Week Ahead: Don't Pass On The Buck; Fresh Longs Attractive

Yellen dealt a heavy blow to the FX divergence trade and sent USD falling across the board. We doubt that this is the end of the multi-year USD bull-run, however, and see the current levels as an opportunity to establish fresh longs.

Indeed, the recovery in commodity prices and the easing of global financial conditions should allow the Fed to hike before long. We also note that the USD is starting to look quite cheap compared to the spread between the US and the average G9 2Y rates. Last but not least, the strong positive correlation between the USD and global risk appetite should limit any loses against EUR, JPY and CHF.

The mood in the markets has improved tangibly as well after the Fed reiterated its dovish bias and as fears about China abated further.

Looking ahead, there doesn’t seem to be much standing in the way of the risk rally. Investors could therefore continue to cut CAD-shorts, and add to longs in AUD and NZD. That said, market liquidity will likely deteriorate ahead of the Easter holidays and that could discourage investors from putting on sizeable risk-on bets.

Next week’s data calendar is rather light and, with liquidity thinning, position squaring could start dominating FX price action. The markets are still running sizeable GBP shorts and a potential short squeeze could support the currency, especially if UK inflation does not disappoint. Position squaring could favour CAD relative to other commodity currencies. Last but not least, with markets running JPYlongs but still generally neutral on EUR. EUR/JPY could bounce alongside USD/JPY if weak Japanese inflation boosts BoJ easing bets.

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What we’re watching

EUR – The EUR should be driven by external factors still, irrespective of next week’s PMI and ifo business climate survey releases.

GBP – Inflation and retail sales data should confirm still constructive domestic conditions to the benefit of rate expectations and the currency.