At the start of September 2022, the forex market is still being driven by a global risk aversion trend, with the US dollar index (DXY) reaching new highs in over two decades on the back of a heavy devaluation underway for the euro (EUR), the Japanese yen (JPY), and the British pound (GBP).
Central banks around the world are competing to raise interest rates to combat the highest inflation in forty years, which has been exacerbated by the European gas crisis caused by Russia’s supply disruption.
There are five major central bank monetary policy meetings this month, beginning with the European Central Bank (ECB) and continuing with the Bank of Canada (BoC), the Bank of England (BoE), the Bank of Japan (BoJ), the Swiss National Bank (SNB), and finally the Federal Reserve (Fed).
Which trends can we expect in major currency pairs? What trading signals have emerged from the most recent forex chart analysis?
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Forex market heatmap: EUR, GBP and JPY sold off against USD
EUR/USD chart analysis: Next support at 0.96 as gas crisis worsens
The euro (EUR/USD) has fallen below parity with the US dollar as Europe’s gas crisis worsened following Russia’s decision to halt supplies via the Nordstream 1 pipeline.
After falling nearly 16% this year, the euro is experiencing one of the worst devaluations in its history.
The deterioration of the Eurozone’s macroeconomic fundamentals is clearly visible:
- In August 2022, both the Manufacturing PMI and the Services PMI for the Euro Area were already in contractionary territory at 49.6 and 49.8, respectively.
- The annual inflation rate is running at 9.1% year on year, marking a new all-time high.
- The balance of trade deficit has reached a new high as energy imports have skyrocketed, while exports have been hampered by a global slowdown.
- Consumer confidence is still near an all-time low, indicating widespread pessimism among households.
Although the ECB is now set to raise rates by 75 basis points, this has not be enough to stop the euro’s depreciation over the past weeks. It’s a symptom that the market expects more from the ECB, namely, large and sustained interest-rate hikes that can reflect the increased risk associated with investing in the single currency today.
Meanwhile, a still-relatively-healthy labour market in the United States continues to support the Federal Reserve in its willigness to hike interest rates aggressively to bring inflation back at target. Markets expect the Fed to hike by 75 basis points this month for the third time in a row.
Soaring natural gas prices in Europe were another major factor that caused the euro to fall below parity with the dollar over the summer. In particular, the wholesale gas benchmark in Europe (Dutch TTF) is currently 8 times higher than US domestic natural gas prices, giving European companies and consumers a big competitive disadvantage compared to those in the US.
When looking at the EUR/USD weekly chart, the next key support test is at 0.961 (September 2002’s lows). If EUR/USD breaks this level, the next hurdles are 0.93 (June 2002’s low) and 0.90 (May 2002’s low). Lower European gas prices and a much more hawkish ECB than the Federal Reserve are required for EUR/USD to return above parity.
GBP/USD chart analysis: Playing with fire at 1.141
Similar to the euro, the pound (GBP/USD) is also stuck in a major downward trend against the US dollar.
The UK’s skyrocketing gas prices have also worsened the outlook for the sterling, raising inflationary pressures and lowering growth projections, with the BoE anticipating a recession starting in the fourth quarter.
The pound’s weakness is reflected in the rapid deterioration of the UK’s main macroeconomic indicators:
- The consumer price index (CPI) reached double digit rates (10.1% year over year) in July 2022, which is the highest level since February 1982. Core inflation, which excludes energy and food, is at 6.2% year on year, the highest level since the series began.
- Annual producer price inflation (PPI) is 17.1%, the highest level since June 1980.
- Gfk Consumer confidence in the UK has plummeted to -44 points, the lowest level ever recorded.
- Real wage growth in the UK is negative by 5% year-on-year, the lowest since the first quarter of 2009, as consumer inflation (10.1%) more than compensated nominal wage gains (5.1%).
Markets have materially repriced BoE’s interest rates amid the soaring inflation outlook in the UK, but that hasn’t been enough to spur the pound. Projected real interest rates are still in deep negative territory, considering what the market is pricing in and how inflation could evolve.
Looking at the chart, GBP/USD is aiming for a test of 1.141 support (March 2020’s low), which would complete a “rounding top” pattern characterised by an inverse U-shaped price action.
There is a lot of fresh air below the 1.141 level, making it a crucial support to hold for the pound’s fate. If broken below, it would take us all the way back to March 1985, with 1.08 and the all-time low at 1.05 (early March 1985) as the next key supports.
USD/JPY chart analysis: August 1998 highs in sight, if the BoJ continues to slumber
The Japanese yen has been the worst performing major currency in the last year. The USD/JPY rate has been steadily rising as a result of the wide divergence in monetary policy between a Fed that aggressively raises interest rates and a BoJ that remains the only central bank that has not done so.
The depreciation of the yen and the rise in global commodity prices have also put pressure on Japan’s economic fundamentals, though inflation there has not shown the same sharp increase as in Europe or the United States.
The weakening growth outlook and relatively subdued inflation (2.6% in July) were the factors that prompted the BoJ to be the only central bank among the majors that has not yet raised interest rates.
Further evidence that the BoJ will remain an outlier among a global wave of central banks tightening policy is that it has stated it will not hesitate to take additional easing measures if needed and that it would continue to buy unlimited amounts of Japanese Government Bonds to defend the yield target.
Recent verbal communications have highlighted the dangers of extreme exchange rate volatility, but no policy actions have been taken in response. In the absence of a major catalyst such as a Federal Reserve pause or a BoJ policy shift, the conditions for a USD/JPY trend reversal are still absent.
The August 1998 highs of 147.7 represent the next resistance level to be tested. A breach of this threshold will bring into focus the August 1990 resistance and psychological level of 150.
USD/CHF chart analysis: Nearing parity, but SNB won’t allow major depreciations
Infected by the crisis of the neighbouring euro, the Swiss Franc has been unable to defend its traditional role as a safe-haven asset.
The USD/CHF currency pair has been on an upward trend since the beginning of the year, briefly breaking above the parity level on two occasions (mid-May and mid-June).
However, strong fiscal fundamentals – Switzerland has the lowest public debt-to-GDP ratio (41%) among advanced economies – and a central bank that surprised markets in June by increasing interest rates by 50 basis points when expected them to stay the same – have curbed heavy selling pressures on the Swiss franc.
Switzerland’s annual inflation rate was 3.5% in August, the highest since 1993, but it is showing signs of peaking and remains relatively contained in comparison to other markets.
If the SNB continues to aggressively raise interest rates, the market may actually reward the CHF as one of the few major currencies with a central bank that is likely to return inflation to its target in the short term. This could signal a regime shift and increase CHF demand, particularly from European investors if the gas crisis intensifies and political risks arise.
The USD/CHF chart analysis indicates a possible test of resistance at 0.9886 (14th July high). If the bulls were to prevail, parity would be the next resistance to watch (1.00).
However, with the RSI approaching overbought territory, some selling pressure could resurface. If the pair fails to break through 0.9886, it may form a new double-top pattern, as seen earlier in May and June, which may result in a downward price action.
We think the SNB is particularly sensitive to currency devaluations that threaten the stability of the Swiss economy and the central bank’s reputation.
AUD/USD chart analysis: No immediate signs of trend reversal
The Australian dollar (AUD/USD) has been trading in a downward channel against the US dollar since January 2001.
Inflation in Australia reached 6.1% in June, the highest since 2001, as food and fuel prices rose.
The RBA is expected to increase rates by 50 basis points to 2.35 percent, but this is unlikely to significantly reverse the major trend in the Australian dollar, which has been under pressure from China’s renewed lockdowns, expectations of stronger Fed rate hikes, and global stock market risk aversion.
We need to see a combination of China stepping up policy stimulus, higher commodity prices, and a de-escalation of geopolitical tensions over Taiwan for the AUD to substantially reverse its course against the US dollar.
However, because Australia is a key player in global gas exports, if global commodity prices continue to rise, the AUD may find support, particularly in crosses against the euro, pound, and Japanese yen.
The AUD/USD daily chart has recently showed a head-and-shoulders top pattern, followed by a close below the neckline at 0.685. This bearish signal may indicate that support at 0.668 (2022 low) might be tested again.