Short Squeeze, Risk-On Boosts FX Rallies

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

With the rising more than 400 points, it was a great day for currencies. All of the major currencies traded higher as improved risk appetite drove traders back into high beta currencies. We saw a combination of short covering and buying. Turkey secured a lifeline from Qatar and their steps to curb Lira selling is working. Their exchange rate, is now back below 6 after peaking above 7 on Monday. U.S. Chief Economic Adviser Larry Kudlow confirmed that the trade talks with China will resume next week while U.S. trade negotiator Lighthizer said he’s hopeful that there will be a breakthrough on NAFTA in the next few days. U.S. data fell short of expectations but the impact was limited by the fact that these second tier reports won’t affect Fed policy. President Trump also seems to have made a U-turn on dollar policy. Today, he said “money is pouring into our cherished dollar like rarely before.” Shortly afterwards Kudlow said “I think the king dollar, the strong dollar….is a sign of confidence….Money is flowing into the U.S.A. That’s terrific.” So not only did rally but so did , and . But the bulls haven’t given up control as we see some of the high beta currencies end the NY session off their highs. Demand for U.S. dollars is still very strong, which explains why Japanese Yen crosses performed particularly well today.

Having rejected a move above 1.14, is still vulnerable to additional losses. Turkey is not out of the woods especially after Treasury Secretary Mnuchin threw out threats of more sanctions if the American pastor is not released. But investors are worried about Italy, who saw its markets go on a rollercoaster ride on the back of Turkey’s troubles. Italian banks have limited exposure to Turkish debt but borrowing costs are rising and growth is slowing. Investors fear that a financial crisis could be looming especially if Turkey’s problems worsen. Data had very little impact on the currency with the Eurozone’s declining slightly. The Eurozone’s current account balance and revisions to July CPI data are due on Friday and unless there is a big change, the impact should be limited as well. The level to watch in EUR/USD is 1.13. If that breaks the next stop will be 1.12, but if it holds, we could see EUR/USD return to 1.1450.

Sterling on the other hand is very weak. Unlike some other major currencies, it had a very tough time rallying despite very good data. Retail sales rose 0.7% in the month of July, 3 times more than anticipated. Excluding auto fuel, consumer spending growth was even stronger. This report should have sent sharply higher and while it did trigger a 30 pip knee jerk rally, the pair nose dived just as quickly. The selling pressure in pound is very strong and there seems to be no signs of let up even though short positions are at their highest level since May 2017. As a result, the risk of a move down to 1.26 is significant. Along the same lines, could revisit 90 cents.

The and dollars extended their gains today while the remained under pressure. After selling off aggressively this month, we believe AUD/USD has found a bottom. Its too early to say whether this will be a short or long term bottom but either way, we see further gains ahead for the pair. Last night, Australia reported mixed labor market data. Job losses were reported but the market shrugged off the headline miss in favor of full-time job growth and the best unemployment rate in 6 years. The Chinese also recovered as the cost of shorting the currency hit to its highest level since 2016. Prospect of trade talks resuming between the U.S. and China provides another argument in favor of AUD recovery. Technically, the main support level for AUD/USD is 72 cents. If that holds, we could see AUD/USD back at .7320. As there were no specific developments in New Zealand, NZD rose alongside AUD. Tonight, New Zealand is due for release and we believe that producer prices saw the same slowdown as CPI. The Canadian dollar on the other hand extended its losses ahead of Friday’s report. While Canadian data has been pretty good, tomorrow’s report could surprise to the downside because price pressures eased in the manufacturing sector according to .

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