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Forex Friday: Dollar, Yen, Aussie, Gold and Pound

Welcome to Forex Friday, a weekly report in which we discuss selected currency themes mainly from a macro viewpoint, but we also throw in a pinch of technical analysis here and there.

In this week’s edition, we discuss the dollar, yen, gold, pound and Aussie, but first look forward to the central bank bonanza in the week ahead.

  • Dollar continues relentless rally ahead of central bank bonanza
  • USD/JPY surges further, so will the BoJ drop YCC?
  • AUD/USD hurt by global, China growth fears
  • Gold likely heading to $1600 amid rising yields
  • GBP/USD breaks trend after another week of turmoil in politics

Dollar continues relentless rally ahead of central bank bonanza

The USD/JPY continues to press higher, now past the 151.00 handle as there are no hints that BoJ is about to chance its dovish stance. Will that change next week? The dollar has also advanced against other currencies, while equities and gold remain sluggish, with bond yields continuing to put pressure on all risk assets. The week ahead is full of interest rate decisions, so it is best to quickly start with a quick summary of the main ones:

Bank of Canada (Wednesday, October 26)

Although Canadian CPI eased for the third consecutive month in September, at 6.9% y/y it remains very high, why core CPI increased to 6% from 5.8% previously, beating expectations. Analysts are split about whether the BoE will hike by 50- or deliver another 75-basis point increase. Governor Macklem remains quite hawkish.

European Central Bank (Thursday, October 27)

The European Central Bank hiked the benchmark deposit rate to 0.75% from zero at its last policy setting, which pushed interest rates to their highest since 2011. Inflation has since continued to rise. Annual CPI accelerated to 9.9% in September from 9.1% previously, rather than 10%. That means prepare for more hikes. Another 75-basis point increase is expected.

Bank of Japan (Friday, October 28)

At 151.50, we are now well above 150.00, which some had predicted might be the line in the sand for the BOJ. the USD/JPY has rallied so much that it has seen the Japanese government try to intervene by selling its huge dollar reserves to help shore up the yen. But its efforts have been futile. Will the government now force BoJ’s hand to change it stance? If BoJ maintains status quo, expect further yen depreciation.

USD/JPY surges further, so will the BoJ drop YCC?

As mentioned, after breaking through the 150 handle the day before, the restless rally continued for the USD/JPY. It crossed 151.50 this morning and was continuing to rise further at the time of writing. Since that Japanese intervention a couple of weeks ago, the UJ has doubled the 555-pip. Is it going to reach 155.00 next?

The USD/JPY is finding continued buying pressure on any dips because of the big divergence in US and Japanese monetary policies. The Fed is hiking and aggressively so, while the BoJ has remained the only major central bank not to drop its ultra-loose monetary policy despite the global inflation upsurge. For the USD/JPY to go down, the BoJ will have to change tack. Otherwise, the buying pressure should keep the downside very limited in this macro environment.

The Japanese government can burn all the dollar reserves it has but buying the yen will only be a temporary fix. Every time it has stepped in, the USD/JPY has repeatedly resumed its bullish trend after bouts of JPY strength quickly fizzled out.

The BoJ has allowed its currency to devalue sharply by keeping its yield curve control in place. It does so by purchasing JGBs with huge amounts of freshly printed yen. In effect, it is supplying the yen that the government is trying to soak up from the market. Hardly surprising then that the government’s interventions have proved to be futile.

Will the BoJ drop YCC?

The above chart was shared by Valerie Tytel of Bloomberg. She warned that the break of the yield curve control (YCC) is a “possibility you can’t ignore.” This is because the 10-year yen swaps have started to rise noticeably above the threshold of 0.25% yield on the 10-year JGB. This shows that investors are hedging their bets by shorting JGBs, as they fear the YCC might be dropped.

Given the growing risk that the BoJ might be forced to drop its YCC, do watch out for a HUGE drop in USD/JPY if it does. That could trigger a move in JPY similar to the 2015 episode in the CHF when the Swiss National Bank dropped its EUR/CHF 1.20 floor.

This of course does not mean you should be shorting the USD/JPY, given that the trend has been very strong. But if you are long, proceed with extra care, always making sure to have a stop loss in place (maybe a guaranteed stop). If you are shorting the USD/JPY in anticipation of a potential drop in YCC, then the position size needs to be small, and in any event always ensure you have appropriate risk management strategy in place.

AUD/USD hurt by global, China growth fears

Following the release of disappointing jobs data, the Aussie has come under renewed pressure. The risk-sensitive AUD/USD has also continued to struggle with sentiment remaining negative towards equities, and Chinese assets.

It has been another bruising week in China where stocks and the yuan fell to fresh yearly or multi-year lows. China is apparently in deep trouble amid its zero covid policy. Remember that China decided to postpone, without giving a reason, the release of its third quarter growth and industrial production figures that were due for publication on Wednesday. Analysts think that economic growth there has slowed to a new three-decade low of 3.3% compared to 4.9% recorded in the same period a year ago. But the fact that China has delayed the release of the data does not look good and investors are worried that the world’s second largest economy may have performed even poorer than those expectations. If China is not doing well, this is not good news for Austria and the rest of the world. The declining exchange rate is a problem seen across many other parts of the world, too.

The AUD/USD’s failed breakout attempt above the bearish trend line and resistance circa 0.6340 means the path of least resistance remains to the downside and such a break to a new yearly below 0.6170 looks likely. There are no other obvious support levels below that, so the next downside target could be the psychologically-important 0.60 handle.

Gold likely heading to $1600 amid rising yields

 Gold, an asset that pays no interest or dividend, is finding it extremely difficult to hold any recovery attempts. The September low at just below $1615 is now in sight. If it can get there, then why not $1600 – or lower?

Both short- and long-dated bonds continue to press lower, lifting their yields higher. The US 10-year yield is now comfortably above 4%, which printed a fresh yearly high of 4.291% earlier. The 30-year yield also hit a fresh cyclical high. This came as the Fed’s Harker reminded us yesterday that the central bank is going to continue pushing interest rates higher and higher. Harker said that inflation will be around 4% next year. If he’s correct, inflation will still be well above target and thus it would require policy to remain restrictive, rather than expansionary to offset a potential recession.

With the dollar also soaring (see USD/JPY!), there is no reason to expect gold to shine in this macro environment until something changes dramatically.

Whatever the outcome of upcoming central bank meetings or macroeconomics, until the chart of gold starts making higher highs and higher lows, I will continue to look for weakness and bull trap signs to emerge. I just don’t think right now – with interest rates continuing to rise – is the environment for a gold market rally. Granted, we will get bounces here and there, but it will all be inside the larger bearish trend.

GBP/USD breaks trend after another week of turmoil in politics

It has been yet another week of turmoil in UK political as Liz Truss become the shortish serving UK Prime Minister in the history after her disastrous mini-budget sent the pound tumbling. As the UK tries to find its next PM, the pressure on UK assets are mounting again, with the FTSE, bonds and pound all falling lower. Double digit inflation in the UK means household incomes are going to squeezed even more, while rising borrowing costs for the government means whoever becomes the next PM, his or her hands will be tied in terms of spending to get us out of trouble.

The gloomy macro outlook has been reinforced by retail sales data in the UK, showing a 1.4% slump in September or a 6.9% on an annual basis. Consumers are reining in their discretionary spending with sentiment remaining close to the gloomiest on record amid high levels of inflation.

Against this backdrop and given the break of the trend line in the GBP/USD, expect more weakness for the cable.

DISCLAIMER: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

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