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USD on an impressive bull run


8 April 2022 Written by Chris Weston  Pepperstone Head of Research Chris Weston

For now, the USD reigns supreme – the trade-weighted USD sits at the highest levels since May 2020, as does the USDX, although this USD basket is heavily skewed towards the EUR. However, the bullish move in the USD sits firmly on momentum trader’s radar, while Pepperstone clients are skewed short suggesting they are seeing mean reversion as the base case.

The USDX is up for six consecutive days, and while it is statistically rare to see seven straight days of gains, we question if the USD basket can break above 100 soon?

US Dollar Index

US Dollar Index

Looking back over the past 5 sessions and we see EURUSD -1.6% - the worst performing pair in G10 FX – predominantly driven by relative bond yield differentials in favour of USDs. We also watch for Sunday’s first-round French presidential election – with the polls becoming closer for the second round (24 April) and in favour of Marine Le Pen, there seems there are some who are hedging risks here with short EUR and FRA40 index positions. The USDX has naturally benefited from the recent EUR weakness, where technically the break of the double bottom neckline targets 101.30, with 100.54 also near-term resistance. 100 is a psychological barrier and we’ll need to see EURUSD into 1.0800 for that to play out and the way EURUSD is trending it seems the likely course of action.

Looking at the fundamental backdrop - the world is long of USDs, which is having some handbrake on its ability to really get going, but there are still many attractions of owning it. Firstly, it’s going up and that’s a great start – buy strong, sell weak is a prudent way to skew the odds someway to your favour.

The US has the highest CPI inflation rate in the G10 FX region, and next week we should see this even higher with the market looking for a 50bp increase in the year-on-year print to get to 8.4% - if this print does come to pass it just reinforces the need for the Fed to step it right up and hike by 50bp in May and start its process of reducing its balance sheet and reserves.

We can look at forward rates and see that hedge and pension funds and corporate Treasury divisions can obtain relative higher carry from US rates, and only NZ has a higher 2-year bond yield. We can see US real Treasury rates are now -19bp and not far off turning positive, which is impressive considering they were -110bp in early March.

If US real rates turn positive, then it could act as a sizeable headwind for equity returns, which again if we see a renewed drawdown in the S&P 500 may feedback into USD appreciation, with the USD retaining its safe-haven status. US growth is in relatively good shape, although we are watching consumer confidence closely – certainly the labour market is in fine form and the household savings rate is still high enough to absorb high inflation.

I do think USDCNH is well worth watching – like other FX pairs, client interest in this cross is driven by trending conditions, the rate of change and general volatility. A trend would have big implications for broad FX markets, and I do sit in the camp that if we see a higher USDCNH, notably if we see a break of 6.4100, then this will flow into further USD strength vs G10 FX. Whilst fundamentals don’t tend to influence the yuan as much as major currencies, there does seem to be growing downside risk for the yuan – a weaker current surplus, inflation running at a low 0.9%, the yield advantage in Chinese bonds diminishing vs US and growth called into question over its Covid-zero stance.

I like the cross higher, which as I say should feed into broad USD appreciation – that said, near-term we watch to see if US bond yields keep moving higher with eyes on US CPI and equity volatility. The French presidential election and the ECB meeting also pose risks. To me, the balance of risk is skewed to a higher USD, but there may be some wood to chop to get through 100.

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