Breaking of the DXY index, USD / JPY reversal in play
US Dollar Outlook:
- US Dollar (via DXY Index) Hit New Yearly High After October US Inflation Report, spurring speculation that the Fed will accelerate the withdrawal of stimulus measures.
- A weak afternoon US bond auction saw US Treasury yields leap across the curve, increasing interest rate differentials in favor of a stronger US dollar.
- The IG Customer Sentiment Index suggests that the USD / JPY has a mixed short-term bias.
The US dollar bounces, the bullish flag breaks
Coming this week, this appeared that the US dollar (via DXY index)was stuck in a beach after the November Fed meeting and the October US NFP report. A drop in the Fed’s bullish ratings as a relative ceiling appeared to be reached (market prices in June 2022) suggested that the greenback could face more difficult trading conditions in the very near term. Admittedly, it was wrong; nothing changes your mind like the price action.
With US inflation hits its highest level since 1990, and a subsequent US bond auction, showing weak demand, yields on US Treasuries rose, providing the US dollar with a new catalyst in the form of favorably moving interest rate differentials.
While the Fed has indicated that it will only decrease by $ 15 billion / month in November and December, speculation is growing that an accelerated decrease could take place in early 2022, paving the way for more rate hikes. earlier than the aforementioned planned date of June 2022.
No more Fed Hawkish now anticipated
We can measure whether a Fed rate hike is built into the price using Eurodollars by looking at the difference in borrowing costs for commercial banks over a specific time horizon in the future. Figure 2 below shows the difference in borrowing costs – the spread – for the November 2021 and December 2023 contracts, in order to assess the direction of interest rates by December 2023.
Spread of Eurodollar futures (NOVEMBER 2021-DECEMBER 2023) [BLUE], US 2s5s10s Butterfly [ORANGE], index DXY [RED]: Daily chart (MAY 2021 to NOVEMBER 2021) (Chart 1)
By comparing the Fed’s rate hike ratings with the US Treasury’s 2s5s10s butterfly, we can assess whether or not the bond market is acting consistently with what happened in 2013/2014 when the Fed signaled its intention. reduce its quantitative easing program. The butterfly 2s5s10s measures non-parallel changes in the US yield curve, and if the story is correct, that means intermediate rates are expected to rise faster than short or long rates.
While last week there were signals that the market may have been too aggressive in its pricing about how quickly the Fed will move to raise rates once the cut is over following Fed Chairman Powell’s press conference and US NFP report ‘October, the October US inflation report completely reversed the price changes.
There is 138-bp of discounted rate hikes through the end of 2023 as the butterfly 2s5s10s recently fell from its widest spread since the Fed began talks in June (and its widest spread of any 2021). It’s a big change since last week, when there were 117 basis points of hikes priced in: there is now a 100% chance of five 25bp hikes and a 52% chance of six 25bp hikes.
TECHNICAL ANALYSIS OF THE DXY PRICE INDEX: DAILY CHART (SEPTEMBER 2020 TO NOVEMBER 2021) (CHART 2)
The DXY index climbed higher during the session, erasing both its old annual high set in August as well as the monthly and annual high set last week after the October US jobs report. In doing so, it also hit the March 2020 low at 94.65 and the September 2020 high at 94.74. A plethora of resistance began to erupt.
Now the bullish momentum is starting to strengthen again. The dollar’s broad gauge is above its daily envelope of 5, 8, 13, and 21 EMAs, which is in bullish sequential order. The Daily MACD rises above its signal line, while the Daily Slow Stochastics once again move into overbought territory. Unless a pullback below 94.62, the DXY Index may have just started its next short-term upward step.
TECHNICAL ANALYSIS OF THE USD / JPY RATE: DAILY CHART (January 2021 to November 2021) (CHART 3)
USD / JPY rates appear to be consolidating in a bullish bearish wedge, supported by rising US Treasury yields. As interest rate spreads widen between Treasuries and JGBs, the one-way street points to greater USD / JPY strength. However, USD / JPY rates can be held back by the fact that the US stock markets experience some volatility, which usually goes hand in hand with the strength of the yen.
The pair is just starting to reassert itself above its daily EMA envelope, which is neither in bearish nor bullish sequential order. The MACD’s daily decline above its signal line is easing, while the Daily Slow Stochastics are just breaking out of oversold territory. While a push to the annual high of 114.70 cannot be ruled out, past advances here seem unlikely as long as the US stock markets are in decline.
IG client sentiment index: USD / JPY rate forecast (November 10, 2021) (Chart 4)
USD / JPY: Retail traders data shows that 33.23% of traders are net long with a ratio of short / long traders of 2.01 to 1. The number of net long traders is 12.80% lower than that of yesterday and of 1.43% compared to last week. while the number of net-short traders is 3.40% lower than yesterday and 5.46% lower than last week.
We generally take a contrarian view of crowd sentiment, and the fact that traders are net short suggests that USD / JPY prices may continue to rise.
The positioning is more net-short than yesterday but less net-short than last week. The combination of current sentiment and recent changes gives us another USD / JPY blended trading bias.
— Written by Christopher Vecchio, CFA, Senior Strategist