The centrally-planned party is over. Here is BofA's Kama Sharma explaining why
The sense of calm which had descended on markets in recent weeks has come to an abrupt end.
This time it has been the USD which has been the focal point. Investors continue to rotate through a vicious circle of concerns on China, commodities and US growth and with a still large long position, further near-term USD losses are likely as broader US data momentum remains weak.
Until positioning becomes cleaner, bad news on the US economy will be bad news for the USD. China will once again be back in focus next week with the release of its FX reserves data and though our estimates are for a more modest decline, any relief rally would be an opportunity to sell into.
FX: Financial conditions to hold back the Fed again?
The DXY is on pace for its worst weekly performance since 2009. A weaker-than-expected non-manufacturing ISM report (representing 80% of the US economy) challenged the presumption that the US could weather a contraction in the much smaller manufacturing sector. The dollar has been resilient to slower growth readings and the re-pricing of the Fed Funds curve since end-2015 (Chart 1) which pushed rate differentials against it.
This dislocation suggests there is further room to run, particularly as FOMC members are showing sensitivity to tighter financial conditions, and, a stronger USD. Persistent trade-weighted USD strength in recent months has been a key factor driving tighter financial conditions (Chart 2).
The divergence with rate differentials suggests non-fundamental factors (such as flight-to-quality) could be driving USD strength, making it more likely Fed officials will speak more frequently about it. This poses further downside dollar risk.
The continued wedge between the dollar and rate differentials continues to leave asymmetric risks in the near-term as the market will need to see sustained signs of a US growth turnaround before rethinking Fed policy. Chair Yellen’s Humphrey Hawkins testimony will be a key focus in this regard. Short positioning in CAD, EUR, GBP, and MXN (according to the latest CFTC data dated January 26th). Should Chair Yellen emphasize the theme of the risks from financial conditions and the USD, we would expect further long USD position unwinds in these pairs.
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So much for the "most crowded trade of all time", as recently as Dec. 15.