As we roll into a new week for financial market participants, the question of where to for the USD continues to be a dominant theme. As many have argued for some time, get your USD call right, and you have half the battle won in other markets and asset classes.
Perhaps the new development late last week was the emergence of profit taking from USD longs across G10; a trade which is certainly crowded after the USD index rallied 8.7% since mid-April. There is enough evidence if we focus on the correlations between the USD and various economic indicators to see that USD inflows have been largely premised on the relative outperformance of the US economy. However, given the moves and Fridays price action it is clear the bar to move the USD is sufficiently high enough that US economic data now needs to not only beat expectations, but it really needs to blow the consensus out of the park, while economic data in other economies need to perform poorly.
As we can see from the Citigroup US Economic Surprise indices (these indices portray the economic data print relative to consensus expectations), US data is generally missing the mark. Moves from the Chinese to reduce speculation in yuan, while draining offshore liquidity have made shorting the yuan more expensive, has removed a further tailwind to USD appreciation and as mentioned last week we should see USDCNH consolidate here, which again has been a trigger to close AUDUSD and NZDUSD shorts late last week. Such was the inverse correlation between USDCNH and AUDUSD. NZD was the strongest performer in G10 on Friday, followed closely by the CAD and the AUD. The CAD helped to an extent on further NAFTA headlines, not to mention a solid Canadian CPI print.
(Citi US economic surprise index)
On the daily chart, the USD index (DXY) has room here to fall into former trend resistance drawn from the 30 May highs, that is now support at 95.72. The USD bulls will want to see this level hold or the risk of a deeper pullback in the USD increases. This would largely coincide with EURUSD pushing higher and testing the 61.8% retracement of the sell-off from 8 August at $1.1503 and the May/June double bottom lows of $1.1509. Last week, by way of levels, the focal point was on a move in USDCNH through 7.00, or below 6.8000. One could argue that EURUSD through $1.1509/10 could be an important level to watch and trade around through this week.

The equity markets also will garner close attention too, with China CSI 300 lower for five consecutive days, losing 5.2% on the week. The divergence between EM and US equity markets is a mature theme, although we have seen a number of strategists suggesting that perhaps now is the time we can see some convergence here. It indeed takes a brave soul to be fighting the trend lower in Chinese equities here, but we are seeing signs that the authorities are growing somewhat more concerned, with the weekend news that banking regulators have ordered banks to lend to exporters. This could be a factor supporting a positive open in various index futures in early trade today. Of course, this support comes ahead of low-level trade talks this week, as well as the rollout of Trump tariffs’ on $16b Chinese imports, while a review on a further $200b commences for a potential late September implementation.
Away from Chinese equities and the index to be long last week was the Dow Jones Industrial Average, which put on 1.4%, followed closely by the ASX 200, which has broken out of its multi-week trading range, and should open closer to 6360 today. Whether traders buy into this opening strength is yet to be seen, but given we saw broad-sector gains in the S&P 500 on Friday, with this index a mere 0.8% from an all-time high, there is the inspiration for buyers to be present.
A market at all-time highs is about as bullish as you can get really and a break in the S&P 500 to new highs will get focus this week, especially as the market internals (percentage of companies above their 50-day average, four-week highs, with an RSI above 70) is by no way flashing extremes. The fact US high yield credit is not giving us any glaring red flags either is encouraging for equity bulls.
By way of other inputs, we can see a better tape in commodities on Friday, with copper closing up 0.5% on Friday, iron ore +0.9% and US crude +0.7%, although crude futures are seeing a few sellers on the open in early Asia trade.
By way of key fundamental drivers, the event risk rolls in as always, with FOMC minutes a key focal point on Wednesday, as will the Jackson Hole Symposium on Friday. The USD is being driven by relative economic data trends, so it is unlikely we see too much new colour here, and while some have raised the issue of an early termination of the Feds balance sheet normalisation program, it seems too early for Fed governor Powell to openly explore this through this week.
By way of interest rate pricing, we see eurodollar futures pricing 36 basis points of hikes between December 2018 and 2019 (so just under 1.5 hikes), which depending on your view on the US and global economy will determine if you think this pricing is optimistic or pessimistic. I feel this is too pessimistic.
USDTRY will also get attention from traders with an elevated tolerance for risk, with the pair pushing the 6-handle again on a mix of conflicting headlines around pastor Brunson’s release, a one-notch ratings downgrade from S&P, not to mention changes to funding charges. While headlines risk remains, let’s not forget that on 3 September Turkey release its inflation report, and the prospect of a further increase headline inflation from 15.9% is real. Should inflation push above its seven-day repo rate of 17.75% and we talking about negative ‘real’ rates, and comes to one of the key issues. That is that monetary policy settings are still too accommodative to really attract TRY inflows and to radically alter the path of USDTRY.  
Published by Chris Weston, Head of Research, Pepperstone