At The Edge Of A Cliff

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by: Dean Popplewell

By Stephen Innes

Was it the mixed data, skewed positioning or merely a lack of confidence that has the USD precariously perched at the edge of the cliff.

Everyone to a tee went all in on a dollar buying frenzy after the CPI number, but the lack of follow-through was very telling, and the quick rebound stopped out all those newly minted positions and then some. The markets sold AUD and NZD heavily at the lows, and then got summarily spanked when traders started to factor in the conflicting data prints.

While the strong CPI reading does present a hawkish risk for the Feds dot plots in March, the miss in the US retail sales data has the Street scrambling to revise GDP estimates lower. The divergent data stream has escalated the market debate of critical importance: specifically, is it inflation or growth that will dictate the Fed pace of interest rate normalisation?

But the bottom line for the US dollar, in my view, amidst rising inflation and the prospect of increasing deficits, both trade and budget, should weigh like an anvil around the dollar bulls' neck.

Equity markets

In seemingly absurd fashion, US equity investors ignored the inflationary signals and focused on the weaker-than-expected US retail sales report. There is an increasing possibility that the Powell may blink and the Feds will be more hesitant to guide monetary policy hawkish given the waning growth narrative.

Gold Markets

Higher US inflation, combined with the USD exhibiting zero correlation to higher interest rates amidst burdening duel deficits, should play out favourably for gold markets. The weaker dollar narrative is playing out most favourably across the broader commodity space, and gold demand could surge and push above this year's highs. Also, the sustainability of the frothy equity market given the weak retail sales print suggests increasing gold equity hedges is a practical move.

Oil Markets

A weaker dollar and verbal intervention from the Saudi Energy minister, who suggested significant oil producers would prefer tighter markets than end supply cuts too early, has seen oil prices do an about-face. The Saudi signal is reasonably convincing, suggesting OPEC and their partners are committed to maintaining an absolute floor on oil prices.

As indicated earlier in the week, the battle lines are forming around this key WTI 60.00 bpd, as the shale oil gusher will continue to weigh heavily on OPEC efforts to blow out the worldwide glut.

However, physical demand remains weak globally, so traders will continue to monitor the USD /oil price correlation, and at first sign of flutter, it could signal a downdraft.

Currency Markets

Japanese Yen

With the interest rate to FX correlation in "Neverland," it could be open season on USDJPY after convincingly crossing the 107 USDJPY Rubicon. If the market focus aggressively shifts to the US's duelling deficit amid higher inflation, the dollar days are numbered in the 107s, if we factor in an expected exporter flow panic, which could be exacerbated by a push from Japanese investors to raise their hedge ratios on US investments fearing a further fall in the greenback.

While we should expect the usual verbal lashing from Japan's currency officials, I suspect we are still ways off from overt intervention.

Australian Dollar

It's always good to go into critical economic data with a Plan B, even if it's from outer space. Expect the unexpected, and today we see the Aussie is benefiting from resurgent commodities and US dollar weakness, as the greenback is showing no correlation to higher US rates.

Malaysian Ringgit

A weaker US dollar and rebounding commodity prices have the MYR sitting well supported, with yesterday's robust GDP print adding good measure.

Dollar weakness is seeping into the USDJPY and USDCNH, which will provide a positive backdrop for regional currency markets, and we should expect the MYR to be one of the key go-to currencies as positions remain underpositioned post the January monetary policy meeting. Higher US interest rates are showing little obstacle for regional currency appreciation, so the MYR should benefit.

Not to weave a cautionary tales, but liquidity is a bit thin in regional markets given the proximity of the Chinese Lunar New Year, so it's best to be nimble in these conditions.

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