Currency markets consolidate after the US dollar rally

Currency markets contented themselves with some consolidation after Friday’s impressive rally. Major currencies traded sideways with UK markets ignoring the extension of pandemic restrictions. The dollar index was almost unchanged at 90.50, where it remains this morning, with EUR/USD at 1.1215 and GBP/USD at 1.4115.

One notable move was USD/JPY, showing once again its sensitivity to moves in the US yield curve. A rise in US yields overnight saw USD/JPY rise 0.40% to 110.10 overnight, where it remains today. USD/JPY has now moved to the high end of its two-week 109.30 to 110.30 broad range. Further gains from here will depend entirely on whether US yields continue to grind higher into the FOMC. USD/JPY has challenging resistance at 111.00 and does not have the momentum to test this level seriously.

USD/Asia has moved slightly higher today after the return of China from holiday saw the PBOC fixing set at 6.4070, slightly weaker than expected versus the US dollar. With the PBOC tightening liquidity today, USD/CNY remains below the fixing at 6.4045, almost unchanged for the session.

There are reports of potential problems with a French-designed nuclear power plant located in Taishan, located west of the Pearl River Delta and just 140 km from Hong Kong. There are fears of a leak at the plant, and the Biden administration has been in contact with French and Chinese officials about the issue.

The evolution of the Taishan nuclear story, if negative, is most likely to weigh on the offshore yuan, USD/CNH, although I expect the PBOC will be out “smoothing” if markets nerve fray.

Overall, currency markets are calm, and I expect US dollar shorts to continue reducing into the FOMC. The Australian and New Zealand dollars are the most vulnerable amongst the major currencies, so we could see some volatility ahead of the FOMC meeting on Wednesday.