The market has moved to discount the likelihood that the next four rate hikes by the Federal Reserve will be in 50 bp increments. As a result, the implied yield of the December 2022 Fed funds futures contract has risen for six consecutive sessions, finishing last week near 2.70%, a roughly 35 bp increase. Now, the swaps market sees a terminal Fed funds rate in this cycle near 3.50%.
The only major central bank that might be able to keep up with the Fed is the Bank of Canada. The swaps market has discounted 200-225 bp in tightening over the next four meetings. The positive impact on the Canadian dollar appears to have been blunted by the sell-off in equities, to which the Loonie seems particularly sensitive. To be sure, the Bank of England is expected to continue its tightening cycle. While the BOE's Mann suggested more rate hikes now could deter more aggressive hikes later, the weakening consumer confidence and a precipitous decline in retail sales excluding gasoline (down four of the five months through March) may encourage officials to go slowly in boosting interest rates.
The April flash PMI suggests the eurozone economy may be more resilient in the face of the energy shock and Russia's invasion of Ukraine than anticipated. With rising inflation, the ECB appears to have signaled an end to the bond purchases in June and the first hike in July. As a result, the swaps market has increased the implied year-end deposit rate for seven consecutive weeks to stand near 0.24%. It rose 16 bp last week alone and was still below zero as recently as April 6.
The dollar stalled against the yen near JPY129.40 in the middle of last week. The jawboning managed to break the 13-day streak but has not been sufficient to push the greenback lower. Not coincidentally, the US 10-year yield approached 3.0% in the middle of last week too. Meanwhile, the BOJ defense of its Yield Curve Control has managed to steady the 10-year JGB yield but has been unable to push the yield much below the 0.25% cap. The BOJ meets next week. It will likely revise higher its inflation forecast but stress that the rise in energy and food and rolling off of last year's cell phone service price cuts will not boost CPI on a sustained basis. It is, therefore, reluctant to change its monetary policy stance. This, coupled with the IMF's regional head acknowledging that the yen's weakness reflects fundamentals, means that material intervention is not really likely, despite some speculation.
Dollar Index: The Dollar Index traded above 101.00 last week for the first time since March 2020. In the panic that ensued when the pandemic first struck, the Dollar Index peaked near 103.00. It is on quite a run, having advanced in 15 of the past 17 sessions, going back to late March. That said, the move has been fairly orderly, and it remains below the upper Bollinger® Band (two standard deviations above the 20-day moving average), which begins the new week around 101.60. The momentum indicators are stretched. The key downside reversal in the middle of last week did generate some follow-through selling, but new buyers emerged on the dip below 100.00. The move on interest rates has been powerful. Watch for signs that the market is getting tired as the momentum is not sustainable. It may take a retest below 99.70-99.80 to prod momentum traders and trend-followers to move to the sidelines.
Euro: The single currency may not have much downside momentum after finding support around $1.0760, but it struggles to sustain even modest upticks. It has risen four times over the past 17 sessions. During this run, it has fallen by four cents. It was the first weekly close below $1.08 since mid-March 2020, though it settled only 0.1% low on the week. The MACD and Slow Stochastic remain stretched but are not falling. Last week's high was slightly above $1.0935, not quite a two-week high. We still think there is potential toward the March 2020 low around $1.06. We suspect a move above $1.0970 is needed to signal anything of technical importance. The US-German 2-year rate differential has been consolidating since reaching almost 255 bp on April 5. This may suggest a range affair in the euro in the near term.
Japanese Yen: The dollar was bid to JPY129.40 in the middle of last week, the highest level in 20 years. As the US 10-year yield consolidated since approaching the 3% threshold, so has the dollar-yen. A push in the US yield below 2.80% may send the greenback below support around JPY127.25, forcing out some of the late dollar-longs. One Japanese television source claimed that Japan's Finance Minister and US Treasury Secretary "likely" spoke about joint intervention, but it was not seen as a compelling threat. And the dollar remained within the range set on April 20 (~JPY127.45-JPY129.40). The sideways movement may help ease official concerns about the pace of the currency adjustment. The five-day moving average has offered support on a closing basis. The dollar has not closed below this average since April 1. It begins the new week near JPY128.10. Since moving above JPY125.50, we have been targeting JPY130, and while that has psychological importance, we suspect the potential may extend toward JPY135. The dollar has fallen against the yen twice this month, and both times took place last week. Speculators in the futures market have amassed the largest net short yen position in nearly four years. Like some of the biggest rallies in stocks in a bear market, a short squeeze could give the yen a dramatic lift. There is no substitute for disciplined risk management.
British Pound: Sterling fell by a little more than 1.7% last week, its biggest decline in eight months. The lion's share of the loss occurred before the weekend after the UK reported a drop in consumer confidence and a collapse in retail sales. Sterling fell to its lowest level since November 2020 and met our $1.2830 target. It is the (50%) retracement objective of sterling's rally from the March 2020 low near $1.14 to the high from last June at around $1.4250. A break of that area could find support near $1.27, though the next (61.8%) retracement target is closer to $1.25. The momentum indicators have turned lower without fully cycling higher. The sharp sell-off pushed sterling below its lower Bollinger Band (~$1.2940) ahead of the weekend. That area may offer an initial cap. While the market has priced in about 250 bp of Fed hikes this year, the swaps market sees 150-175 bp from the Bank of England.
Canadian Dollar: Although the Bank of Canada is one of the few central banks expected to keep up with the Fed in this cycle, it has not protected the Canadian dollar from the broad strength of the greenback, especially in the risk-off phase that has seen equities drop dramatically. The correlation between the change in the exchange rate and the change in the S&P 500 is the strongest of the year. Since the bullish hammer candlestick on April 5, we saw potential toward CAD1.27, which was surpassed ahead of the weekend. There is little chart resistance before CAD1.28. The momentum indicators are not stretched, but the greenback settled above the upper Bollinger Band (~CAD1.2690). Initial support may be seen in the CAD1.2630-CAD1.2650 area.
Australian Dollar: The Australian dollar fell 2% against the US dollar last week. It was the weakest of the major currencies. It was really a week of two halves for the Aussie. In the first half, it found support around $0.7345 and bounced to almost $0.7460, where it appears to have met a wall of sellers. It reversed lower on April 21, and follow-through selling ahead of the weekend was dramatic. It dropped to $0.7235 and convincingly violated the three-month uptrend (~$0.7335). The (61.8%) retracement of the Aussie's rally this year (from the ~$0.6970 low on January 30 to the $0.7660 high on April 5) is slightly below the pre-weekend low. Chart support is seen in the $0.7185-$0.7200 band. The MACD is trending lower, but the Slow Stochastic has flatlined in oversold territory. As we saw with sterling and the Canadian dollar, the pre-weekend sell-off pushed the Aussie below its lower Bollinger Band (~$0.7300).
Mexican Peso: The peso was a market darling in March. It had appreciated for 11 consecutive sessions. The demand carried into the first part of April. It rose in seven of the first 10 sessions this month. However, the aggressiveness of the anticipated Fed tightening and more limited appetite for risk has taken a toll. As a result, the peso has fallen in five of the past seven sessions. The greenback rose to almost MXN20.38 before the weekend, its highest level in a month, which is a little below the (38.2%) retracement objective of the greenback's decline from the early March high around MXN21.50. While we anticipated a move toward MXN20.20, the stronger gains have lifted the technical outlook. The momentum indicators are trending higher, and a double bottom appears to have been forged earlier this month around MXN19.73, which should now offer support. The measuring objective is around MXN20.65. The next retracement objective (50%) is a bit lower, near MXN20.60. That said, the pre-weekend move seemed exaggerated, and the close was near the middle of the range. Latam currencies led the emerging market FX complex higher this year, but last week were among the worst performers, accounting for five of the weakest EM currencies.
Chinese Yuan: The dollar rose 2% against the Chinese yuan last week, the most since August 2015. The greenback gapped higher in the middle of the week, egged on by a sharply higher dollar fix by the PBOC. Last week, we warned of the risk into the CNY6.50-CNY6.60 but did not think it would be seen so quickly. The greenback's surge left it more than three standard deviations above the 20-day moving average. The pace of the move may be surprising for Chinese officials who may want to avoid a vicious cycle of the weaker exchange rate fueling capital outflows, sparking more currency weakness. Still, the divergence of monetary policy means that shadowing the dollar, like the PBOC, is not realistic or helpful. The jump in volatility and the surge in the put-call skew (25 delta risk-reversal) suggest the demand for dollar calls, which could be used to hedge Chinese exposure. The three-month implied vol rose from 3.9% at the end of the previous week to more than 5.3% now. The skew reached its higher level since the spike in March 2020. Reports suggest volume in the offshore yuan (CNH) and yuan options surged.