There has been a huge unwind of the US dollar (USD) strength in the past week. The move has played out across major forex pairs. However, the moves are stalling today and this seems to be coming at around crucial medium-term levels. The market reaction in the coming days could be crucial to the outlook moving forward. It seems that an important crossroads has been reached.
- A big USD unwind has been driven by Treasury yields pulling lower. The direction of “Real” bond yields remains key for the USD outlook.
- Major forex pairs are hitting crucial pivot levels.
Falling yields have weighed on the USD
The big turnaround for major markets came as the Bank of England stepped in to prop up dysfunctional UK Gilt markets. This show of support helped to steady bond markets around the world. The risk of contagion following a chaotic “mini-budget” from the UK Government was being contained.
Cue a big unwind on bond yields (that had been spiking higher). The US 10-year yield dropped by -46bps in a week.
This weighed on the run higher in “real” US bond yields (US bond yields minus inflation expectations). Real yields are taken as the US 10-year Treasury Inflation-Protected Security. The yield on the 10-year TIPS has fallen back in the past week. This has a strong positive correlation with the USD. The correlation averages around +0.29 over the past year, but is currently very strong at +0.83.
The USD has been in correction mode and there has been a big rebound in risk appetite. We can see that all major currencies have rebounded against the USD in the past week.
A near-term unwind on USD
However, this move over the past week has merely unwound the USD into its first significant band of support, around 109/110 on the Dollar Index. It is interesting to see that US bond yields are moving higher again this morning, helping to drive a USD rebound.
The big question is now one of how markets react to this threat of renewed USD buying. We have long been advocates of buying USD into weakness. This seems to be just that opportunity. For the USD correction to continue, there needs to be a significant reaction. If the Dollar Index rebound begins to falter around the 111.10/111.45 resistance, this would suggest that the USD correction may not be done yet.
Key crossroads on major forex pairs.
Several major forex pairs have reached a crucial crossroads in their outlook. There are significant technical factors that we are now looking out for.
On EUR/USD the rebound has gone through the resistance band 0.9865/0.9950. As the market drops back this morning, this becomes crucial support. In previous big rebounds (of May and August) the old support has been new resistance, almost to the pip. Breaking above this resistance of the old July/September lows) was an important improvement. However, the big barriers of the 55-day moving average and 8-month downtrend are just above parity. A bull failure around here would simply be seen as another chance to sell. A break above 1.0200 resistance would be a decisive signal of a sustaining recovery.
It is a similar outlook on GBP/USD, although the moves have been more volatile. A rebound into 1.1350/1.1450 is a key test of the rally, especially with the daily RSI again unwound to 50. However, as the market has fallen away this morning, the 1.1350 level is coming under pressure on the downside again. A failure would be disappointing and would seriously question whether the rebound had already played out. There is still scope for a further rally within the six-month downtrend and the market continues to trade with elevated volatility. However, we still favour using near-term rallies as a chance to sell and the likelihood of this kicking in again is growing.
The vulnerable AUD
Despite the risk rally and rebound against the USD on major currencies, it is notable that the AUD (and to a lesser extent the NZD) has failed to take part. It has been a stuttering recovery in the past week. No doubt, the more dovish than expected hike from the Reserve Bank of Australia (+0.25% instead of the +0.50% expected) has played into this. However, the recovery appears to have been stuck under the resistance between 0.6525/0.6545. Momentum remains correctively configured and this is set up to be a continued sell into strength. Already it seems as though the strong USD position is set to weigh once more and retest the 0.6363 low.