am/FX: Runup and USD Down

Subscriber-only

1. Big USD runups into CPI have not seen follow-through.
2. What could trigger a USD turn??

by Brent Donnelly

October 12, 2022

Current Views

Long a 3-month USDBRL 4.90 digital put at 20%

Spot ref. 5.1850 on 10OCT22

Expires 11JAN23

October 12, 2022

Runup and USD down

The runup trade into CPI has obviously been to buy USD and sell stocks. Given the monster move after CPI last month, and the inflationary macro environment, this makes sense. The issue is that the follow-through after a big runup trade like this hasn’t been great this year. Obviously the number itself matters tomorrow, but the conditions going in are important too.

Here’s AUDUSD into, day of, and after CPI releases this year.

AUDUSD %return: 3 days before CPI, the day of CPI and 3 days after CPI

Look at the dark blue bars. The USD ran up (lower AUDUSD) into most CPI releases. But then look at the lighter blue bars. The move often reversed on the day of CPI. The takeaway is that in months like January, March, April, and August, the big runup in the dollar was a fade once CPI came out. The only exception was June, where you had a 1% drop in Oz going in, and another 0.7% drop on the day of CPI.

Dreaming of a USD turn

There is a decent cohort of speculators and investors that are more sympathetic to short USD here than long USD. The reasons vary, but the main ones are a) the moves are extreme, DSI is mega oversold, etc., or b) the US twin deficit story smells a bit like the UK so maybe the bond vigilantes are coming to the United States at some point. The US deficit story is an evergreen narrative so I’m not a huge lover of that story but in FX things matter when they matter so I’m open to the idea that this could be a theme at some point. Here’s a brief pictorial history of US dollar and US debt doom-mongering.

To the first point, about the USD being overbought, overvalued, etc. Sure, yes, that is true. I have never seen one person in FX ever make money trading valuation, but overbought can certainly be traded. This is the largest one-year rally ever for the USD, so by that metric, it’s hard to argue long USD is a layup from here. Check out this chart, which provides a fascinating history of the USD since before Bretton Woods.

Annual change in DXY, 1968 to now

So perhaps that’s one ingredient for a USD sell off at some point. However, a more comprehensive, realistic, convincing bearish view on the USD must include a view on improvements in global growth. Almost every meaningful USD down move that I have seen in my career was the product of decent or strong global growth or at least pockets of strength and optimism… Usually from Germany and/or China. When money flows to other countries, the USD can sell off.

Here is a grid of every USD move greater than 6% since 1968, along with US equities compared to the rest of the world (labelled “SPX vs. RoW”), the move in SPX and the move in US 2-year yields. You can see the SPX almost always underperforms the rest of the world in USD down years and outperforms in USD up years. The exceptions are mostly explained by idiosyncratic factors like intervention or the Homeland Investment Act in 2005.

So, what’s going to make money flow out of the United States and into the rest of the world? The end of COVID-zero? Maybe! A warm winter in Europe? Perhaps. It’s not obvious what will trigger this, and that’s why it’s still hard to be bearish USD other than for a quick correction trade.

Speaking of COVID zero

People in the Americas seem to think there’s a chance COVID zero ends soon. People in Asia are betting on Q2 2023 or something around there. Chinese media have been sending aggressive smoke signals over the past few days suggesting there is nothing imminent. For example:

https://www.scmp.com/news/china/politics/article/3195434/coronavirus-be-more-patient-chinas-zero-covid-drive-peoples

Final Thoughts

Interesting! The ratio of people that care about FX to people that care about stocks on my Twitter feed is 0.4688 to 1. I would have thought 1:1. Have a green day.