24 August 2010 at 13:59 GMT
New bout of risk aversion punished USDJPY to a new 15-year low and EURJPY to all-time lows. Is there more fuel for the JPY rally?
A Fed divided?
Ahead of Friday's Bernanke speech from the yearly symposium sponsored by the Kansas City Fed in Jackson Hole, Wyoming, it is worth noting the Wall Street Journal article today that suggests the Fed was very divided on the degree to which additional treasury buying is the right medicine for the US economy at its August 10 meeting. Bernanke was able to push through with the policy statement as published, obviously, but the "at least 7 of the 17 Fed officials....spoke against the proposal [altering the Fed policy to keep balance sheet at the same size) or expressed reservations." This suggests that even stronger moves in the future by the Fed may be hard to come by as the market has tried to price in the coming of QE2 to varying degrees in the recent cycle of USD.
EUR perking up a bit - in places..
The Euro has taken a heavy hit of late, but outside of the G-3 is showing small signs of perking up in today's trade. Interest rate spreads suggest it is underpriced against sterling, the kiwi, the Aussie, and the Loonie in particular, and as long as we remain in a risk averse environment and don't suddenly get any negative developments out of Europe that see further deterioration in sovereign debt spreads there, these pairs may be set for a hefty rally in the short term. Still, it is hard to get excited about owning any Euros considering that a real default of Greece must be on the way soon as that country falls into a downward spiral and will never be able to make good on its debt. 2-year Greek notes yield over 11% and 10-year debt yields nearly that level. An eventual denouement of the Greek situation could present another setback for the Euro on contagion fears. Note that EURJPY is trading at a new all time low below 106 as we are writing this...and it is more than interesting to note that Bund yields seem poised for a charge at the 2.00% level, trading below 2.20% this morning. That compares with the '08-'09 crisis low of . And this is with the DAX only a few percent lower from its recent high for the cycle.
JPY trading to new 15-year lows
USDJPY is trading at the lowest level since 1995 as interest rates continue to press lower. The various rhetorical efforts by Japanese officialdom to stem the currency's strength are obviously having no effect as interest spreads remain in the driver's seat. Perhaps helping to feed the additional boldness of JPY longs at these levels is a Wall Street Journal article about the JPY that suggests the currency can strengthen quite a bit more without crippling the Japanese economy, because the stronger JPY means that manufacturing inputs from abroad are cheaper and that many companies are already producing abroad and not feeling much pain from the currency's moves.
If we have a look at the current USDJPY level compared to that of 1995, the equivalent level is actually much lower (some have suggested 70 or lower) simply because of the inflation differential between the two countries. So in theory, the pair can continue to fall with abandon. But this calculation doesn't take into account the debt Armageddon that awaits Japan due to is excessively large public debt, however, and the risk of an official response to the strong JPY ratchets higher with every figure lower in the USDJPY pair. But the lower rate environment seems to also mean that the market takes away the bid on the price for default since the tiny rate make financing enormous piles of debt manageable, this is a self-reinforcing spiral that will work the other way as well if rates ever increase (or even if they don't as Japan will still have to roll the debt one day...).
Chart: USDJPY and Interest rate spread
The chart below shows that the ever-tighter interest rate spread between the US and Japan is supportive of the USDJPY falling to these levels. But note also that there are only 25 bps left in the spread between the two countries - can the spread tighten any further or even head below zero? Possible on the former but doubtful on the latter. Of course, farther out on the curve, there is far more wood to chop in the spreads. 10-year JGB's yield about 93 bps compared to the US' 250+ bps, so that spread has significant further potential for tightening.
It's interesting to note the speed of the USDJPY descent today when we note that speculators have already been quite long the JPY. Here's a possible explanation: some significant minority of JPY bears have made a stand around the 85.00 area and we are seeing a mini-capitulation of this crowd. Any further progress lower in the JPY crosses will demand strong support from the fixed income market.
Canada Retail Sales
CAD is suffering in this environment of risk aversion and with oil prices plunging another five dollars in just the last few trading days. An ugly retail sales data point for June isn't helping things out for the Loonie and it appears that USDCAD will soon look to challenge the top of the 1.00-1.0850 range again. It appears that the BoC will be stopped in its tracks soon if the Canadian economy shows further signs of decelerating. It's tempting to think that the BoC would like to hike to 1.00% (another 25 bps) so it has something to work with in case things go the wrong way again, but the numbers are beginning to move very quickly in the wrong direction for the Canadian economy. The next BoC meeting is on 8 September.
Looking ahead
The commodity currencies are getting the worst of it as one would expect in times of risk aversion, and key support just gave way in AUDUSD today (0.8850 area), our favorite risk barometer within the G-10 outside of USDJPY. It's interesting to note that gold has a tendency to head south when risk aversion gets particularly nasty. The big curiosity here, and what may be preventing an all-out rout in the Aussie, is the resilience in copper prices, which may be due to China-related speculation. Copper prices have fallen in recent days, but a bear market in that and related commodities is the final piece needed to assemble a new bear trend in Aussie. It is also worth noting that emerging markets are finally appearing a bit shakier in today's trade after trying to put a brave face on things recently. There is a lot of catching up to do in EM if the market begins to downgrade the global economic outlook. Considering the above developments, a USDZAR long could get interesting. It still feels like the volatility potential here is under-recognized by this market in all asset classes, particularly in light of the moves in bond markets.
Looking ahead, watch for today's auction of US 2-year notes after yesterday's auction. We suspect that the reception of auctions at the front end of the curve will look less robust than the auction of longer term securities, as everyone seems to be looking to increase their duration. So today's auction may be less successful than tomorrow's 5-year auction and the 7-year auction on Thursday may perform the best of all. In any case, all JPY-trading eyes should be on the auction results and reaction following them.
Be careful out there.
Economic Data Highlights
- UK Jul. BBA Loans for House Purchases out at 33.7k vs. 34k expected and 34.6k in Jun.
- EuroZone Jun. Industrial New Orders for Jun. out at +2.5% MoM and +22.6% YoY vs. +1.5%/+24.0% expected, respectively
- Canada Jun. Retail Sales out at +0.1% MoM and less Autos out at -0.5% MoM vs. +0.4%/+0.1% expected, respectively
Upcoming Economic Calendar Highlights
- US Jul. Existing Home Sales (1400)
- US Aug. Richmond Fed Manufacturing Index (1400)
- US Weekly API Crude Oil and Product Inventories (2030)
- US Weekly ABC Consumer Confidence Survey (2100)
- Japan Jul. Corporate Service Price Index (2350)
- Japan Jul. Merchandise Trade Balance (2350)