Over the past x months, one thing has become all too clear in FX land: the EURUSD must stay rangebound between 1.40 and 1.50, even though as Goldman's John Noyce presents in his latest "not-for-retail" packet, the fair value of the European currency continues to be higher than where it should be. Whether this is a simple case of the tail wagging the dog, whereby the ECB and China are terrified of the downstream effects should the European currency trade under the psychological barrier of 1.40, is unclear. What is clear is that every country in the world has skin in the game, and is forced to keep the EUR in Goldilock rangebound territory: not too low to spook European investors, and not too high to accelerate the German double dip. Some other risk assets correlations observed include the AUD vs 2 year swap spread basket, the VIX vs the S&P, and lastly, on the until recently massively overstretched CHF. Noyce tops it off with some technical perspectives on US govvies and the 2s10s, which is once again diving, although unclear if due to a bullish or bearish flattening.
Attached is the full podcast with notes and the accompanying presentation below:
Noyce 8.27 by user5452365
Lower Lows in the EURUSD:
While it’s difficult to draw the recent EURUSD consolidation as a classic triangle pattern (the highs/lows cannot be joined to form clear trend lines) the market is certainly in a well defined contracting range - a long series of lower-highs (from the 4th May high at 1.4940 onwards) and an, albeit shorter, series of higher-lows (from the 12th July low at 1.3837 onwards) being evident
As discussed in numerous recent written updates and client meetings the idea of another sustained uptrend in EURUSD seems very difficult to rationalise based both on the pure technical setup on the longer-term charts and also due to the correlated asset market backdrop.
From a MT-LT (multi-week/-month) perspective this leaves a bias that a sustained downtrend is more likely to develop at some point than a material and importantly sustained uptrend.
However, even with the above in mind, based on the simple daily chart a break of the recent chain of lower-highs and higher-lows, i.e. a classic range break, would at this point likely generate a quick flurry of “breakout trade” interest regardless of the direction of that eventual move.
The pivots to confirm an upside or downside break look to be the interim high from 27th July at 1.4537 and the interim low from 19th August at 1.4258 respectively.
EUR Overvaluation based on German-USD 2,5,10 curve correlations.
On the chart above the green line shows the performance of an equally weighted basket of the 2-, 5- and 10-year Germany/U.S. yield spreads and blue is EURUSD spot. As can be seen, from June last year until early-July the two were quite highly positively correlated. Since then the two have diverged and at this point the spread basket argues that EURUSD should be around 6 or 7 big figures lower than it currently is. The question however, as pointed out by clients in a number of meetings recently, is whether this discrepancy is currently due to a “safe haven premium” bid built into German fixed income markets.
AUD is likewise overvalued:
The one issue with the chart shown opposite ,which has been highlighted by a number of clients, is that there is now a good rationale to argue that a “discount” is being priced into the USD due to specific “U.S./USD issues” which is not necessarily reflected in the other asset markets. The chart above attempts to “control” for that potential issue. It instead overlays our AUD/Broad Index(*) with the related 2-year swap spread basket (i.e. AUD 2-year swaps less an equally weighted basket of the 2-year swaps for the other “Old World G10” currencies). Here too there is a significant “valuation gap”, with AUD not falling to the same degree as the spread basket since the start of this year.
Recent moves in VIX and true risk:
The high on the VIX earlier this month was set at 48.00, very slightly below the highs of the historic range (excluding Q4’08/Q1’09) which was set at 48.20-49.53
- As previously highlighted, historically once the VIX has moved into that 48.20-49.53 region the S&P has tended to enter either a material period of consolidation/correction or the early stages of a material uptrend.
- With this in mind some further volatile, but range-bound, consolidation on asset markets is possible.
- Just as something to keep in mind, ..if.. asset markets begin to weaken again and the VIX pushes above the old pivot centred on 48.20-49.53 it would be a warning of a significant deterioration in outlook as on our data this only happened to a material degree in Q4’08.
And, perhaps, most importantly, the technicals of the 2s10s.
- The recent bounce in yields has been focussed on the longer-end of the curve hence the 10s/2s spread has steepened over recent sessions (following the sharp flattening of the last few weeks).
- For now this move could be viewed as a re-test of the neckline of the multi-year double topping pattern formed by the October ‘10 low at 204bps 10s over 2s. As long as the market doesn’t make a weekly close materially back above this prior cycle extreme the eventual risks still look skewed towards a flatter curve from a multi-month perspective (with an ultimate target of 123bps 10s over 2s).
- From an FX perspective a flattening curve is often viewed as a USD positive (material flattening trends over recent years have tended to be driven by higher short-end rates), however if this is a bullish flattening driven by lower long-end rates as seems more likely the FX implications are less clear.
And much more in the full presentation below.