Forex Weekly - The dollar comeback continues

Friday, 5th February 2021 09:27 - by Rajan Dhall

It's been another interesting week in the FX and macro markets where the risk environment has been mixed. The risk sentiment has been tied to the stronger dollar as on the days where the dollar surges the indices and commodities usually suffer. Another big story that is not in the limelight is the fact that the Chinese central bank and authorities seem to be tightening up their liquidity. This could affect equities in the border term once the theme comes into fashion. Over in the US, the S&P and Nasdaq continue to motor on while the FTSE 100 can't seem to keep up.

Looking closer at the greenback, the dollar index has had a bumper week so far. Since the lows seen in January, the index is now 2.57% higher and has broken through the 91.50 area. This is due to a fair amount of overextension (selling) in the US dollar but also a repricing in the money markets. They believe the Federal Reserve will taper from its massive asset purchase program sooner than they did in the past and this led to an increase in the mid-term yields. A few Fed members have mentioned tapering in their comments and this is at an interesting time especially when new President Biden and Treasury Secretary Janet Yellen pushing for more fiscal stimulus. At the time of writing, the President is now waiting for the house vote on the stimulus bill but Biden is pushing for bigger stimulus cheques than was previously expected. Some reports have suggested that they could rise to $1600 per adult in the US.

We are also due to get the latest non-farm payroll data and the analyst consensus estimates that 50k jobs will be added in January. With the US firmly in the midst of the pandemic, this is optimistic but the NFP number can be a lottery from time to time. The current unemployment rate in the US stands at 6.7% and any change in this will need to be watched closely as it remains one of the Fed's key mandates. Just today a Fed member did state that they are willing to accept an overshoot in inflation to meet its objectives in employment and that is why it is such a key figure.

 Source: TradingView                                               

The pound has been a story in itself. As some of the other currencies have faltered against the US dollar the pound has held firm. The Bank of England has been talking up negative rates but the market has decided to look on the bright side and focus on the positives. Interestingly despite the BoE pushing negative rates the money markets have pushed back bets on negative rates to February 2022. The BoE have said that GDP could surprise to the upside and the vaccination program has been a success so far. This leads to a brighter horizon vs that was expected at the last meeting.

It has to be said the strength in the pound is not great for the FTSE 100 but the FTSE 250 seems to be a better reflection of the economic state of play in relation to the other major indices worldwide. BoE's Ramsden also said that the BoE will need to slow down the pace of QE at some point. This is the first time someone at the MPC has commented on the matter although it does seem obvious that it would have to stop at some point.

The chart below is EUR/GBP and the strength in the pound has taken it through the red support level at 0.8866. It was a pretty decent level as it had been tested on 3 separate occasions before the subsequent break lower. Next up the support level marked in blue at 0.8671.

 Source: TradingView

In the Asia Pac area, the Reserve Bank of Australia have also provided the market with an update this week. The market was not expecting any change in monetary policy but the RBA surprised with an additional round of easing. The bank's board decided to buy an additional AUD 100 billion of bonds issued by the Australian Government and states and territories when the current bond purchase program is completed in mid-April. These additional purchases will be at the current rate of A$5 billion a week. The bank is not expecting to raise its interest rates until 2024. This led the AUD to be one of the worst-performing currencies this week, especially against the US dollar.  From the daily AUD/USD chart below you can see that a long term trendline has now been broken. The next support is some way off at 0.7374 around 225 pips away. 

 Source: TradingView

Next week we get the latest US CPI data - Key especially after the NFP result. If inflation starts to rise sharply it could indicate the Fed may need to tighten. Although they have mentioned they are flexible on an overshoot.

US Federal Budget - What is spent where. How much have the US government put aside for spending. Biden has promised a spending plan lets see what he can deliver.

Fed monetary policy report - What are the latest FOMC thoughts. We have heard from many central bankers since the last report so it is not likely there is something new but you never know.

UK GDP - The BoE have talked up GDP this week so let have a look at how the economy has performed during the latest lockdown.

Chinese new year - When the Chinese markets are closed it causes a lull, especially in the metals markets.

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.