Overnight Headlines

*USD drops as the risk mood improves, pulling back below 92

*US equities reversed Friday’s losses, best session since mid-May

*Oil jumped by the most in a month, Brent trading through $75

USD fell back after topping at a two-month high of 92.40 at the end of last week. Risk-on sentiment returned meaning more support for commodity-$s. GBP outperformed as PM Johnson said the UK remains on track for the new freedom day on 19 July, gaining nearly 1%. EUR trades around 1.19 as it tries to recover from the two-month low at 1.1848. A drop in safe haven demand also saw the yen at the bottom of the major currency charts.

US equities rebounded strongly with the Dow erasing last Friday’s loss and jumping nearly 600 points (+1.8%) while the S&P500 added 1.4%. You guessed it but rotation again was the name of the game – back into cyclicals and small caps with energy, industrials and financials topping the sector charts. The Nasdaq gained 0.8% in contrast to the Russell 2000, up 2.2%. Losers from yesterday in Asia are bouncing back with US and European futures modestly higher.

Market Thoughts – Market over-reaction?

Has the market misread last week’s Fed? The move has been all about position adjustment whereby the easy money trade has turned into the pain trade. When consensus is fully on board with a Fed that has consistently declared that inflation is transitory and they will be patient in reigning in any bond buying, then for sure there will be a violent readjustment when a surprise more hawkish shift is advanced.

This has been seen the most in the US government bond yield curve which has become flatter – this indicates that investors believe monetary policy could tighten before the economy has fully recovered. But it is rare to see this after a supposed hawkish Fed meeting and before a hiking cycle. Scrambling dollar shorts have also extended the currency moves. Jay Powell speaks later today although his testimony was released in advance yesterday with the Fed Chair saying that he regards the current jump in inflation as likely to fade.

Chart of the Day – USD/CAD on key support

The CAD has suffered over the past few weeks as the USD’s stabilisation around 1.20 developed into a “rounding bottom” pattern of support and a strong rebound with the 2.6% gain the largest 5-day advance since January. Directional risks shifted with the Fed meeting last week but questions remain about the intended outcome. The loonie’s softening does in fact give the BoC cover to continue with its own taper process in July and surging oil prices will also give additional support to CAD with underlying CAD fundamentals still constructive.

USD/CAD has tested the 1.2475/80 area several times since last week but has struggled to remain near 1.25 with the pair trading well outside the upper Keltner channel. The 100-day SMA has also proved to be a barrier of resistance and the pair is now trading just above a previous cycle low at 1.2365. Overbought conditions on the RSI have eased but there is congestion resistance between 1.25/1.2650. There are more Fed speakers today (Daly and Mester) to hear and see if they pull back on last week’s hawkish message.