We have been long the USD for a little over 6 weeks now and that trade accelerated on the playbook the Fed gave the market at its September meeting.
However, this acceleration needs to be evaluated and it would be wrong of us not to review which the USD now finds itself.
DXY is now at the upper end of its 12-month range and has even reach a new 12-month high last week. This is interesting as it suggests the Fed did give it the kick it needed having failed to breach the upper band in March, July and August. But the momentum gained from the Fed announcement has waned and has seen DXY stuck in a trading between 93.7 to 94.4.
The notable momentum loss could be the fact that the US growth story has stalled of late due to Delta. The best example of this stalling growth is the Atlanta Fed’s Q3 GDP falling from 5.0 per cent at the end of August to 1.3% at its latest update. Couple this with supply chain issues and the debt ceiling debate and it’s easy to make a case for the loss of momentum.
So, if we relate this to an FX theme – our call on the EUR/USD has been correct and has seen the pair fall to $1.155 an 18-month low. But if the US growth story slows further, but Europe continues to stimulate in the interim (as, it has announced) the growth differential will likely add upside to the pair.
In fact, what is being proposed currently by the ECB and European governments is likely to mean they will benefit more than any other developed economy.
This would suggest there is now a floor to EUR/USD, and we wouldn’t be surprised to see it slide back up to $1.20 over the coming 3-6months. Now this comes with a caveat and a large one at that. The Fed is still in play here and the slowdown in US growth will be dissipate.
We would also argue that the FX fundamentals overall are still weighted to the USD. But, at $1.15 something really hawkish from the Fed is needed or a massive upside push in the recovery maybe to see this pair slide to $1.12. Something to really watch, What hasn’t changed because of the growth differential is lour view on USD/JPY. As we mentioned in the Fed Playbook piece a few weeks again, the JPY is inversely related to US real yields. This trend is well and truly still intact. It had fallen last week on issues around the debt ceiling but is back testing the ¥112 handle at ¥111.93 a break and hold above this level is a very positive sign for the pair.
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