A Santa Claus rally on equities and pop higher on bond yields has lent a risk positive bias to major forex pairs at the beginning of 2022. We look at how this has impacted markets and whether it changes our outlook.
- There has been a clear theme developing in recent weeks, where higher risk majors are outperforming safe havens
- EUR/USD is struggling for traction still
- GBP/USD and AUD/USD are on track in their recoveries
Higher risk outperforming safe havens
Bond yields are considerably higher over the past month. Rising bond yields (in orderly markets) tend to be associated with a more positive risk appetite. Since the beginning of December:
- US 10 year Treasury yield is +16 basis points
- UK 10 Gilt yield is +24 basis points
- German Bund yield is +21 basis points
- Japanese 10 year JGB is +3 basis points
What is noticeable is that these yield differentials have also been key to driving currencies in this time. Sterling has been a key outperformer, whilst the Japanese yen has been the big underperformer in the forex space. Furthermore, the euro has been relatively stable relative to the US dollar (USD) for during the past month.
From this chart of performance relative to the USD we also see a very clear split, with the performance of safe havens (JPY, EUR and CHF) all in-line or underperforming the USD; whereas the more cyclical (higher risk) currencies (AUD, NZD and CAD) along with GBP (which has a tightening central bank) have all been outperforming.
If bond yields continue to climb in the coming weeks, we can expect these trends to continue.
USD strengthening has stalled
At the end of 2021, we discussed why USD strengthening could continue into 2022, but would eventually begin to reverse. This strengthening has failed to seriously ignite. Before yesterday’s rebound (fueled by a spike in Treasury yields), the dollar has been drifting lower. The only currency that it has strengthened against to any serious degree is the Japanese yen.
Despite this though, there is still a decisive uptrend intact on the Dollar Index. This month-long consolidation is still more likely to resolve to the upside to continue the run higher.
This consolidation is being driven by EUR/USD which has remained stuck in its multi-week trading range. (The EUR accounts for around 56% of the Dollar Index calculation, so is inherently significant for the index direction).
Throughout the past seven months, we have seen several consolidations on EUR/USD, all of which have resulted in a downside break. With momentum (RSI) having a bearish medium-term configuration, the strength of the downtrend and the 55 day moving averages (a medium-term trend indicator) pointing lower, rallies remain a chance to sell.
GBP/USD and AUD/USD continue to recover
We have seen better progression in the recoveries on GBP/USD and AUD/USD. Cable is recovering amidst the tightening of interest rate policy by the Bank of England. The Aussie has recovered with risk appetite, and still being one of the most oversold of the major currencies appears to have found some short-covering rally momentum.
GBP/USD has rallied through 1.3350/1.3410 and is on track to test 1.3570/1.3600 and the big seven-month downtrend. How the market reacts around these resistance levels will be important for the development of the next leg in the coming weeks.
For AUD/USD, the recovery is at a key inflexion point. Yesterday’s retreat to the support of the 0.7170/0.7185 breakout and the mini uptrend of the recovery, means that this is a key moment.
Breaking under these key levels would seriously question how sustainable the recovery momentum is. However, if this support is now a platform for another leg higher, there is still plenty of room for a recovery towards the primary downtrend which is currently up around 0.7440.