The US dollar suffers a sharp correction lower
A strong 30-year bond auction overnight, and a flattening of the US yield curve once again, led by a fall in long-dated yields post US inflation data, saw the dollar index fall sharply. The dollar index plummeting by 0.54% to 94.00, before posting a modest gain to 94.05 in Asia. What cannot be denied is that the dollar index has traced out a major top at 94.50, and a daily close above there will be a strong indicator of a further directional move higher. Only a fall through 93.50 changes the bullish outlook for the US dollar temporarily in my opinion.
Admittedly, part of the US dollar retreat is likely due to the large amount of speculative long dollar positions built up in futures markets versus the major currencies. In the major currency space, it is not a coincidence that the euro, sterling and Swiss franc all rose by over 0.55% overnight, having been under the pump in recent days. Perhaps more significantly, USD/JPY, AUD/USD and NZD/USD hardly moved overnight, suggesting that yield differentials remain in play, and that risk sentiment remains elevated.
Although the PBOC withdrew a lot of money market liquidity today, it did set the CNY fix slightly weaker with USD/CNY fixed at 6.4412. With the CNY having hit multiyear highs on a trade-weighted basis this week, the PBOC might have an incentive to weaken the yuan to support exporters. However, I believe that China’s imported energy and raw material bill is far more important in the short term to the PBOC. I believe today’s weaker fix was an attempt to introduce some two-way volatility and market complacently pricing in stronger fixings and is not the start of a weakening cycle. China is unlikely to mess around with the yuan too much ahead of US/China talks and trade negotiations.
The fall of the US dollar overnight was mainly confined to the DM space and mostly passed Asian currencies by as they posted only modest gains. The Bank of Korea intervention ahead of 1200.00 has worked for now, but USD/Asia has started rising again this morning. Asian currencies remain acutely vulnerable to rising tapering expectations in the US and the accompanying stronger dollar. With only the G-10 space correcting overnight, that signals it was a culling of speculative long-dollar positioning and not a swing in overall directional sentiment. Unless regional markets try to get ahead of the curve like Singapore, which tightened policy on Thursday, the downward pressure on Asian currencies should resume sooner, rather than later.