As we come into a busy week of tier one data, major forex markets appear to be trading around key levels. The inflation data for March and monetary policy updates from several major central banks are high on the agenda. This could significantly impact the near to medium-term outlook across major forex.
- US Treasury yields remain key for USD/JPY
- EUR is threatening to engage in a near term recovery as the ECB approaches
- Commodity currencies are struggling. Reaction to the RBNZ will be key for NZD this week.
Rising yields are driving USD/JPY higher
The chart of USD/JPY has taken off since early March. The move has been driven by the acceleration higher in US bond yields. There is a strong positive correlation between the direction of longer-dated US bond yields and USD/JPY. This is due to yield differentials, where the US Federal Reserve is raising interest rates whilst the Bank of Japan retains a rate of -0.10%. The expanding difference in the rates means it is better to buy US debt over Japanese debt.
The move is reflected in the chart of real US bond yields (bond yields minus inflation) and USD/JPY. First of all, the increase in real yields is coming as inflation expectations have broadly flattened, whilst the nominal US 10 year Treasury yield has risen sharply.
If we chart the real yield versus USD/JPY we see an average correlation of +0.35 since the beginning of 2021. The correlation is especially strong right now.
The higher the real yield goes, the stronger USD/JPY. The major pair has broken out again this morning and is above 125.00 now and is on course to test the crucial 125.85 high from June 2015. If US CPI inflation data continues to soar higher, we could see further selling pressure on US Treasuries which would drive higher yields and continued upside on USD/JPY.
EUR is rebounding towards a key near term resistance
Ahead of the ECB monetary policy meeting, it is interesting to see the EUR strengthening. The rally on EUR/USD is now approaching key near-term resistance at 1.0940/1.0960. Despite the French Presidential election moving into the expected head-to-head between Emmanuel Macron and Marine Le Pen, French assets have strengthened today. This is helping the euro higher.
However, the key test lies ahead. The reaction to the ECB meeting on Thursday will be key for the euro. There is an increasingly vocal cast of hawks on the Governing Council and if there is a move to bring forward the winding down of the Asset Purchases Programme (the ECB’s long-running quantitative easing) then there could be a jump for the EUR.
For the EUR/USD pair there is also US inflation to elevate volatility this week, and the reaction around 1.0940/1.0960 could be a key early test this week. It is a pivot in the middle of what is effectively a range now between 1.0805/1.1185.
USD/NZD has pulled back into a key uptrend support
Commodity currencies have fallen away strongly in recent sessions. A correction in the oil price has reflected this move as there has been a sharp unwinding of the previous strong outperforming NZD and AUD.
For the Kiwi, this is an important moment for what has been a strong recovery trend over the past 10 weeks. Technically, the unwinding move of last week has broken USD/NZD back below the key breakout support band 0.6860/0.6900 to test the 10-week uptrend. A failure to recover back above 0.6900 would start to threaten a new corrective formation of lower highs.
The Reserve Bank of New Zealand meeting this week is expected to include a +25bps rate hike to 1.25%. Given the strengthening of the US dollar we have seen recently and the unwinding of commodities prices, it might need a more aggressive tightening from the RBNZ to keep the 10-week uptrend intact for NZD/USD. Any disappointment for the hawks might even open 0.6700/0.6730, the next key support band.
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