Investors flock to safety of US dollar

The US dollar remains near 5-month highs versus the majors, with the dollar index closing 92.90 on Friday, not far from its 93.20 high last Monday on the “delta-dip.” The persistent strength of the US dollar, even as US bond yields continue to ease, likely reflect flows into the bond market and a continual haven bid from emerging markets that are battling the delta-variant globally, notably in Asia.

Markets are vulnerable to more US dollar upside surprises this week, given that the overall environment, when looking at US yields, should not support US dollar strength. Especially with no infrastructure agreement in the Senate and a looming US debt ceiling. If the FOMC surprises with a change of language this week, we can expect another surge in the US dollar, particularly versus the low low forever euro, and emerging market currencies.

EUR/USD is trading sideways at 1.1775 today and appears to be slowing, forming decent support at 1.1750. However, its rallies have been shallow, and 1.1800 has mostly been contained. EUR/USD needs to close above 1.1800 a couple of times this week to change the bearish narrative; otherwise, the risk remains of a deeper selloff to sub-1.1600.

GBP/USD looks more constructive, helped along by “freedom week”, passing mostly without incident by British standards. GBP/USD closed the week above the 200-DMA at 1.3710, and a rally above 1.3800 would signal further gains targeting 1.4000. A stabilisation of the US 10-year yield has seen bids creeping back into USD/JPY, which has risen to 110.35. A rally through 110.70 targets a retest of the 111.60 May highs, although we may have to wait for the FOMC outcome first.

USD/CNY has shied away from resistance at 6.4900 since the start of June. A daily close above 6.4900 likely signals that authorities are happy with another bout of yuan weakness, having put a floor under the appreciation trend in early June. The turmoil in the China stock market and the ongoing clampdowns by the government across multiple sectors means USD/CNY is unlikely to fall very far this week.

The Australian and New Zealand dollars are trying to trace bottoming formations at the moment, but the rallies are shallow. With their high correlation to risk sentiment in Asia, sustained rallies will be hard to come by, especially with the Indonesian rupiah, Malaysian ringgit, Thai baht and other ASEAN currencies suffering deep delta-discounts. On that note, regional ASEAN currencies will trade nervously into the FOMC. Any change to the language will see them suffer additional selling, being highly sensitive to US interest rate trajectories at the best of times.