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It was the day before quarter (and month) end and all was……not making a lot of sense.
That is often the case on a day where portfolio rebalancing and other variances of technical flows are at hand. So, when we see the USD having its best one-day gain (+0.8%) since 10 August, and breaking the downtrend seen since mid-August, materialising amid a backdrop of modest equity and rates appreciation, with limited change in US Treasuries, naturally we have to question this move. We can even look through other asset classes, such as commodities and see gains in crude and question what actually fell.
(USD index)
(Source: Bloomberg)
The equity story is interesting because we have seen such as strong outperformance of the S&P 500 relative to US Treasuries in Q3. So, the fact the US equity benchmark closed +0.3% suggests the notion that balanced funds, who would have had to re-weight from equities to US Treasuries didn’t have much influence on the broader tape, although this could still be a consideration for US trade today.
Either way, the fact the index closed in positive territory provides Asia with a solid platform by which to progress, and we should see the ASX 200 open its last trading day of the quarter above 6200, where a close above 6194 is needed to see the index finish the quarter in positive territory. The Nikkei 225 has been the market to own this quarter, rewarding investors with a 6.9% rally and one can imagine we see the index opening back above 24,000 this morning given USDJPY breaking to new year-to-date highs.
I touch on USDJPY here, because the pair is a pillar of strength, with price printing a bullish outside day reversal taking the move into a new yearly high. The bulls have control here, although it is partly technical factors at work, while a reasonable bid in EM currencies has helped ease off the JPY and the CHF. Firstly, we can make a relatively weak argument that USD data has been at play and while durable goods gained 4.5% (versus 2% eyed), there was little immediate reaction and as I mention rates markets were bid on the session. Here, we see the market very modestly reducing its expectations by a couple of basis points for Fed hikes between December 2018 and December 2020, while US Treasuries were basically unchanged across the curve.
We can also say there was angst to hold EUR’s, given the noise around the Italian budget, but this argument doesn’t hold much sway as the Italian MIB rallied 1.4% off its low and Italian BTP spreads relative to German bunds widened by a mere two basis points to 2.35%. In fact, German CPI easily beat consensus at a 2.3%yoy clip, coming in at the highest level since 2011.
It seems that the primary reason for USD inflows was down to funding pressures, which will often result in higher demand for USDs. Here, the focus has been on some huge moves in cross-currency basis swaps, especially in that of 3-month EURUSD and 3-month USDJPY, where we saw one of their biggest one-day moves since 2009. Primarily this is due to spot FX settlement now falling into Q4, so given these products have a duration of three months we see these dates rolling over into 2019 and picking up the year-end ‘turn’- as swaps traders would say. Either way, when we combine higher USD funding costs with what is coming to a quarter end, we have a USD that has found a bid, when other more traditional drivers, such as rates and USTs have given no apparent reason to push the USD +0.8%.
(3m EURUSD basis swap)

On the session ahead, it will be worth watching USDCNH, as well as the PBoCs CNY fixing at 11:15aest, which could influence G10 crosses, such as AUDUSD, not to mention precious metals with gold looking weak here. Any larger than expected weakness in CNY could be the trigger to push USDCNH through 6.9000 and subsequently trigger a move in AUDUSD through 72c and gold through $1180. We will also be focused on EURUSD, which is naturally having a strong impact on the USD index, given its 57% weighting on this basket. EURUSD had been trending higher in a bullish channel since 10 September, as had GBPUSD, but the moves on the session have seen both pairs come crashing through trend support.
The question, of course, is whether these clear technical factors will be a one-off affair, and will decrease once we turn the page on the quarter. The answer is seemingly found in moves in USD funding costs and whether they reverse, and from here we can re-focus on moves in rates, fixed income, with economic data, political headlines and central bank rhetoric driving capital flows.
Published by Chris Weston, Head of Research, Pepperstone