One of the few things that EURUSD typically has going for it to the upside is the strong deflationary forces that pervade its economy. However, today’s HICP inflation print for the Eurozone tells us otherwise. Below, we show US and EUR inflation rates, respectively:

As we can see, the most recent print puts EUR HICP quite close to USD CPI, making its real rate of return even more unattractive. Of course, these inflationary pressures could be transitory, but they are not additive to EURUSD strength for the time being. Since the start of 2021, we have been bearish on EURUSD based on our fundamental outlook that the US would outperform Europe, resulting in inflows to the dollar. Our execution of this view has been augmented by our trading ranges, which we show updated for EURUSD below:

As a reminder:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.

Our current read of these technical tools tells us that EURUSD is still attractive to short. Implied volatility continues to paint a picture of complacency, and momentum is definitely in favor of more downside. As the market begins to look past weak European data, EURUSD can bounce. However, our judgment is we are not at that point yet. US data’s relative outperformance has likely only just begun, so there are likely legs left for EURUSD to slide.

Today, we received updated consumer confidence data in the US. The data was extremely strong relative to consensus expectations (109.7 vs. 96.9). This data came after we also received the best initial claims data since the start of the pandemic. All of the indicators bode well for future spending:

This is being reflected in equity markets, which remain at all-time highs. However, from a trading perspective, the S&P 500 does not look like a buy right now, as it is in the middle of our trading range (equal upside and downside):

Momentum in the S&P 500 still remains broadly positive. However, markets are discounting less volatility than is justified by historical volatility, suggesting there is a possibility for a pullback. This pullback should provide a good entry-level for long positions.

There is a narrative in markets that the US dollar is on its way to losing its place as the world’s reserve currency. This view has been supported by a dramatic decline in the dollar last year relative to virtually every currency and asset. However, beginning this year- we at FXDD were among the few strategists warning our readers that this dollar decline couldn’t continue (in trade-weighted dollar terms). This view has played out well so far, particularly in EURUSD. Below, we show one of the primary reasons this has held up:

Above, we show consensus estimates for GDP growth for major economies. What we can see above is that the US is expected to grow the most consistently in 2021. This expected economic growth is fueling expected returns on assets relative to other countries. We can see this in our measure of US asset average expected returns, a measure which coincides strongly with the dollar index:

As the US economy continues to outperform other economies, the dollar will rally. This will be particularly against currencies of countries that underperform relative to the US. At this junction, it’s important to remember that there are strong reasons why the dollar is the world’s reserve currency- it is supported by a dynamic and profitable economy with deep financial markets. When choosing short dollar expressions, we need to be careful in choosing countries that can outperform the US, a fairly high bar.

Today we received updated data on UK PMI’s and CPI. While CPI was a little disappointing, PMI data was strong relative to expectations. This growth recovery is supportive of GBPUSD:

However, we have to remember that GBPUSD is the product of both the US and UK legs of the currency pair. PMIs are survey data that give us an insight into the underlying real economic data, i.e., manufacturing PMI’s give us insight into how industrial production will look. Looking at the US vs. UK industrial production, we see that their rates of recovery are neck-and-neck:

Further, as we alluded to last week on this page- the criteria for positioning in GBPUSD has not been triggered for all our signals. We show our updated panel of trading indicators for GBPUSD. They include:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.
  
  As we can see, GBPUSD remains at the high end of the trading range, with 1-month momentum signaling more downside as well. Overall, while the UK’s outlook is improving significantly, its scope to outperform the US in the rate of change terms is diminishing.

While we often take a fundamental approach to understand direction, we just as often take a quantitative approach to assess trade positioning. Particularly, a big part of our risk process is establishing where the prevailing trend is and then understanding its sustainability. Below, we show some of the measures we look at to understand momentum in currencies and select commodities:

We see above that popular short-dollar expressions from last year continue to see strong momentum to the downside, particularly for Euro, Yen, and Gold. This is coming when US real interest rates are picking up, offering a significant yield advantage over these assets. Hence, it makes sense that these continue to experience negative momentum. We show our momentum indicator for each of these below. We first show gold:

Gold is currently experiencing a counter-trend bounce. However, it will take a lot of price action to change the underlying trend ad we can see above. That being said, with downside momentum this extended, it is possible to see a moderation in the pace of declines in gold.

Next, we look at EURUSD:

After a stellar 2020, EURUSD remains a strong downside call for us in 2021. US relative outperformance will likely push the Euro lower- but with momentum this stretched, we might see a breather.

Finally, we look at the USDJPY (inverted):

The Yen has seen significant weakness as this safe-haven currency has experienced both outflows and debasement by its central bank actions. Momentum to the downside has been significant over the last few months.

Overall, these expressions of dollar alternatives have seen significant losses as US yields have risen. A US recovery increases the attractiveness of US assets relative to these alternatives. We’re likely only seeing the start of these moves- though, from a momentum perspective, it is worth noting that these moves all look extended.

The most dominant theme in the market right now continues to be the reflation theme okaying out in US markets. Cyclical assets are outperforming safe/stable assets, and we see this across asset classes. The best case in point is in the US Treasury market, with US long-term bond yield selling off considerably. These moves are largely due to the US economy’s cyclical outperformance, a move which is expressing itself in EURUSD. EURUSD is exposed to this narrative as Europe is struggling to grow out of the COVID-19 crisis. Hence, the relative attractiveness of US assets weighing down EURUSD. We show this here:

From a trading perspective, our risk range is pointing to an attractive entry point on EURUSD given the recent bounce:

After periods when a currency pair hits/exceeds our upside or downside ranges, we typically see a correction. While we don’t think trading just for that move is the best idea, the current environment seems to favor a weaker EURUSD.

The FOMC made its policy decisions today, and as expected, there were no changes to the policy. The most significant take away in our opinion, is that the Fed expecting transient inflation. Most committee members expect inflation to rise this year, with a median estimate of 2.5%, after which they expect inflation to drop back down to 2% in 2022. Hence, while bond market vigilantes and private forecasters can continue to talk about inflation, the Fed intends not to move until their full employment objective is met and will be patient on inflation. Monetary accommodation continues!

In 2021, the major theme in markets has been relation, i.e., higher growth and higher inflation. However, gold has received little love during this period. Why? This is because gold, unlike other commodities, has significant currency characteristics and is far less procyclical than other commodities. Gold demand is usually for its value as a store hold of wealth, which can be compared to other currencies. Over extremely long periods of time, gold has performed well as a store-hold of wealth, particularly as interest rates in developed economies have fallen. This is because the opportunity cost of holding gold is the real interest rate available in fiat currencies. In 2020, global central banks cut their interest rates to near-zero levels, and as inflation began to creep up- gold was a desirable proposition. However, as growth began to rise and opportunities to invest elsewhere once again became viable, the demand for risk increases and the demand for safety reduces- hence, gold has seen a significant decline from its all-time highs. If reflation continues, gold will likely remain unloved and vice-versa.

Today’s FOMC will largely be focused on the economic outlook of committee members. Particularly, we should be looking for changes to the Summary of Economic Projections (SEP). Markets are awaiting this information as it will likely inform the Fed’s reaction function to economic improvement. However, it probably makes sense to look past the immediate term and realize that the Fed is boxed in by its objectives of maximum employment, i.e. until unemployment improves they cannot move interest rates. Further, there are likely to be a lot of questions surrounding the recent bond sell-off in order to assess the Fed’s tolerance of this move. So for Chair Powell has been steadfast in his commitment to looking past “transitory inflation”, but markets will likely be looking for reassurance.

Going into tomorrow’s FOMC meeting, we look at our panel of trading indicators for GBPUSD. They include:

• Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
• Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
• Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
• Implied Volatility Discount/Premium: This tells us what the market expects in terms of volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.

Going into tomorrow’s FOMC meeting, the GBPUSD looks a little expensive due to a recent jump. However, fundamental trends, medium-term momentum, and volatility seem to favor GBPUSD. The shorter-term indicators aren’t as positive- particularly our trading range and price relative to their 52-week highs. An ideal situation for entry is when all of these signals align, so while GBPUSD probably has upside, all our signals are yet to be triggered.