Welcome to Super Data Week

After an extremely turbulent week, the market finally calmed down, with risk sentiment continuing to recover on Friday. US stocks closed higher, the 10-year US Treasury yield has returned to the level before the non-farm data was released, and the VIX fell.

In this article, let's discuss the three main trading themes in the recent foreign exchange market:

Theme One: Has the unwinding of carry trades ended?

Theme Two: Will the US enter a recession, and has the rate cut expectation gone too far?

Theme Three: What impact will the US election have on the US dollar?

Has the unwinding of carry trades ended?

After two weeks of position adjustments, high-beta currencies that rose in the first half of the year saw the most significant declines in the past two weeks (such as MXN in emerging market currencies and GBP in G7 currencies), while the worst performers in the first half of the year became the biggest winners (JPY, CHF, CNH, and other low-yield currencies).

Last week's CFTC positions showed that speculative short positions in the yen have been significantly reduced for four consecutive weeks, with net shorts dropping from a peak of 184,000 contracts in early July to 11,000 contracts, the lowest level since February 2021.

As a high-yield carry trade asset, the net long positions in the pound have also been significantly reduced.

Although futures account for only a small part of the foreign exchange market, and we cannot know more about off-exchange positions, from what we can see, it is speculated that the unwinding of carry trades has already been mostly completed, and many trend-following CTA strategies have even started to shift to long positions in the yen.

Therefore, this trading theme has most likely come to an end.

Has the rate cut expectation gone too far?

The initial jobless claims data on Thursday was more important than ever, greatly restoring market confidence. Initial claims were 233,000, a decrease of 17,000 from the previous week, marking the largest drop in nearly a year. This refuted the deterioration of the labor market, indicating that the impact of the hurricane on July's non-farm data was temporary. The 2-year US Treasury yield jumped 10 basis points after the data, and the initial jobless claims data every Thursday going forward may be crucial.

Expectations for rate cuts this year have retreated from an extreme 116 basis points to 100 basis points. Currently priced in for a total cut of 209 basis points by the end of 2025, although still leaning towards being "overdone," returning to the "normal level" of 2-3 rate cuts within 2 years will require continued strong US economic data

For this "Super Data Week," the author believes that retail and employment data (Thursday) may be more important than inflation (Tuesday PPI, Wednesday CPI). This is because the market consensus is already on the decline in inflation, and the decision on whether the Fed will cut rates by 25bp or 50bp in September depends mainly on the economic situation.

1. If CPI, retail, and employment are in line with expectations, or one good and one bad: the expectation for rate cuts for the year will fluctuate between 100bp and 75bp;

2. If CPI, retail, and employment continue to weaken: the market will continue to lean towards trading for a 125bp rate cut, and in extreme cases, it may be priced in for consecutive 50bp rate cuts in September and November;

3. If CPI, retail, and employment all exceed expectations: the expectation for rate cuts for the year will return to a reasonable level of less than 3 times, i.e., 25bp per cut.

Regarding retail data, MS believes that due to the weak month-on-month income index of non-farm payrolls in July, there is a higher possibility that retail sales will fall short of expectations. (Market expects a month-on-month increase of 0.3%, previous value was 0%)

For CPI, the current inflation swap implied CPI fixing is 2.92%, slightly lower than the market's expected 3%, and in the past, CPI fixing has been able to predict CPI quite well.

The author believes that for the data this week, scenarios one and two are more likely, and U.S. bond yields and the dollar may still be weak.

How does the U.S. election affect the dollar?

Recently, the market has been too volatile, to the point where the heat of the U.S. election has begun to wane. However, the balance of polls has quietly shifted, with Harris now leading over Trump (58% vs 45%)

From the perspectives of the two candidates, the impact on the dollar is twofold:

1. Trade policy: Harris opposes trade protectionism and is more moderate on tariff policies than Trump, which is bearish for the dollar.

2. Fed independence: In a speech on August 8th, Trump openly criticized the Fed's actions as "either too early or too late," stating that the U.S. president should have a say in Fed decisions and if elected, he would call for a significant rate cut by the Fed. Democratic candidate Harris, on the other hand, directly opposes interfering with the Fed's "independence," which could be bullish for the dollarThe next important milestone is the debate between the two parties on September 10th, and it is expected that the impact of this election on foreign exchange will be much smaller than in 2016.

Author: Fang Yuqi, Source: Good Morning Market, Original Title: "Embracing Super Data Week"