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EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

John Kicklighter, Chief Strategist

EURUSD, EURJPY, Dollar, S&P 500 and Ethereum Talking Points:

  • The past week ended with further favorable news between US spending and the Amazon earnings aftermath, but yet again, risk appetite refused to take hold
  • The S&P 500 closed out its most restrained week’s range since the Christmas holiday of 2019
  • A sharp Dollar rebound (EURUSD tumble) may just be short-term seasonality adjustment or perhaps a sign of trends to play out over the week ahead

Risk Trends Refuse to Budget When All Green Lights, But Something Will Rouse Markets

The incredible lack of traction from risk-leaning markets was impossible to miss this past week. Despite a run of typically high-profile, market-moving event risk from Fed dovishness to Presidential stimulus hawking to impressive tech earnings results to the fastest pace of US growth in decades, the benchmarks of ‘risk appetite’ refused to extend the already mature bullish trend of the past year (and decade). This wasn’t just an abstract obliviousness from a further unrelated asset like carry, it was also the US indices which were well within the blast radius of the data. For those that revert to the ‘traditional fundamentals are broken’ line, this has happened many times before and influence has waxed and waned. Perhaps that return of influence is already close at hand with EURUSD signaling a reversal of focus. Itself prone to complacency and following inertia, the pair put in for its single-largest daily slide since April 2nd, 2020 following a month-long contained bull trend. Of course, the key question for traders is whether this shift in activity and bearing for the pair and broader capital markets will carry over to the new trading week and month.

Chart of EURUSD with 100-Day Moving Average and 1-Day Rate of Change (Daily)

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Chart Created on Tradingview Platform

To reiterate just how extraordinary the conditions were that paint the backdrop for the new trading week, I have to once again highlight the S&P 500’s extraordinary inactivity. At the end of the day (week and month), the benchmark index posted its smallest range through the entire week – as a percentage of spot – since the week of Christmas 2019. These should not be comparable conditions. That is especially true given the prevailing trend is clearly bullish and all of the high profile event risk of the past week was tapping the key themes that most often impress the default bullish crowd in the open market. And, just to ensure we don’t misconstrue this as a single benchmarks’ peculiar issue, all the major US indices including the Nasdaq 100 backed by tech earnings suffered the same while alternative risk assets (global indices, emerging market assets, carry trade, junk bonds and more) suffered the same.

Chart of S&P 500 with 20-Week Mov Avg and 1-Week ATR (Weekly)

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Chart Created on Tradingview Platform

One semi-permanent influence that may be at work here is the curb in liquidity and turnover. This past week represented the confluence of there different time frames for speculative breaks – the shortest of which was anticipation for the major event risk on tap, which passed without relieving tight trading ranges. On a higher level, there is the seasonal consideration which sees both April and May as restrained in both volume and volatility (via VIX) when evaluated from the VIX. However, I also believe there to be a structural shift in which the we have worked off the pandemic discount and stimulus upgrades of 2Q 2020 and are now seeing price reflect exceptional enthusiasm for the future.

Chart of Monthly S&P 500 Return, Volume and VIX Performance

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Chart Created by John Kicklighter

What Is Motivating the Dollar…And, More Importantly Can It Continue?

While there are a few innate matters that were likely charging the Greenback, it is worth pointing out a couple of prompts that fell outside of the fundamental shift of the benchmark currency. First, there is the end-of-month flows consideration. I do not believe that the period end (monthly/quarterly/yearly) capital flows is an all consuming influence for markets, but there is certainly necessary capital flow that can be attributed to the shifts and influences market movement. Given the Dollar was dropping consistently through the month of April, a ‘rebalancing’ move would naturally assume a bounce. The other external factor to highlight is the Euro – the second most liquid currency and principal counterparts. The currency dropped broadly through Friday with data showing a double dip recession for the Eurozone in the background. The currency’s slide was fairly broad with EURJPY, EURCAD and EURCHF offering up impressive moves in particular. If either of these factors was a principal motivation, I wouldn’t expect the Dollar’s recovery to simply continue next week without a further motivator.

Chart of EURJPY with 20-Day Mov Avg (Daily)

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Chart Created on Tradingview Platform

With the Dollar’s own control, there is the market’s own doubt around the Federal Reserve’s commitment to maintain a perpetual dovish regime. While the FOMC and its leader kept to the line that they had no intention to consider the timetable of normalizing extremely dovish policy for now, the markets maintained an obvious perspective of skepticism as can be seen in the US 10-year Treasury yield and the implied rate forecasts derived from Fed Funds futures. It was really only the Dollar of these three measures that continued to suffer and the convergence saw the Greenback capitulate. At the end of the week Dallas Fed President Robert Kaplan who made clear not all members saw the situation the same way. He remarked that he believes they should discuss taper soon, he believes that the first hike would come in 2022 and that he feared there were “excesses and imbalances” in the financial markets. These are remarkable comments, but the market likely expected them from the known-hawk. Of course, we should watch rates forecasting into next week.

Chart of DXY Dollar Index Overlaid with US 10-Year Yield and Implied Fed Rates (Daily)

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Chart Created on Tradingview Platform

The Top Event Risk and Market Mover Options Next Week

Speaking of next week, the docket is markedly lighter with far fewer top-tier listings relative to what we have just closed out. Nevertheless, there are matters to absolutely keep track of for volatility potential should the market be in a fundamental mood. From the US docket in particular, there is a noteworthy listing every day of the week. Given the Fed’s commitment, all of its is important. However, I will focus most on Wednesday’s ISM service sector report given it is a proxy of GDP and timely up to April and Friday’s NFPs as the Fed seems to have shifted its dual mandate to weight more heavily towards employment.

Calendar of Key US Macro Economic Events

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Created by John Kicklighter

Another key theme to draw out of the event risk ahead is monetary policy. On the back of the Federal Reserve’s dovish hold, it is important to remind ourselves that the Bank of Canada (BOC) actually took the step to taper its weekly asset purchases. It is therefore leading the normalizing swing in policy. Ahead, we have the Reserve Bank of Australia (RBA) and Bank of England (BOE) on tap to weigh their own policy. The former supports a typical carry currency and has gotten its covid curve under control faster than many while the latter is seeing an impressive reopening and similar inflation pressure build up. As noteworthy as these two central banks are, they are unlikely to change monetary policy now. In contrast, two emerging market central banks would surprise not to adjust. We have the Turkish Central Bank which is sitting at 19 percent as a benchmark rate and the Turkish President recently replaced the group’s head because he found that lending rate far too onerous. They held last meeting perhaps to inspire stability, but how long will they hold at that level? Then there is the Brazilian Central Bank which has strained under a rise in coronavirus cases and is expected to cut its benchmark by 75 basis points. Add USDTRY and USDBRL to the watch list.

Chart of Relative Monetary Policy Standing Perception

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Created by John Kicklighter

Finally, a note to watch the difficult-to-track flows of speculative appetite. We have seen an extraordinary drive of risk appetite in the recovery from the pandemic which has witnessed a shift in target from Bitcoin to FAANGs to Tesla to meme stocks to Dogecoin and now the verdict is out as to what the next target of ‘hot money’ will be. I would suggest watching Ethereum as it outpaces Bitcoin with a record high, Tesla given Elon Musk’s constant activity in social media and AMC as it reports earnings. Of course, the actual top billing is likely to be something else complete, but only an observant disposition will point you in the right direction.

Chart of Ethereum, Tesla and AMC (Daily)

EURUSD Posts Biggest Daily Drop in a Year - Can the Dollar Carry That Trend?

Chart Created on Tradingview Platform

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