The USD is starting the week with a firmer tone as last Friday’s Non-Farm Payroll data was strong enough to make another FED Funds rate hike in December a near certainty. The CME Fed Funds futures contract reflects an 81% chance of a December hike.
The 250,000 headline jobs number eclipsed the median consensus forecast of 190,000, even after the weather-related rebound was taken into account. The unemployment rate remained unchanged at a 40-year low of 3.7% and year-on-year wage growth reached a 9-year high of 3.1%.
This was a healthy report by every measure and follows the news earlier in the week that Chinese PMIs have slipped lower, manufacturing growth in the Euro-zone has stagnated, The BoE is handcuffed by Brexit and Australian Retail Sales and inflation are both trending lower.
De-synchronized global growth and interest rate divergence have been the foundation of the strong USD story for Forex traders during 2018.
The US policy mix of tighter monetary conditions combined with looser fiscal measures has underscored a strong US economic performance, while growth in the EU, UK and most of Asia has disappointed.
And while a poor showing by Mr Trump’s Republican party in Tuesday’s mid-term elections may dampen some of his fiscal agenda, we are confident that the FOMC will continue to lift rates throughout 2019 while the other G-7 central banks will remain idle.
Looking at each G-7 currency through the prism of interest rate divergence, the EUR has the most downside potential over the next 12 months.
The current interest rate differential between the USD and EUR in the 2-year part of the Treasury curve is trading at a historic high of 330 basis points. That pencils out to almost 800 pips in the EUR/USD 2-year forward market.
In more simple terms, this means that the 2-year outright forward at just below 1.2200 is much more expensive than the current EUR/USD spot level at 1.1380 would suggest. It’s not unusual for European corporate names to sell their USD receivables 2 years forward. In this sense, they will not consider the current EUR/USD rate cheap compared to the 1.0700 to 1.1800 range last year.
In addition, with the ECB announcing on Friday that they may restart their Targeted Longer-Term Refinance Operations (TLTROs), we can’t see how these interest rate spreads can narrow in a material way. As such, we see a much higher likelihood that the EUR/USD will break below 1.0900, as opposed to above 1.1800 over the medium-term.
We are currently short the EUR/USD at 1.1650. We suggest short-term traders can sell the pair at 1.1445 with an initial target of 1.1210 and a 1.1540 stop.
The recovery in global equities has lifted the USD/JPY for now. We still expect to see a traditional “risk off” pattern emerge later in the week. We suggest holding short the pair from 112.70, or better, with an initial target of 110.10 and a 113.70 stop.
The Aussie Dollar ended the week with the exact opposite chart pattern as the previous week. The price action failed at the .7260 area and internal momentum indicators have turned negative again. We suggest holding short from .7225, or better, with an initial target of .6925 and a .7380 stop.
It seems that the Brexit risk to the Sterling has asymmetrically shifted from the downside to the upside. In other words, positive headlines are lifting the GBP/USD higher than negative reports are beating it down. Still, the technical resistance near 1.3045 continues to cap the pair on intraday rallies. We are currently short from 1.2985. We suggest adding to short positions at 1.3015 with an initial target of 1.2685 and a 1.3095 stop.
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