can extend, I suspect it can continue for a while, but will rapidly become self-limiting as USD strength becomes so destructive at anything approaching the current momentum. We are already within about two percent of the levels that triggered Yellen’s abrupt slowing of rate normalization plans back in early 2016, although to be fair, that was after a sustained rally of some 20% from the mid-2014 time frame. Levels of note would include the higher of the sub-0.7000 targets for AUDUSD mentioned above, the 1.1300 area for EURUSD and the 115.00 level in USDJPY. Anything significantly higher than these dramatically accelerates Fed or coordinated central bank action as the USD would be suffocating the global economy. Otherwise, fundamental factors that could help the USD lose speed would be:
- US economic loss of speed (watching current fiscal argument closely on that front, but higher energy prices are a recovery risk as well if these head higher still) forcing a rethink of the degree to which the Fed can ever extract itself from QE. Longer term, the Fed can’t, but that remains for the all of us to discover over time.
- German coalition forms quickly and the EU shows signs of getting its act together in responding to the current energy crisis with massive new fiscal stimulus – importantly geared towards supply-side on energy rather than as income replacement to keep demand elevated – the current global supply side can’t even cope with current demand levels. Ditto for Japan…
Elsewhere, on the US fiscal front, today is critical for the outlook as the House is meant to vote on the infrastructure bill passed by the US Senate. Will the progressive Democrats hold true to their word and nix the bill in protest as the larger social- and climate spending bill has been de-linked from this bill? If so, the fiscal cliff next year for the US looms that much larger, requiring massive consumer dis-saving if the US economy is to continue to expand. The immediate threat of a US government shutdown/default has been averted for now by a stop-gap spending measure that delays that issue until at least December 3.
Disclaimer
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
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