Potential Key Reversals Forming in AUD/USD, EUR/USD
- Outside engulfing/key reversal bars suggest USD selloff slowing.
- Expect risk on/off relationship with USD to continue.
- With FX volatility edging higher again, it's the right time to review risk management principles to protect your capital.
It sure has felt like the heyday of QE around markets recently: the US Dollar has fallen; commodities have rallied; higher yielding currencies have jumped; equity markets have climbed higher; and global sovereign bond yields have fallen. The risk on/off paradigm that governed markets so significantly in the years after the GFC seems to be back, as market participants have become increasingly sensitive to the prospect of the Fed hiking rates next week.
The simple fact is, whereas rate expectations at the beginning of the month were around a 22-26% probability for a hike, they're now at 0%; and now February 2017 is being priced as the most likely period for the Fed to raise rates (it breaches the historically important 60% probability threshold).
This collapse in rate expectations has driven the US Dollar lower quickly, but in turn, reflexively, this means that it will only take a little bit of improved US economic data to spur a stronger greenback. If US economic data improves meaningfully through the summer, the pulling forward of Fed rate hike expectations to say, September, would help the US Dollar become relatively cushioned.
Until then, the US Dollar needs all the help it can get. With USD/JPY sliding back towards its yearly lows, the developing daily key reversals in AUD/USD and EUR/USD (perhaps foreshadowing a pause in the recent greenback weakness), risk assets are appearing a bit softer. Considering that rate expectations are basically on the floor, anything remotely USD-positive could have a rippling effect across asset classes. The first litmus test is today's release of the weekly US claims data, which should get extra attention after last week's terrible May US Nonfarm Payrolls report.
--- Written by Christopher Vecchio, Currency Strategist
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