USD/JPY Breaks 110 on Fed Minutes, Beware of Short Squeeze

Daily FX Market Roundup 05.18.16

It is rare for Fed minutes to trigger such a big move in the U.S. dollar but when the market feels one way and the Fed signals another, these surprises can cause exaggerated movements in currencies. The greenback ripped higher after the minutes revealed that, “most Fed officials saw a June hike likely if economy warranted.” We are highly skeptical of the central bank’s ability to pull the trigger on tightening right before the U.K. referendum, but there’s no question that the momentum is on the side of the dollar. Today’s minutes caused the greenback to spike, Treasury yields to soar and in a matter of hours Fed fund futures went from pricing in a 4% chance of tightening in June to more than 30%. Such strong and consistent movements generally have continuation and we would not be surprised to see further dollar gains over the next 24 to 48 hours. Today’s move has taken the USD to a 2 month high versus AUD, CHF, a 1-month high versus CAD and a 3-week high versus EUR and JPY. With speculative JPY long positions at record highs, USD/JPY is prime for a short squeeze that could send the pair to 112.

Sterling was also a big focus today as pound rose more than 1.5% against the euro and nearly 1% against the dollar. EUR/GBP dropped to its lowest level in 3 months. U.K. employment numbers were better than expected with jobless claims falling and average weekly earnings growing more than expected. However the main driver of the breakout was once again politics. More polls have been taken and they show growing support for remaining in the European Union. Many traders have been short sterling on the premise that the close polls would make pre-referendum trading messy and the widening gap has encouraged aggressive short covering. Resistance in GBP/USD is now at the May high of 1.4770 and even though we believe retail sales could miss given the drop in spending reported by the British Retail Consortium, that may matter little to the high flying GBP.

Unlike GBP, EUR fell sharply against the dollar.
According to the latest reports, inflation in the Eurozone was unchanged in the month of April with the year over year rate of CPI growth falling -0.2%. Low inflation has been a big problem for the European Central Bank but the softness of the report was mostly due to Easter holiday sales. Between the rise in energy prices and post holiday adjustment, prices are likely to move upwards in May. Eurozone current account numbers are scheduled for release tomorrow and while the numbers should be strong given healthier German and French data, the account of the last ECB meeting could have a more significant impact on the currency. When the central bank last met, the ECB left rates unchanged and Mario Draghi avoided talking about more easing at his press conference, choosing instead to say that ECB policies must be given more time to work. EUR/USD soared on the back these comments but ended the day sharply lower as investors chose to focus on the ECB’s view that euro area outlook risks are tilted to the downside and investors should expect rates to remain at present or lower levels for an extended period of time. While we are looking for the “minutes” to be dovish, the report may be a bit more balanced given Draghi’s arguments for optimism. Last month he also said broad financing conditions improved, low oil prices are supporting domestic demand and inflation is expected to pick up in the second half of the year and improve further in 2017/2018. Today’s move has taken EUR/USD below the 50-day SMA and until this moving average is broken, selling pressure will dominate.

USD/CAD broke above 1.3000 on the back of U.S. dollar strength and a significant rise in oil inventories.
We continue to believe that oil is near its peak and with 2 year U.S. – Canadian yield spreads pointing to a further rise in USD/CAD, we view dips as a opportunity for an eventual move to 1.3200.

Both the Australian and New Zealand dollars traded sharply lower ahead of tonight’s employment report.
With the U.S. dollar rising and copper prices falling to a 3 month low, AUD/USD tested and finally broke its 200-day SMA, opening the door to a deeper slide towards 0.7150 but traders are hesitating because tonight’s data is important. if the labor market improved, the level to watch on the upside is 0.7350. A close above that rate would be needed to break AUD/USD out of its current range. This month’s labor market numbers are difficult to handicap because according to the PMIs, job growth accelerated in the service and construction sectors but deteriorated in manufacturing. Yet economists are looking for a softer release because last month’s report was very strong. Like AUD, NZD lost over 1% of its value versus the greenback today. Producer prices continued to fall in the first quarter but at a slightly slower pace.

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