USD is always the King

Thks to HEAT for his comments....

USD strikes back

After some months of rangebound trading US dollar finally managed to break higher, although it has been quite rapid we can´t take this move as a big surprise since it has been supported by stronger economic data in the US (in fact is the only Advanced Economy providing positive economic surprises) which ultimately is driving US yields at years highs (USt 10Y >3.1%, 2011). Speculative position against the greenback played its role also and some sort of relief on the trade wars saga did the rest.  Once EurUsd broke the key 1.2150 support level the pair was one way traffic below 1.1800 where the pair has found some support but we are targeting for lower levels around 1.1600.

eurusd

As mentioned there are some signs of slowdown mostly in the EU and UK which has been reflected in latest Central Bank appearances, EU inflation in April came much lower than expected and despite being affected by transitory factors it doesn’t support a hawkish stance by the ECB , manufacturing sectors in Germany and France looked weaker also and 1QGDP for Germany was the lowest since 2016. There are some rumours that the ECB could leave the Bond Purchase Program as open-ended, for the time being they are reluctant to  come up with a date for stopping the program, taking into account that they will wait a considerable period after finisihing the program to hike I still believe that there are great odds Draghi will leave office without hiking the depo rate. On the UK front BoE remained on hold, don´t forget that May hike was fully priced by the market just two weeks ahead of the meeting (expectations driven by Carney) which in my opinion seemed (another) policy communication mistake by the governor, UK economy is clearly decelerating and there are still lots of Brexit uncertainties ahead so they should remain on a cautious approach. The pound has been sold of the back of it and eurgbp traded >0.8800 and 1st hike market pricing has been pushed back to the end of year, we seriously doubt there will be any in 2018.

The recent collapse of the Argentinian peso and other EM  currencies is a warning sign, those countries with weak fiscal positions, i.e. Argentina,Turkey and Russia are suffering the most but we can say that the whole EM spectrum is under heavy pressure. EM countries have benefited from the central bank “carry trade” of low interest rates and abundant liquidity which flooded markets with cheap usd used to buy “growth” and “inflation-linked” assets in EM, when that extraordinary and excessive flow of US dollars into EM suddenly reverses and funds return to the U.S. looking for safer assets and higher returns (yields+tax)the exit door is considerably smaller and the currency market collapses, this capital flow dynamic is called “sudden stop”. Since the bubble was used to increase their imbalances rather than strengthen their economies,  I think more pain is to come if US yields continue to grind higher. However in just purely technical terms LACI index (Latam currencies) trades at lowest levels since 2016 so we could find some support here.

LACI index (Latam ccies)

What really  amazes me is how well Risk Assets (mainly stocks) are performing in this context of higher Oil,rates and EM selloff, S&P500 tested a few times the 200MA level but held it quite well and managed to bounce back higher. I´ve mentioned in previous notes that I expect a decent correction in equities which ultimately would bring more volatility to market but it has simply not happened yet. There are some  other potential risks out there such the geopolitical situation in the Middle East once US has left the nuclear deal with Iran (oil up to 80$), US yields seems to have broken key resistance levels so more pain in that front could be expected… so the question here is what level of 10y UST yield would cause investors to rotate from equities into bonds?.

US 10Y Positioning at extreme SHORT

Xccy basis market keeps tightening across the curve, this move can be linked to tax reform, specifically by BEAT which punishes American corporates for maintaining overseas balance sheets so the need for issuance has clearly diminished. US corporates now prefer to use the domestic market and then use FX forward market to refinance their subsidiaries. On the back of that we are seeing a rapid move against the USD in front end g10 forwards fueled by poorer liquidity.

XCCY Basis Swap 1year

Note: This analysis is a personal opinion based on my experience, not a professional signal service. For trading, you must base your decisions on your own criteria