FX Daily: Edging to the exits

FX markets behaved quite sensibly on Friday. An unambiguously positive jobs report saw the dollar enjoy some modest gains - particularly against the low yielders - firming up the view that the Fed would be in a position to announce tapering of bond purchases later this year. One of the big questions for markets, however, is whether a well-flagged and gradual tapering could still upset asset markets.

A litmus test here may be Wednesday's release of US July CPI, expected to peak around the 5.3/5.4% year-on-year area. Any higher, especially if the core were to surprise on the upside, could suggest that the Fed's exit from loose policy may not be quite as relaxed as most think. So US CPI will be the key event risk in an otherwise quiet week for markets.

Overnight, we have seen a flash crash in Gold and Silver, plus Chinese inflation data, reminding us why Chinese policy makers have a strong interest in taming commodity prices. In July, Chinese PPI was running at 9% YoY, while CPI was running at just 1% YoY. Local concern is that SMEs simply cannot pass on higher input prices and thus face compressed profit margins. Local policy makers are trying to help the situation by selling from strategic stockpiles of industrial metals. Does this mean that the People's Bank of China has an interest in keeping the renminbi strong to insulate against higher import prices? 6.50 in USD/CNY remains an important benchmark for this thesis.

With a Fed inching towards the exit and the risk environment a little fragile, we would say the dollar can stay bid this week. A better performance in some of the emerging market high yielders may need to wait until the CPI event risk has passed.

EUR/USD has not reacted much, if at all, to remarks made on Sunday from European Central Bank hawk Jens Weidmann that inflation could pick up more quickly than expected. Those remarks were somewhat undermined by his forecast that eurozone CPI would still be at 1.4% in 2023 - i.e. well below the ECB's new symmetrical 2% target.

The latest CFTC data suggests leveraged funds are adding to their EUR/USD short positions in the latest reporting week. This community is now running the largest short EUR position since early June 2020. This coincides with the ECB's trade-weighted EUR (against 19 trading partners) breaking decisively lower, in line with the ECB's strategy of driving eurozone real rates deeply negative. This will increasingly make the EUR a funding currency of choice and, counterintuitively to the euro's cyclical position, could see the EUR rally if the risk environment deteriorates substantially.

Expect a quiet day's trading today, but for the week EUR/USD should stay heavy with scope to retest range lows near 1.1700.

The week starts with media reports suggesting some tension between Prime Minister Boris Johnson and his Chancellor Rishi Sunak - such that Sunak could get demoted. Sunak is seen as one of the rising stars in the Tory party and a safe pair of hands at the Treasury, such that any demotion could briefly hit GBP. Yet these are quiet summer markets and FX traders will likely focus their attention on what any fresh inputs mean to the newly-minted hawkish policy from the Bank of England.

The highlight here will be Thursday's 2Q21 UK GDP release, where we see quite a strong 5% quarter-on-quarter reading. We favour EUR/GBP continuing to press strong support at 0.8470, beyond which the move could quickly extend to 0.8400.

Switzerland releases weekly CHF sight deposit data at 10CET. The data will face a little more scrutiny than normal in that EUR/CHF was under heavy pressure near 1.0720/30 last week and the Swiss National Bank may have needed to intervene. The weekly CHF sight deposit data is seen as a good early gauge of the amount of FX intervention undertaken. (Formal intervention data only comes out with a three-month delay and aggregates the activity for the quarter.)

A big increase in CHF deposits, e.g. CHF3-5bn , could lift EUR/CHF on the view that its intervention activities are not so hamstrung by US surveillance after all.