China data weighs on the US dollar

Currency markets continued to trade sideways on Friday, with the US dollar edging lower as markets continued to price in a US stimulus trade. Another impressive set of economic data from China this morning has lifted G-10 and regional Asian currencies modestly, as the recovery narrative takes precedence over the increasing risks in the week ahead.

The US dollar index is unchanged at 93.72, with the EUR/USD and USD/JPY unchanged, but the pro-cyclical AUD, NZD and CAD all moving 0.15% higher. GBP/USD has also risen 0.10% to 1.2930 on hopes of a Brexit trade-deal breakthrough. With zero risks of a no-deal priced into markets, sterling is the most vulnerable G-10 currency to a substantial pullback. A daily close below 1.2850 signals that a deeper correction is ahead.

Bullish yuan comments from the PBOC over the weekend, followed by an 18-month high USD/CNY fix at 6.7010 today is supporting Asian currencies in general. The USD/CNY is unchanged this morning, with support at 6.6950 not far away. A daily close below that signals more yuan strength ahead, with a substantial interest rate differential over the US (and most of the world), and positive economic data underpinning the rally.

Currency markets, in general, have taken a back seat to the recent rally in risk, not entirely buying into the exuberance priced into equity markets. That may well be a wise choice in hindsight. Markets are confronted with several threats this week that have not been remotely priced in. Brexit trade talks and Covid-19 could threaten both the euro and sterling. A disappointment on US stimulus talks and the mentally exhausting 1.5 hours of television we call the presidential debate, could all spur a quite intense bout of risk hedging this week.

The prime beneficiary of a flight to safety would be the US dollar, and to a lesser extent, the Japanese yen. Add in US elections now just two weeks away along with a large amount of market complacency, and we have the ingredients for some potentially severe volatility. In the bigger picture, I still believe that the US dollar will continue to strengthen into the US election, potentially materially so.

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