US Dollar Price Action Setups: EUR/USD, GBP/USD, AUD/USD, USD/JPY
US Dollar Talking Points:
- The US Dollar bounces off confluent support ahead of tomorrow’s FOMC rate decision.
- The Fed is expected to hike 75 basis points, but the bigger question is what else is being said at the press conference regarding future hikes in September and beyond.
- The analysis contained in the article is based on price action and graphic formations. For more on price action or chart patterns, see our DailyFX Training section.
- Quarterly forecast just released by DailyFX and I wrote the technical part of the US dollar forecast. To get the full article, click on the link below.
Tomorrow brings the Fed, but you probably already know that. And you probably already know that a 75 basis point hike is widely expected here, as if that doesn’t happen, there could be trouble elsewhere. If the Fed goes too lightly, questions will abound about its commitment to fighting inflation or, perhaps more troubling, what does the Fed see that prevents it from doing so? On the other hand, if the Fed goes heavier with a 100 basis point hike, well, we might see the turbulence that had shown a few weeks ago, when the markets had started to expect that. This was compensated Thursday and Friday (July 19e/20e) while FOMC speakers dismissed that prospect.
But, inflation remains aggressively high and, so far, the Fed’s rate hikes haven’t shown much impact on the issue. However, rate hikes usually take time to pass through, and the Fed only started to take off just over four months ago, so we’re still in the early stages. And that’s usually why central banks might want to be hawkish when inflation goes above target, because once it takes on a life of its own, it can be hard to get it under control, just as we have. seen in the 1970s.
Treasury rates have fallen lately and many are pointing to the fact that inflation may have peaked, and it is the bond market that reflects that message. But, a look at the yield curve adds some context because if so rates are falling this is also happening unevenly and at this point the 2/10 yield curve is at its most inverted since over 20 years.
This is not a positive signal for future growth: as rates rise on the short end of the curve, driven by Fed hikes, investors exit the curve to take duration on Treasure. Simply buying Treasuries at current rates exposes the potential for a principal gain if/when rates fall further. So essentially, as the Fed raises rates, market participants seem to be betting more and more on some economic headwinds ahead, as this strength in longer-dated Treasuries indicates.
To illustrate this theme, the 2/10 yield spread, or the difference between two- and ten-year Treasury yields, has reversed and is at its lowest since November 2000.
US Yield Curve Spread Between Two-Year and Ten-Year Treasuries
Chart prepared by James Stanley; data from Commercial view
This means that two-year Treasuries are currently yielding more than ten-year Treasuries, by around 26 basis points.
So ask yourself: why would an investor take 10 years of risk at a lower rate, 0.26% as of this morning, as opposed to a higher rate for less duration risk? It would be like walking into the bank and applying for a 10 year mortgage and then receiving a higher rate than if you had taken out a 30 year mortgage. Which bank would offer this? Probably none, because the long term entails more risk which should be compensated by a higher interest rate.
When that’s not happening in the markets – like what’s being shown right now – it’s extreme distortion and again, probably due to investors and funds buying longer-dated Treasuries in anticipation of the eventual move to lower rates, which may be driven by worsening economic conditions.
The US dollar is in a special situation right now. Not only has the currency been driven by higher rate themes, which would be a traditional currency driver emanating from rate divergence. But, there is also the possibility of refuge flows as the clouds darken over Europe.
So this may be a rare situation where the safe haven is also the highest yielding currency and that would add some perspective the rise of the US dollar over the past year and, more specifically, the last six months as the Russia-Ukraine storyline continues.
In the short term, the US Dollar is currently trying to maintain high-low support. This showed at a confluence point on the chart both an uptrend line and a 38.2% Fibonacci retracement plotted around 106.24. This may keep focus on USD uptrend continuation themes.
US Dollar Daily Price Chart
Chart prepared by James Stanley; USD, DXY on Tradingview
EUR/USD in the box
EUR/USD is currently in a formation of rectangles and this is something that will often appear around consolidation. The rectangle or box is usually approached for breakouts and this morning the underside of this box was tested at 1.0120, with wicks emphasizing the reaction at this level. For bullish USD themes, bearish EUR/USD positions are likely to be a significant part of this approach.
Overall, the question is what might develop in Europe in the second half of this year. With natural gas prices rapidly returning to a new high and the ongoing Russia-Ukraine scenario not improving, there is a risk of a troubling winter in Europe with energy rations and a spike in oil prices. ‘energy.
Europe is already struggling with inflation and the ECB just started raising rates in a bid to fix the problem. But energy prices are kind of an uncontrollable variable here and higher energy prices could persist even with higher tariffs.
But, if the ECB does not increase more, then there is more risk that the euro will lose value, which can increase this inflationary pressure. So the ECB really seems to be locked in here: it needs to rise to try to fight inflation and prevent the euro from falling through the floor, but, on the other hand, it needs to rise cautiously lest it choke anything. growth is left. And then, when all is said and done, there could be an energy crisis in Europe later this summer.
Collectively, this is why the single currency has struggled to hold up lately, with its first peg foray into EUR/USD in nearly 20 years.
For now, the rectangle is set and a bearish breakout exposes the parity level for another test. On the other hand, in case of a break up, potential resistance exists at the previous low of 1.0340.
EUR/USD four-hour price chart
Chart prepared by James Stanley; EURUSD on Tradingview
Cable’s short-term price action looks messy. When I looked at the pair two weeks ago There was a formation of drooping corners which was taking place. Such formations are often approached with the aim of bullish reversals, and it started popping up last week.
Prices have since reached the resistance level of 1.2090 and there has been continued construction of lowers and highers. At the moment GBP/USD seems to be trying to defend 1.2000 psychological level.
The complication with bullish themes at the moment would be a lack of bull runoff near the highs or at resistance. This allows the initial stages of a rising corner to form, which is the mirror image of the descending wedge from two weeks ago and is usually drawn for the purpose of bearish reversals.
GBP/USD four-hour price chart
Chart prepared by James Stanley; GBPUSD on Tradingview
AUD/USD also broke the recent formation of a falling wedge, although the setup for AUD/USD was a little longer term than discussed above for GBP/USD .
The AUD/USD falling wedge built from mid-June to mid-July with last Monday showing the breakout of the formation. And, initially, the pair had a run up which propelled the price towards the big figure of 0.7000.
Price action over the past few days, however, has been particularly “feisty” with little direction. On the daily chart below, note elongated locks either side of the last day candles. This indicates a search direction of the market and opens the door for a test of support at 0.6854 or a test of resistance at 0.7000.
Given the deviation from EUR/USD or even GBP/USD above, AUD/USD may have a preference for bearish-USD biases or pullback themes around USD entering the FOMC tomorrow.
AUD/USD daily chart
Chart prepared by James Stanley; AUDUSD on Tradingview
USD/JPY is looking for support. Last week’s BoJ meeting produced no significant change at the Central Bank of Japan. Nonetheless, the yen’s weakness has since eased, raising the question of whether markets are starting to price something else or whether there is a growing expectation for a possible shift.
In USD/JPY, the price remains at the support guided by an uptrend trend line, but the buyers have not yet been able to overcome the short-term resistance, drawn around 136.70-137.00. there is deeper Support in the area 134.48-135.00.
For traders considering yen strength strategies, EUR/JPY or maybe even GBP/JPY may be of some interest.
USD/JPY four-hour price chart
Chart prepared by James Stanley; USDJPY on Tradingview
— Written by James Stanley, Senior Strategist for DailyFX.com
Contact and follow james on Twitter: @JStanleyFX