Major Europe FX Pairs On The Precipice.....The CTA Nightmare To Continue

As the dust settles from the saber-rattling equities move of  ~11% (shocking to some), many CTA's are attempting to lick their wounds and regroup for a profitable rest of the year.

As they proceed down this path, there are a few other trend-following trades that are on the precipice of reverse and could prove to be obstacles to these funds' Pnls.

I believe we are near a meaningful reversal in the dollar versus developed Europe, namely EUR, GBP, and CHF.


How did we get here?

Well, back in 2017 I was a proponent for the major European currencies. I spoke extensively about GBP based on rate differentials here, as well as  EUR in a few posts here and here. Although were drivers in the currencies above, just as importantly was the dollar move that materialized after that time.

It was around this time last year.  Trump went around saying he wanted a weaker dollar. We had headlines like this:

Trump says the dollar is "too strong" -- good luck weakening it

Well, it turned out that he actually had pretty good "luck", since that turned out to be a major top in the dollar.

Where are we now?

Today, it seems that the unrelenting move in EUR and GBP has promoted participants to pile in on the long side for a number of reasons that could be broadly grouped together as the following:

1) Prospect of renormalization in monetary policies of non-US countries
2) Shifts in reserve policies in non-US countries
3) Higher beta to global growth in non-US countries

This line of reasoning and speculative FX market positioning has stretched so much that participants have hypothesized that things like interest rate differentials no longer work!

Yes, interest rate differentials as a signal for trading currencies go through prolonged periods of "working" and "not working" (my friend Goofy Man from a large macro hedge fund noted that 2004-2006 was a period when interest rate differentials did not "work").

However, we are at a point where I think the markets have over-anticipated and other fundamental factors beneath the surface of price action can trigger a reversal.

First, let's talk about rate differentials.

2yr notes in the US, UK, and Germany.

2yr swap rates in USD and CHF IRS.

Clearly, we see that rate differential in nominal terms has been stretched. In addition, FX cares even more about real rate differentials, which roughly reflect the same pattern, but could serve to explain why this phenomenon has failed to impact things until now.

Next, let's talk about policy.

When we look at some of these other central banks, we hear a somewhat similar, yet importantly different tone.

ECB:
As late as last week, the ECB stated that it was too early to review policy and that the latest it would even consider revisiting policy would be sometime "early this year".

As with most central banks, the surprise the world and rip rates mantra no longer exists and what we have in place these days is the announce, announce, and announce until finally ticking rates up at the slowest possible pace. So reasonable to say, the market has over-anticipated a bit here.

They've also expressed their intent on not targeting the exchange rate.

BOE:
We know they came out last month and stated that they could be moving on policy changes more swiftly than previously thought  (This was what I was looking for last year). There was a nice pop for GBP on the news. Now that the cat's out of the bag, we need to think about what they might do going forward.

As our very own Macro Man has documented, the BOE's flip-floppy nature, so that could be a risk.

Tying that to the price action - we have seen that GBP topped out right around that announcement. Not exactly a good harbinger for GBPUSD.

With that said, it is still important to keep in mind that trade-weighted GBP still looks cheap.

SNB:
The SNB has not shown clear signs of tapering yet. Not only that, they are trying to invest in stocks (sign of the times in 2018). Thus, the appreciation of CHF versus the dollar is probably not sustainable.

The Fed:
Lastly, thinking about the dollar leg.

We had the latest Fed minutes last week and Powell speak recently. They have made it abundantly evident that the Fed will do it's best to maintain it's attempt to continue its pace of hiking.

Breakevens have slowly started building a head of steam. There are enough stories delineating the tax cuts. I've detailed some of Trump's Fed choices in the past here. It is clear that we are starting to get a hawkish Fed. Shawn has recently put up details regarding some evidence of J-Powell's intents.

Finally, there's my favorite indicator - Jay Powell's height - he's over 6 foot!!

And a picture is worth a thousand words:

Finally, let's talk about Donald Trump who seemingly always does his best (whether intentionally or unintentionally) to keep things interesting.

Unlike this time last year, he and Steve Mnuchin has come out and said that they want the dollar stronger from these levels.

Here and here, etc.

Ironically, the market once again fails to pay attention to the most important man in America as he explicitly states his goals and intent (look, no mystery here).

With this combination of reasons in mind, I now turn to the dollar chart (using DXY as a proxy - which is mainly composed of EUR, JPY, GBP, and CHF)

Looks pretty clear to me that it is looking for a bottom. From this one should be able to construct clear entry and stop levels to either take profits if you've been riding the trend or to get into a speculative long position.

This has been such a persistent move for G10 currencies, it will be hard to see CTA's getting out of the way of this one.

And for the rest of us, good huntin'.