Thursday risk off in global market was driven by Fed tapering concerns reducing future liquidity prospects, while the Delta wave is tempering recovery and corporate earnings forecast. The move was amplified by the desire to book profits on any pullback and equity option expiration August 20. The option expiration can still put downward pressure on equities and will be watched. The Fed tapering and Delta wave fallout are unlikely to fade quickly though, as headwinds for riskier assets. The commodity shakeout is now getting noticeable, with China steel output curbs crushing iron ore.
Friday light data calendar will likely mean that the FX market reflects on Fed tapering and the Delta wave, as the two big driving forces into September. The considered view is that the July FOMC minutes increase confidence that the Fed will actually taper, with the timing of the announcement being secondary – most expect actually tapering to start by January. This could weaken the resolve of the USD bears and help produce a further drift higher in the USD across the board. The scale will also depend on how U.S. Treasury yields adjust, but this is being tempered by the risk off in equities/commodities for now.
The other dynamic is the Delta wave. Data in the UK/Europe shows a lower percentage of hospitalizations and deaths from new COVID cases, due to vaccine effectiveness. This breaks the link with the economy. However, the U.S. is struggling somewhat more with the Delta wave, due to lower vaccination rates than Europe. A new large scale report in the UK also backs the idea that vaccines effectiveness reduces through time against mild/modest infections. This could cause a headwind of increased voluntary social distancing and hurt economic growth, if booster campaigns in DM countries are not effective. Growth forecasts are being trimmed in the U.S. for Q3 in part due to the delta wave in contrast to Europe, but not enough to derail the Fed tapering debate or USD bullishness. Thus our bias remains for EURUSD to extend gains and we look for a test of 1.1650 and a multi week move to 1.1500. We also look for 127.00 on EURJPY.
AUD and NZD remain vulnerable as only 40% and 34% of the population have received at least one vaccine dose and both governments have a zero COVID policy rather than trying to live with COVID. The economies could be stuck in this limbo for a further three plus months until vaccination rates are high enough and hurting confidence.
In contrast, Japan has made great progress over the last month with 51% of the total population having at least one dose. The current COVID wave is causing problems, but widespread vaccination could reduce the adverse effects of COVID. This is JPY supportive. AUDJPY has scope to 77.50.