Passing into the second half of the trading year, there is considerable upheaval in the fundamental backdrop. All but the technical analyst purists recognize the implications for trade opportunities. With systemic threats of rampant inflation, aggressive interest rate policy and rising fears of recession, it is likely that the normal slide in ‘summer doldrums’ is replaced with unseasonal volatility and heavier pressure for general risk aversion. Risk aversion was not an unfamiliar sight through the first half of 2022. The Dow and S&P 500 pitched lower from record highs almost from the start of the year on their way to ‘bear markets’. Yet, despite this and so many other measures of risk in strong trends lower, USDJPY and the Yen crosses managed to head higher.
Chart of USDJPY with 100-Day SMA and 100-Day Rate of Change (Daily)
Chart prepared by John Kicklighter, created with IG Platform
One of the unique aspects of the risk aversion that we have seen in this new cycle is that it comes alongside a sharp reversal in global monetary policy. Up until this year, the world’s central banks were flooding the system with money via near-zero interest rate policy and massive stimulus programs. As that largesse is retracted, sentiment reverses but so too does the potential to collect ‘carry’ as yields rise. As the West raised rates aggressively and the BOJ attempted to keep its policy anchored, appetite for return managed to offset the sense of self-preservation for capital. I don’t think that will last moving forward. Should risk aversion deepen, even the hearty yield forecasts through year-end won’t offset the potential exchange rate volatility. Further, it is likely that the BOJ cannot keep up its isolated dovish policy especially as the government worries about the Yen. I will be looking for signs the market is committing to a turn with taking out levels like 132 and 126.
Chart of USDJPY with 100-Month SMA (Monthly)
Chart prepared by John Kicklighter, Created with IG Platform
When it comes to exchange rates, there is always a relative value that comes into play to define which way the capital is flowing. Relative growth and risk exposure represent key fundamental themes that drive the market; but through the first half of 2022, the principal driver of the FX ‘majors’ has been monetary policy and rate forecasts. Notably, where rate forecasts are relatively close (eg USDCAD), there has been relatively modest trend. EURUSD on the other hand has seen a significant decline of as much as 10 percent through the first half as the ECB attempted to avoid tightening rates while the Fed stepped on the accelerator. A considerable differential was priced in between these two principal economies around April/May, but the tides started to turn into June as the ECB realized it couldn’t avoid the inflation fight any longer.
Central Bank Monetary Policy Standing and Year-End Forecasts
Chart Created by John Kicklighter
Looking out over the second half of 2022, it is very likely that the Fed will continue a course of significant rate hikes while the ECB wavers on how to start its own tightening regime and at what pace to keep it going. The Dollar’s premium is unlikely to grow significantly more exaggerated than where it was at the midpoint of the year. Should rate differentials and growth trajectories remain on relatively similar courses, I will look for EURUSD to hold up the 1.0635 floor stretching back nearly two decades. A normalization of trend is likely to see some movement back into the broader range up to 1.2150/1.2000. The wild card is the intensity of risk trends. Should risk aversion grow extreme, the Dollar’s safe haven appeal could force a break.
Chart of EURUSD with 50-Week SMA (Monthly)
Chart prepared by John Kicklighter with TradingView Charts