BofA
USD has all bases covered
All roads continue to lead to the dollar as the USD index broke to new cyclical highs this week. The depth of USD buying has been indiscriminate this year with only CAD exhibiting some semblance of composure through 2022. But what strikes us about the dollar’s performance this year has been the lack of clear delineation between high/low beta FX performance in G10 and this is a clear indication to us that USD remains the currency for all seasons: higher rates = USD positive; higher volatility = USD positive. We think that the current market setup provides the perfect storm for further USD outperformance – yield support versus low yielders such as JPY, EUR and CHF and risk[1]off support versus the high beta complex. We have previously discussed how we think that the USD is benefitting from both sides of the so-called USD smile.
This theory asserts that USD tends to benefit when the US economy outperforms its peers or when global growth slows and market volatility is high. Despite mounting evidence that the US economy is slowing, the domestic economy remains in a strong position, supported by a strong labor market and the Fed appears to be on autopilot in terms the tightening cycle. We would argue that of the major central banks, that the Fed has the strongest commitment to fighting inflation despite signs of an impending slowdown in growth. However, on the flip side has been the obvious deterioration in market conditions. BofA’s own GFSI™ measure of market risk (composite measure of cross asset volatility) has correlated strongly with USD particularly versus commodity FX.
Despite the news this week of China fiscal stimulus, we doubt that this shifts the dial materially on further USD strength. It seems clear that markets are focused on parity in EUR/USD, a key risk which have flagged for some time. Next week’s US data flow is significant and could provide that catalyst. At the same time, we doubt further rate hikes by the RBNZ or the Bank of Canada next will provide any support for the NZD and CAD respectively if AUD price action in the aftermath of the RBA is any guide. Elsewhere, the UK entered yet another sliding doors moment with the resignation of Prime Minister (PM) Johnson.
Since the Brexit Referendum, the UK has had three Prime Ministers and three leadership contests. At the time of writing, contenders are yet to reveal their hand but we are puzzled by GBP price action this week. In 2019, GBP rallied on news that Johnson had won the leadership contest to replace PM May; in 2022, GBP rallies on news that PM Johnson was to resign. We find this response perplexing: the resignation of Johnson does not suddenly vanish away all of the UK’s issues; it does not guarantee more fiscal spending or tax cuts; nor does it solve the Brexit conundrum. Quite the opposite as we think the quid pro quo for leadership support will be a tough stance on UK-EU relations.
Finally, and not least, this does not impact the near-term reaction function for the Bank of England. Our views on GBP are therefore unchanged though admittedly the risks are become slightly more symmetric in the near-term.
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Written by James Harte
With 10 years of experience as a private trader and professional market analyst under his belt, James has carved out an impressive industry reputation. Able to both dissect and explain the key fundamental developments in the market, he communicates their importance and relevance in a succinct and straight forward manner.
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Daily Market Outlook, July 13, 2022
Source: Tickmill
