USD/JPY broke 112 today, hitting a 1 month high in the process while euro also rose to its best level against the US dollar since March 26. The only times that we see simultaneous strength in pairs like USD/JPY and EUR/USD is when risk appetite is strong. Stocks pulled back at the start of the week but rebounded strongly on Friday to end the week not far from 6-month highs. There’s been a lot of talk about recessions, trade tensions between the EU and US are escalating and there’s still no final resolution to US-China trade talks or Brexit. And yet investors are optimistic because bank earnings are strong and they believe that policy accommodation abroad will help to mitigate a deep slowdown in global growth. They are also relieved that the Federal Reserve won’t add to the pain by tightening again this year. While this may be incredibly optimistic, until all signs point to a significant slowdown in the US that will spillover to the rest of the world, investors see their glasses as half full.
The big question now is whether trend has completely shifted for USD/JPY making 114 more likely to be hit before 110. We are skeptical of the rally because US growth is slowing not accelerating and central bankers are worried. Fed President Bullard in particular thinks the March hike marked the end of policy normalization and favors removing the word “patient” from the policy statement because it suggests a tightening bias. Fed fund futures are pricing in a 48% chance of a rate cut in January so easing is certainty on their minds. Fundamentally USD/JPY should see 110 before 114 but technically, USD/JPY hit a 7 week high and the positive momentum is strong. The 200-week SMA is at 112 so if the pair breaks this year’s high of 112.14, the next stop should be 113.
Meanwhile EUR/USD rose above 1.13 for the first time since March 26 but the rally should be faded. Data was better than expected with the German trade surplus growing and industrial production falling less but these reports are not enough to be optimistic about the euro. Trade tensions between the European Union and the US are at a boiling point with President Trump threatening $11B in tariffs over Airbus subsidies. In response, the EU is preparing its own list of retaliatory tariffs worth over $22B. The World Trade Organization hasn’t officially recommended a penalty for the EU but if they do or the US pushes ahead with the tariffs, it will be very damaging to the region’s economy and the euro. This is a risk that the central bank is fully aware of. The German ZEW survey and Eurozone PMIs are scheduled for release next week and if the data softens, reinforcing the central bank’s concerns, EUR/USD will resume its slide. Ultimately, we expect the pair to test 1.10.
Easter week is always an interesting one in the FX market – we usually see a burst of activity the first 3 days followed by consolidation. This year may be different because there are a number of important economic reports scheduled for release on Thursday so volatility could extend until then. Nonetheless most markets are closed for Good Friday and Easter Monday (the US is only closed Friday) so many traders will leave early for their long weekend and look to square up or reduce their positions shortly after the US retail sales report is released.