Chris Weston, Head of Research for Pepperstone offers his weekly analysis of what’s brewing in the Forex markets.
The event risk this week is really centred on Federal Reserve chair Jay Powell’s speech at the Jackson Hole forum on Saturday, with other global data points unlikely to promote as great a reaction. Powell should keep the option of a 75bp hike at the 21 Sept FOMC meeting firmly on the table, but offer the flexibility to go 50bp if we do see sufficient softening in the labour market in the US Non-farm payrolls report on 2 September and the pace of headline CPI inflation (13 September) falls again in the August read.
The prospect of acknowledging future triggers that could lead to the Fed cutting rates will not be present in his speech. The market would be highly surprised if they did hear this.
As it stands, the market prices 61bp of hikes from the Fed in the September FOMC meeting, leaning closer to a 50bp hike. It would not surprise us to see this pricing between 60-65bp by the end of the coming week. Powell will want to give the Fed maximum flexibility and optionality until they know the NFP and CPI prints. For this week, it’s likely less about the known event risks and keeping it thematic, reacting to flows from a targeted group of markets.
5 key markets that could influence cross-asset volatility this week:
- The USD – notably USDCNH
- EU Natural Gas & German Electricity prices
- US 5 & 10-year real rates
- US volatility index – the VIX index
- Federal Reserve balance sheet
Specifically, EU Natural Gas prices are front of mind. EUR and EU equity index traders should watch EU energy markets closely. On Friday we saw the EU Natural Gas price trade to EUR262.78, a new high in this bull trend and price continues to home in on EUR300. We see German ‘baseload’ electricity prices moving exponentially and again the further this rises, the worse economics in Europe will be into the next few months. News that Gazprom is to close the Nord Stream pipeline between 31 Aug and 2 Sept for maintenance has traders worried that the shutdown may be extended and is a EUR negative. Germany has done a decent job of stockpiling gas for the winter, but the market is nervous.
Federal Reserve balance sheet dynamics
We also watch the Fed’eral Reserves balance sheet dynamic. Like many, I have been focused on excess reserves passed to the Fed from US commercial banks. Reserves have been on the rise, and by more than the Fed has been reducing its assets via Quantitative Tightening. Tthis better liquidity backdrop has been well correlated with risky assets. All the focus is on the Fed ready to ramp up the pace of reduction in the US Treasuries and potentially mortgages it holds on the asset side of the balance sheet. There is little doubt that these dynamics are boosting the USD.
And what a week it was for the USD. EU Natural Gas and Fed liquidity dynamics aside, a 1.4% move higher in USDCNH above 6.8300 have all contributed towards boosting the USD. With the People’s Bank of China likely to cut the 1- & 5-year Prime rate by 10bp a piece, we watch USDCNH. While a cut is priced, an upside break of 6.85 would impact broad markets and should be on the radar. High beta FX was carted out last week, with USDZAR and NZDUSD leading the charge. AUDUSD gets prime time on the radar, and while 1-week implied volatility is not overly punchy, at 11.75%, and pricing the downside on the week into 0.6870, the technicals are looking weak, with Friday’s close just holding the 5 August swing.
USDJPY has been a Pepperstone client favourite too, and it feels like this could squeeze into 138.00/20 before I have a greater conviction on fading the move. EURUSD sits on the 61.8% fibonacci of the July-Aug rally and parity is a whisker away. A fresh push higher in EU Natural Gas takes EURUSD through parity and possibly to 0.9920, and negatively impacts the DAX, with funds further shying away from EU exposure. We do get some data points in Europe to focus on – such as S&P global manufacturing PMI on Tuesday and consumer confidence on Wednesday, but the EUR should take its cue from energy.
GBPUSD looks weak and the obvious level is the 14 July low of 1.1760. Rates markets price 56bp of further hikes from the Bank of England in the 15 September meeting, and this week’s data (again we see S&P global manufacturing PMI) may see traders’ massage that pricing. UK growth rates weigh on the GBP, and the market feels the UK may have crossed the Rubicon, to the point where high inflation becomes less supportive of a currency and impacts growth through the feedback loop to social channels.
If the USD is to find further form, driven by the US exceptionalism story, rising 2yr Treasuries and reduced liquidity from the Fed’s balance sheet, then other risky assets should head lower this coming week. BBBY aside, the risk ‘canary in the coalmine’ plays are looking vulnerable. ARKK, cryptocurrencies, SPAC’s and IPO’s, to name a few.
Implied volatility is still sanguine, with our US volatility index making a move into 24.3% on Friday but not at levels indicative of greater S&P500 hedging demand. With options expiry now passed, we can watch (and/or trade) this index, but the higher this goes the greater the opportunity to trade from the short side, as liquidity comes out of the market, the buyers stand aside, and cross-market correlations rise.
The momentum is to the downside in the S&P500 and Nasdaq, although I am still waiting on a bearish MA crossover. A break of 4203 would put 4065 on the table. With so many turning bearish, a renewed push into 4340 would be the pain trade. I favour the downside tactically, but as always holding an open mind.
This article is brought to you in association with Pepperstone. All opinions expressed in this article are from the author and do not necessarily represent the opinions of The Armchair Trader.
