Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 27 May 2013 at 5:16 GMT

3 Numbers to Watch: USDJPY, Spanish and Italian bonds

Blogger / MoreLiver's Daily

Due to market holidays in the UK and US, today’s calendar is practically empty and the European session will be very quiet. There will however be some key speeches: The European Central Bank’s Jörg Asmussen speaks at 04:15 GMT and 06:30 GMT. Chinese premier Li Keqiang and German chancellor Merkel are also meeting, and I would not be surprised if we see a headline of cheap talk that Europe is important to China, and that China is ready to co-operate with Europe. This could create a short-lived pop higher in EURUSD and stock prices. The markets are currently driven by three major factors:

  1. Inaction of the European Central Bank, and uncertainty over whether the bank will initiate plans to alleviate the tight credit conditions in the Mediterranean countries.
  2. Uncertainty over the US Federal Reserve’s asset purchasing programmes, specifically when and under what conditions the central bank would slow down its purchases.
  3. Japan’s ‘Abenomics’, or inflation goal and massive government bond purchases.

For today’s ‘3 numbers’ I take a look at the 3 markets that could be affected by the above factors – USDJPY and Italian and Spanish bonds.

USDJPY Channel: The chart below shows the pair moving higher in a moderate, sawing motion. After reaching the channel top, the exchange rate has turned down, and is on its way to the lower end of the channel. Assuming a correction of similar size as the past ones, the USDJPY could reach 100, or perhaps even 99. That would be a good opportunity to go long for holding periods of five to 10 days.

 USDJPY 27May2013

There could be a nasty stop run, especially if the 100-level is broken, so the trade would require plenty of leeway. If the move up after the bottom is gradual, like what happened after the number one and three bottoms in the chart above, it could make sense to wait for a bottoming-out on intraday charts. However, the move up after bottom number two in the chart above was a fast one, so after reaching the possible buy levels one could also use a buy stop at a higher level to enter the long position in case there will be no bottoming-out process.

The idea is that ‘Abenomics’ is hitting “speed limits”: when the inflation expectations build up, bond yields go up, and the resolve of the central bank begins to be questioned – resulting in the USDJPY’s  oscillating grind higher. Also, the JPY shorts and Nikkei longs are probably the first two that institutions think of when they want to lower their market exposure. The huge drop in the Nikkei after a negative day in US stock markets is one sign of this.

Italian and Spanish government bonds: The yields have oscillated between moderately normal and high levels implying partial default – always saved by the ECB, first with the SMP, then with LTRO. After the darkest hour of the euro crisis in 2012, the ECB came out with its promise to do “whatever it takes” with the conditional OMT-programme. Ten-year bond yields have hit crisis lows, but nothing has changed in the economies – growth is elusive, unemployment is record high, budget deficits are unsustainable. The only positive factor has been the continuous relaxation of the fiscal targets and the ECB’s promise of support. With the repayments of the LTRO loans, liquidity in the euro area banking system is getting tighter. There is talk of referendum on the euro and EU-memberships in both countries.

 Spanish bond 27May2013

 Italy bond 27May2013

CDS Spain and Italy 27May2013

Yields have moved higher in the past few weeks, and there are many reasons why the OMT-promise might not be enough to keep yields from rising further: domestic reasons in both countries, the need for Merkel to sound tough before her elections, the ECB’s empty toolbox and as The Economist reported, sleepwalking by European leaders. In addition to yields, credit default swap prices have also hit crisis lows, and are showing signs of bottoming out. Should these developments in the credit market continue, the markets might call Mario Draghi’s bluff and we would be in for the showdown of the decade.  EURUSD would obviously be hurt by a bond sell-off. I am not saying that yields necessarily turn higher from here, but I am fairly certain that we have probably seen the lows in both countries’ bond yields.


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