Powell turns hawkish but US dollar weakens
It is difficult to unpick the overnight movements in currency markets. The Moderna omicron headlines sent haven currencies such as the Japanese yen and Swiss franc soaring, but the US dollar also faded badly versus the euro and the emerging market space. Inflows into the German Bund market will have assisted the euro, but heightened concerns over omicron should have weakened EM currencies, not strengthened them. Additionally, a hawkish Powell narrative in overnight testimony should have been US dollar positive, although the US yield curve flattened afterwards.
I can only surmise that in the confused menagerie of overnight trading, month-end institutional flows played their part in the US dollar’s demise. Notably, the sterling and Australian and New Zealand dollars barely moved on a closing basis, despite the EM FX rally. That suggests the risk sentiment remains fragile and that the EM rally overnight should be taken with a huge grain of salt. The prospect of a faster Fed taper and earlier hikes in 2022 should start to reassert themselves.
The dollar index traded in a frenzied 100 point range overnight between 95.50 and 96.50, before closing 0.31% lower at 95.89, rising slightly to 95.95 in Asia. 95.50 to 96.50 will probably cover the rest of the week, at least until the next omicron headline. EUR/USD rose 0.40% to 1.1330, but its rally looks fragile. USD/JPY and USD/CHF plummeted on haven buying, with USD/JPY testing 112.50 intra-day before closing at 113.20. The cross looks very overdone at 112.50 and I will stick my neck out and say that will be the week’s low.
The US dollar has strengthened this morning, notably against the majors, perhaps as risk sentiment has recovered. That is evidenced by the 0.40% rise by AUD/USD and NZD/USD today, which are key barometers of market risk sentiment. Both currencies remain vulnerable to headline risk though and a move below their 2021 lows at 0.7100 and 0.6800 remains the path of least resistance.
Asian currencies rallied sharply overnight with USD/CNY falling 0.405 to 6.3940, USD/MYR falling 0.90% to 4.2000 despite oil plummeting, and USD/KRW falling 0.70% to 1182.70, a pattern repeated across the Asia FX space. I believe month-end flows, as well as the fall of the USD/JPY, helped drive the EM outperformance. Asian currencies have continued to book more gains today in Asia, driven by improved risk sentiment after the vaccine efficacy story from Israel gained wider circulation. With Asia FX rallying on positive virus news, its stands to reason that the next negative headline will see them about-face. With Jerome Powell setting a hawkish tone overnight, I would urge caution about the longevity of the Asian FX rally.
