As the near-term strength of the dollar (USD) continues, we have seen some significant moves across major forex pairs. Safe-haven assets have been particularly badly hit by USD strength. Although for higher-risk major currencies (such as GBP or AUD) this may prove to be a chance to buy, the safe havens look under ongoing pressure. The euro sits somewhere in the middle of all this as the European Central Bank approaches this week.
- The ECB is once more sitting in an uneasy position. A sustainable economic recovery still needs further monetary (and fiscal) support, however, rising inflation and bond yields leave this difficult to get past the “hawks” on the Governing Council.
- As for markets, the strengthening dollar could have further to run near term.
- Safe havens such as the Japanese yen look at risk of continued underperformance.
ECB likely to play a waiting game on Thursday
For the ECB monetary policy decision, whilst there is plenty that they could (and arguably should) do, it could be a case of all talk and no trousers.
There is an update to economic projections due. Since the December meeting, the early 2021 lockdowns will mean that 2021 GDP projections will need to be downwardly revised. Also, with a sharp move higher in the oil price (Brent Crude is up almost $20 year to date), and jumps in global bond yields, we are likely to see inflation (HICP) projections raised.
The ECB still needs to provide on-going economic support and to sustainably lift the Eurozone economy back off its knees following the pandemic. However, for this meeting, the Governing Council may not be able to agree to an increase in the Pandemic Emergency Purchases Programme (PEPP) asset purchases. Instead, they could bring forward already promised PEPP purchases, increasing the monthly purchases from the existing €60bn for a few months. There could also come with a promise to increase the PEPP “envelope” if needed.
For EUR, this could be enough to lend at least near-term support.
A USD rally is impacting across major forex
How far can this USD rally go? The near to medium-term outlook has significantly improved as Dollar Index (DXY) has broken clear above 91.70. This could open 93.50/94.30 (and possibly test the September high of 94.75).
If US bond yields continue to soar (the US 10yr yield currently c. 1.50% could perhaps push towards 1.70% or 1.80% in the coming weeks) then this would drive USD further higher.
Safe havens are suffering at the hands of a stronger USD
The EUR/USD chart is almost a mirror image of DXY (because euro trade comprises around 57% of the Dollar Index basket). EUR/USD has subsequently broken below key support at 1.1950/1.2000, opening a potential towards 1.16/1.18. Additionally, unless the EUR/USD bulls can pull the market back above 1.1950/1.2020 (old support becomes new resistance) then rallies will continue to struggle.
For the safe-havens, the yen tends to be the benchmark. USD/JPY has shot higher as USD has rallied and JPY has suffered. However, the pair has rallied into resistance 108.50/109.80 and does look very overbought near term. It is ripe for a pullback/correction, possibly into 107.00/107.50.
However, it is likely that this move would be short-lived and be another chance to buy. US bond yields are still likely to rise (USD positive), COVID vaccines are being rolled out across the world and broad market sentiment remains positive (bad for JPY). This all sets up for ongoing JPY weakness.