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Forex Analysis
Having begun a Quantitative Tightening process at the start of June, the Fed is now letting its balance sheet runoff. Even though the primary tool of Fed tightening remains interest rates, QT also has important implications for markets. By reducing reserves, QT tightens financial conditions, increases duration supply, and eliminates the backstop bid at auctions.
When reserves are removed, banks can also lend more because Supplementary Leverage Ratios widen, allowing them to take on more liabilities. This creates new money into the wider economy and facilitates economic growth. This is a massive positive for the economy. In addition, QT permits non-governments to profit from interest payments by holding more collateral that has a yield, such as US Treasury bonds. This also directly stimulates the economy.
Currently, banks have a lot of cash on their balance sheet, and they can lend that overnight to the NY Fed in return for the highest quality collateral and at the same time they receive an interest payment. This suggests that QT may go a long way to removing that collateral shortage and for the Reverse Repo Operations to become redundant, the interest rates on excess reserves needs to be higher. This operation can be tracked through the overnight Reverse Repo facility at the NY Fed. It should be noted that the real cash drain at the banks is when the US Treasury issues new debt.
As the price of US Treasuries goes down, we are seeing the yields rising and at the time of writing the benchmark US 10-year yield is slightly higher today at 2.915%. The high at the beginning of May was 3.146%.
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The high in the benchmark yield also marks the same time of the US dollar peaking before it sold off to get below the $102 support level. The US dollar index is heavily weighted towards the moves in the euro and yen, but primarily the euro. So, what we need to watch for now, is how the US Treasury market reacts to the start of QT as well as how the situation in Ukraine and the geopolitics involved, moves the euro. If things in Ukraine get better, or stabilise at least, the euro will rise, and the US dollar will no doubt weaken. But currently we are looking at a weaker euro and so should be looking for signs of support in the DXY.
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The EURUSD found old support on the daily chart acted as resistance around the 1.07500-1.0800 zone. There is a chance that there is slightly more liquidity above the current swing high to test, but sentiment and momentum could drag price action lower.
The ActivTrader platform sentiment indicator offers no bias currently, so there is no cohort to counter trade against.
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If we look to the intraday chart and use the daily as a bias for direction, I am now looking for the EURUSD to continue making lower lows and lower high, with resistance capped at the 200-period moving average. 1.0600 is the significant support level, that still needs to be tested and when price action gets there, I will assess whether to take some risk off the trade or whether price has done enough to signal further downside pressure. I shall also have to take into consideration what the US 10-year yield and US dollar index are signalling as the next most likely move.
