Short covering lifts USD – Scotiabank

A big week lies ahead for markets. There is plenty of US data to work through but the NFP update at the end of the week is the primary focus for traders looking for guidance on how aggressive a widely expected Fed rate cut on September 18th will be, Scotiabank’s Chief FX Strategist Shaun Osborne notes.

Last week’s USD rebound develops ahead of NFP data

“The US Dollar (USD) rebound that got underway last week has extended a little today after a quiet session Monday while North America was out. USD short-covering is the primary motivation behind USD gains, although the risk backdrop does look soft today amid broad losses in global stocks. Fed rate cut expectations have not changed—swaps still reflect the risk that the Fed cuts by more than 25bps at next week’s meeting and continue to price in 100bps of cuts over the remainder of the year.”

“Short-term rate spreads moved significantly back in the USD’s favour. The situation leaves the DXY looking moderately overvalued, based on weighted 2Y interest rate differentials, according to my model. The charts do suggest there is a chance that the DXY rebound extends a little more after last week’s firm (technically bullish) close, however. Over the longer run, lower US interest rates and slowing growth momentum are likely to weigh on the USD.”

“On the session so far, the USD is notching up gains against most of the majors, with the exception of the JPY and MXN. The JPY is outperforming broadly after BoJ Governor Ueda submitted a report to the government reiterating that the central bank will tighten rates further if the economy develops as anticipated. Doubts around further BoJ tightening steps arose following the volatile reaction to the July rate hike.”