Weekly analysis

The commodity sector traded lower for a third week, with the main market focus being the risk of an economic slowdown caused by runaway inflation and central banks stepping up their efforts to bring it under control .
Gold, which has been on the defensive for the past five weeks in response to stubbornly high US inflation driving up the dollar and US government bond yields, slumped below support-turned-resistance at $1680 as the market was overwhelmed by momentum and technical-driven selling related to the risk of a 1% US rate hike next week. In addition, the market continued to raise expectations for how high Fed funds will rise over the coming months.

Crude oil traded lower in the week, partly driven by losses across fuel products such as gasoline and diesel, but remained within a recently lowered range, with demand concerns once again being the main focus more than offsetting potential supply challenges in the coming months. Growth and demand concerns, as well as the stronger dollar making the cost of fuel increasingly expensive around the world, remains the focus as the market prepares for another growth dampening rate hike from the US FOMC next week.

In addition, demand in China continues to linger after the IEA said the world's largest importer of oil was heading for its biggest annual drop in demand in more than three decades. Meanwhile, the US Department of Energy walked back on its SPR refill stance by saying that it didn’t include a strike price (that was said to be around $80/barrel) and it isn’t likely to occur until after fiscal 2023.

In Europe and increasingly also Asia, elevated prices for gas and power continue to attract substitution demand into fuel products like diesel and heating oil. In addition, the supply side will also be watching the impact of the EU embargo on Russian oil, which will begin impacting supply from December. The IEA in their latest monthly oil market report highlighted the embargo as their reason for lowering Russian supply in early 2023 by 1.9 million barrels per day – a development if not arrested by a peace deal or any other political development in Moscow could see the market turn increasingly tight again. In addition, the current lull in Chinese demand look set to reverse once lockdowns are lifted and, together with the risk of supply tightening, we see potential weakness in Q4 being replaced by renewed strength next year.

With Fed Chair Powell’s refusal at the FOMC meeting on Wednesday to provide forward guidance and indication that coming rate moves will depend on incoming data, the risk as we noted would be an increased sensitivity to data releases. And we saw that yesterday after the release of the weak first estimate of US Q2 GDP, which had annualized growth falling at -0.9% relative to the prior quarter (so an actual fall of less than 0.25%), led by shifts in inventories, weaker government spending and fixed investment, while personal consumption was +1.0%. Fair or not (and to be fair to observers like the Biden Administration, this does not look like a real recession at all yet) this drove the USD sharply lower, with the USD touching new local lows against the majority of G10 FX pairings and the JPY the highest beta currency to the situation on the sharp move lower in treasury yields. That reaction, rather like the kneejerk reaction to the FOMC meeting the day before, has in turn faded fairly quickly, if not fully, suggesting that the market realizes very well that the next data release could fail to support the trend toward lower and earlier peak Fed funds rates. Today we get the June PCE inflation data, but the busy data calendar through next Friday’s July US jobs report may offer a minefield for tactical USD traders, especially when the next CPI data points roll around on August 10 and September 13. Tactically, an important coincident indicator is the US 10-year Treasury yield benchmark, which finally punched below the 2.70% in the wake of the data release but has not followed through lower – if it reverses back sharply into the old range, that may be the end of this USD move lower for now – also in USDJPY terms (assuming no BoJ shift).

The Fed’s halt to QT and eventual move to cut rates and even resumption of QE was possible as there was no inflation to complicate the backdrop, and it while had softened a bit, there was no whiff of recession in the air. This time, the Fed is only likely to relent on further tightening and to begin ease because the labour market has come under severe pressure, which only happens in recessions. And recessions are historically where the Fed is busy chasing to get ahead of a worsening of financial conditions. And the latter only improve in a recession once the Fed has eased sufficiently to get ahead of the downturn. In short, the market is getting way ahead of itself here and we are likely well ahead of peak financial condition tightness – the point at which “something breaks” as we have phrased it before.
This week has seen a tactical capitulation of the USDJPY bulls after the FOMC meeting and negative US Q2 GDP estimate. Overnight, the Tokyo CPI was a bit hotter than expected as well, although it is unlikely the BoJ will carry out a policy shift unless it is under duress at a time of weaker JPY and higher commodity prices. The Ichimoku level of note in coming days is the bottom of the cloud near 131.50, conveniently near the old cycle high that was retested back in June.

Trade accordingly with your risk

EUR/GBP advanced significantly this week to trade back within the ascending channel. A series of extended lower wicks set the scene for the bullish move which appears to have encountered an immediate level of resistance at 0.8670  a level that has kept higher prices at bay many times before.

Price action also trades around the midline of the ascending channel which may serve as additional resistance in conjunction with the 0.8670. Should we see an advance above immediate resistance, the next significant level of resistance comes in at 0.8723  a stronger level that has proven to be rather effective in acting as a pivot point.

Support appears at 0.8670 and if we are to see a retracement of this weeks move, 0.8470 becomes the next level of support.

Trade accordingly with your risk

The pair closed the week slightly higher, with the highlight being Powell’s comments on inflation that drove investors to the safe-haven pair.

“The Federal Reserve will not let the economy slip into a “higher inflation regime” even if it means raising interest rates to levels that put growth at risk,” Fed Chair Jerome Powell said on Wednesday.

These and many more comments emphasized the bank’s commitment to taming sky-high inflation. Powell said the more significant risk was not a slowed economy but rather the failure to restore price stability.

On the daily chart, bears pushed the price to 0.95004, where it found support. The week had been choppy for the pair until the last day when the price increased impulsively. The choppiness is a sign of weakness in the bearish move. Bulls have come in to test the waters and see if it is possible to start a bullish move. However, bears are still in charge since the price is trading below the 22-SMA and the RSI is below 50. The trend will only change if the 22-SMA fails to act as resistance and the RSI starts trading above 50.

USD/CHF picks up bids to consolidate intraday losses, struggles to extend Friday’s downside move. Market sentiment remains positive but US dollar bounce off daily lows as traders recheck hawkish Fed bets. SNB, Fed expected to ease on rate hikes amid recession fears. 

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If we have a look at the reaction in Fed expectations from Friday’s Fed Chair Powell speech at Jackson Hole, there was no major market takeaway. During the speech, there was a trivial marking down of expectations as Chair Powell emphasized the “totality” of data in setting the appropriate rate at the September meeting. (And 90 minutes before his speech, the July PCE inflation data was out a tad softer than expected, while the final University of Michigan sentiment survey for August saw longer inflation expectations 0.1% lower). But for that September 21 FOMC rate decision, the payrolls and earnings data this Friday and the Sep 13th CPI release will weigh more heavily.

Somewhat more importantly, Powell underlined the importance of ensuring that The Fed’s policy remains persistent enough to ensure that the inflationary cycle has abated. One of the key passages worth highlighting is “Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.” Powell then went on to invoke Paul Volcker and his fight with recurring bouts of high inflation in the 1970’s and early 1980’s. 

Watching USDJPY closely this week to see if US data takes US treasury yields higher still – especially at the longer end of the US yield curve, which could serve to renew the pressure on the Bank of Japan as it insists on maintaining the yield-curve-control policy. Arguably, as long as the longer end of the US yield curve is anchored below the June highs, the pair doesn’t have particularly cause to run higher unless there is a USD liquidity problem not connected to yield volatility. And if we get weak US data this week through Friday’s jobs and earnings report, we might be instead looking at a “double top” scenario. The 139-140.00 zone looks important this week. 

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The nearly unprecedented pace of Fed tightening this year has seen the Fed hike rates 150 bps in the space of three meetings, and the market has priced another 200 bps of tightening for the 2022 calendar year. If tightening proceeds as expected, that will be a total of 350 bps in a brief space of a nine months. Consider that it took Yellen and Powell three years to hike 225 bps and Greenspan and Bernanke nearly two years to hike rates 425 bps—and that’s without the quantitative tightening (QT) of the post-global financial crisis (GFC) era. In short, the Fed has not moved at this pace since the early 1980s.

The Fed still tries to push back against over-the-top tightening expectations even after its tardy start to the hiking cycle. At the FOMC meeting on 4 May, Fed Chair Jerome Powell specifically pushed back against the idea of hikes larger than 50 bps, only to hike by that much on 15 June, after what many believe to be the Fed guiding the market via a WSJ op-ed. Then, at the 15 June press conference, Powell tried to float the idea that the July hike might be 50 bps instead of 75. Clearly, the Fed retains the fervent hope that the current high inflation levels will still eventually prove transitory. This is in abundant evidence in the latest Fed staff economic projections as well, where the June FOMC meeting refresh still puts the 2024 expected personal consumption expenditures (PCE) core inflation at 2.3 percent. This is no change from March, although the Fed actually lowered the projected core inflation reading for 2023 and the headline inflation for 2024 by -0.1 percent. As we express in this outlook, the risk is that inflation is a runaway train and the Fed is still chasing from behind the curve, never able to catch up.
One argument for how the US dollar might peak and begin its turn lower despite the Fed’s tightening regime is that many other central banks are set to eventually outpace the Fed in hiking rates, taking their real interest rates to levels higher than the Fed will achieve. This very development has been behind a few emerging market (EM) currencies like BRL and MXN already posting the kind of resilience one might never have thought possible in an environment of rapidly rising US yields and a stronger US dollar this year. But within a G10 FX context, outside of the important exception of USDJPY, most US dollar pairs haven’t shown much correlation with the developments in yield spreads driven at the front end of the curve by central bank policy expectations or at the longer end of the yield curve. Take a pair like AUDUSD, where the Reserve Bank of Australia (RBA) hiking expectations have now caught up and surpassed Fed expectations for the coming nine months, and where the 10-year Australian government bond yield (as of late June) traded 80+ bps higher than its US Treasury Note counterpart, compared with a range of 0 to 50 bps for the first few months of this year. This leads us to believe that the dominant strong US dollar driver in this cycle is the US dollar’s global reserve status and the simple directional fact of US inflationary pressure requiring the Fed to continue to tighten. This wears on sentiment and global financial conditions. If that is the case, then the USD will only begin turning once economic reality finally flounders, sufficiently reversing inflation via a demand-induced recession. Only then will the US dollar finally roll over after its remarkable ascent to its highest level in more than 20 years.
With the huge fiscal outlays to combat the pandemic in the US in 2020 and 2021—some $5 trillion in total—came strong new fears about the fiscal sustainability of the US government. Fast forward to 2022 and we discover that the booming asset markets in 2020 and especially 2021, as well as record boosts in personal income from the huge pandemic cash splash, brought enormous tax revenues, helping to ease these budget concerns, even if only temporarily. While things don’t look too alarming for this calendar year, the next few years will likely prove a different story. That’s because since the 1990s, tax revenues have become increasingly correlated with asset market returns—and these are looking a bit ugly for this year, to say the least. The brief 1990 recession and bear market saw nominal tax revenues actually rising 2 percent in 1991, but that compares to rises of revenue of 9 to 10 percent in the two years prior. Compare that with the wake of the tech bust of 2000 to 2002, when nominal tax revenues fell for three years running from 2001 to 2003 by a total of 12.3 percent, despite a nominal economy that continued to grow. The 2008 nominal US tax revenues did not recover to a new high until 2013.

The 2022 US budget deficit is forecast to only reach -4.5 percent of GDP this year and maybe even less, up from a projected -6 percent at the beginning of the year. The fiscal turnaround is so vast that the US Treasury may even reduce the size of some of its treasury auctions this year, helping offset some of the pressure on the market to absorb treasury issuance as the Fed actively reduces its balance sheet at a rising pace until reaching $95B/month in September.  

So even without a recession, assuming at best that US asset markets trade sideways to slightly up for the rest of this year, next year’s budget balance will deteriorate badly as capital gains tax revenues shrivel and the cost of servicing existing debt skyrockets on all maturing and new Treasury debt resetting to sharply higher yields. Throw in an eventual recession sometime next year and the US Treasury will be in trouble, challenged to fund its spending priorities. In all likelihood, due to the lack of investment to improve the supply side of the economy, inflation won’t have fallen much by then and won’t allow the Fed to ease as forcefully as it has in the recent cycles since 2000. At the risk of getting ahead of ourselves, we will have to consider the next recession policy response. And in that environment, the Fed may be sidelined as the US Treasury reaches for stronger medicine. An example would be implementing capital controls to keep savings at home and/or financial repression through forcing a percentage of private savings into US treasuries that offer savers negative real yields because of caps on nominal treasury yields. In other words, monetary policy is rapidly becoming irrelevant as it can’t keep up with inflation risks. If it did, it would challenge the stability of the sovereign. To watch the Fed is to look in the rear-view mirror.

Lower fuel costs lowered Canada’s July inflation. The BoC governor believes inflation is still too high. Investors will take a lot from Fed Chair Powell’s speech next week regarding monetary policy.

The weekly USD/CAD forecast is bullish as the pair might continue its rally next week with the dollar strengthening further. 

USD/CAD had an intense week with news releases from Canada and the United States. Official data released on Tuesday revealed that Canada’s inflation moderated marginally in July due to decreased gasoline costs, leading the central bank governor to comment that the annual rate may have peaked but will “remain too high for some time.”

Underlying price pressures indicated that another significant interest rate increase was possible. Bank of Canada Governor Tiff Macklem stated that inflation is still “far too high” in an opinion piece published on the National Post website following the release of the statistics.

Despite rising gasoline prices and increased sales at car dealerships, Statistics Canada data showed on Friday that Canadian retail sales rose 1.1% in June, surpassing estimates. However, sales were predicted to decline in July. Statscan, in a preliminary estimate, said it sees July retail sales falling 0.2%.

On the other hand, the US dollar soared last week after Fed officials emphasized the need for more significant interest rates to control inflation. This dollar rally saw USD/CAD closing the week higher.
In the coming week, investors will wait to hear what the Fed chair, Powell, will say in his speech regarding monetary policy. US GDP for Q2 is expected to grow from -1.6% to -0.8%.

Looking at the daily chart, we see the price trading above the 22-SMA with the RSI above 50, showing the trend is bullish. The price is heading for a strong resistance level that has stopped bulls several times. The 1.30258 level might cause a reversal to the downside.

From late May through early June, the USDCAD pair broke down through key support and the 200-day moving average on the persistent rise in crude oil and as US equities had rebounded sharply from the lows of May. CAD was the strongest G10 currency for much of this period. Then, things suddenly turned south for CAD and USDCAD launched a sharp rally higher from nearly 1.2520 to 1.3000 when global stocks suffered an ugly rout from June 9-11, accelerated by the US May CPI release on June 10 that send US and global yields soaring in anticipation of a tighter Fed and the WSJ tip-off that the June 15 FOMC meeting would deliver 75 basis point hike. USDCAD peaked (and risk sentiment bottomed) on June 17, two days after the FOMC. Since then, the WTI crude oil benchmark has backed off from highs well north of 120 dollars per barrel to as low as 101.50 before rebound to about 106 as of this writing. That is extremely CAD negative, and yet USDCAD has traded in a tight range over the last week because off-setting that is the USD-negative sudden mark-down in Fed hiking expectations accelerated yesterday by weak flash June PMI data that mimicked the weak EU flash June PMI data. The market has marked the peak rate from the Fed by around 50 basis points and pulled the anticipated peak in the policy rate into very early next year.

As long as yields continue falling and risk sentiment prefers to celebrate that fact rather than fact that this is an expression of the fear of recession, the pressure for the USD to rise fades. But if the next batches of economic data show that the Fed can’t back down any time soon due to persistent inflation readings from services inflation, rising rents and/or a still-tight jobs market, the USD could yet rise on a re-adjustment back higher of Fed tightening anticipation. On the other hand, if risk sentiment begins to falter on recession concerns, the US dollar may trade higher as a safe-haven. Technically, the comeback of the last couple of weeks is remarkable and trend-followers will look for a solid fall of the very well-defined 1.3000 area to indicate and next leg higher toward 1.3500. The tactical situation to the downside is rather more uncertain due to the huge swings in both directions within the range in recent weeks. 

The pair closed the week slightly higher with a small-bodied weekly candle showing there were mixed reactions to the news releases over the week. The move up was mainly caused by the weakness in the US dollar after disappointing US data showed a slowdown in the economy.

The US dollar also lost ground after the FOMC meeting, where Powell came off as less hawkish than investors had feared. Markets seized on this as a possibility that the Federal Reserve would loosen its tight policy. All these developments helped support the EUR/USD. 

However, this move up was capped by the crushing eurozone economy. Several things have been ailing the region this past week, including political instability in Italy, the ever-growing gas crisis, and the red hot 8.9% inflation rate. All these things played a role in dragging the pair down.
The daily chart shows the price at a very important level. The bulls have been trying to break above 1.02503 since July 19. However, this level has held strong. The RSI trades below 50 and shows bears are still in charge. At the same time, the price is on the cusp of breaking above the 20-SMA, showing a looming shift in sentiment.

If 1.02503 holds as resistance, the price might retest parity, while a break above could hit the June 28 resistance at 1.05879. 

Trade accordingly with your risk

The Bank of Japan continues to swim against the stream of global central bank tightening as it maintained course overnight with its policy mix of negative yields and yield-curve-control, triggering a wave of fresh JPY weakening that was only moderated slightly by a sharp drop in US treasury yields.
The Bank of Japan refused to budge overnight, standing pat on its policy of yield-curve-control and announcing daily operations in the bond market to defend the policy, with no guidance suggesting a change of course, though a brief comment on foreign exchange was inserted into the policy statement.

That suggests that there is some level of JPY weakness at which the Bank of Japan may be forced to revisit its policy commitments, but that we aren’t there yet. 
Sterling rallied hard yesterday in the wake of the Bank of England meeting yesterday, with UK rates and the currency focusing more on the hawkish guidance the meeting produced rather than due to the small 25-basis point hike. The bank said it would react “forcefully” if inflation doesn’t develop as hoped (which will take some doing – the Bank of England expecting the CPI to hit north of 11.0% before falling back after October) which suggests the willingness to hike by 50 basis points even if the economic outlook is not promising.

Trade accordingly with your risk