USD may correct lower following yield decline on Wednesday…

…but still has potential to gain on employment report

JPY looks well supported as US long term yields struggle to rise

GBP remains vulnerable

SEK could rally but struggles to break below parity against the NOK

There isn’t a great deal on the calendar on Thursday ahead of Friday’s US employment report, which remains the main focus of the week. The USD remains higher on the week after the gains following the Powell testimony, but gains against the JPY have largely disappeared after the decline in yields on Wednesday, and the USD’s strength is most marked against the riskier currencies. However, with equities also stabilising on Wednesday, the USD now looks to have potential to correct lower against the riskier currencies as well, and that looks to be the risk if the employment report doesn’t support the recent rise in yields. Even if it does, an employment report that shows strong employment but moderate wage growth might not lead to higher yields and consequently might even benefit equities and the riskier currencies. 

The recovery of the JPY on Wednesday came not just against the USD but on the crosses. It was notable that after the Powell testimony the US curve flattened with long term yields barely rising at all in spite of the sharp increase in short term yields. This is significant for the JPY as USD/JPY retains a correlation to long rather than short term yields this year, so this suggests that upside scope for USD/JPY is very limited. Conversely, EUR/USD has tended to move with short term yield spreads. Bearish curve flattening therefore suggests scope for EUR/JPY to decline if EUR yields don’t follow US yields higher. In any case, we believe the market is overpricing the scope for ECB tightening, so spreads are unlikely to move in the EUR’s favour. While the EUR could gain support against the USD if the equity market holds up, this is unlikely to prevent losses against the JPY if yields are topping out. 

GBP continues to look vulnerable, with short term yield spreads against the EUR suggesting scope for a EUR/GBP move up to 0.90. While we believe the EUR curve is probably pricing in too much tightening, it is still unlikely that the ECB will sound dovish at next week’s meeting while it is possible that the Bank of England don’t hike rates at all, even though there is a 25bp hike priced in and another priced in for May. This may change after the UK January GDP data on Friday, but even if it doesn’t, the combination of current yields suggesting upside scope for EUR/GBP and potential for the BoE to turn out more dovish relative to expectations than the ECB suggest EUR/GBP has upside risks here. 

While there isn’t much data on the calendar on Thursday, there is some Swedish production and orders data. There is no consensus, but a bounce could trigger some recovery in the SEK, which has suffered this week from the USD’s gains against the commodity currencies, given its attachment to the NOK, which is greater as we approach parity. However, yield spreads suggests scope for a recovery against the EUR (and the NOK), so we favour the SEK upside.