View: FX floor to remain unchanged for now, USD/CHF still the better bet
No matter what the excuses, and in this case they look poor, it’s impossible to think that any central bank chief could survive one’s wife booking healthy profits on FX trades made ahead of key policy decisions. And so exits CNB President Philipp Hildebrand, which is a shame as he was one of the more interesting of his type. His brief tenure (barely 2-years in the top spot) had been marred by controversy, having survived earlier criticism after his failed efforts in 2010 to curb CHF appreciation – after exhausting more traditional monetary policy options – led to record losses at the bank…………..
Full report attached:
View: Still early days for the EUR decline, dollar index has ample space to extend gains m/t
Markets are playing out very much as we expected. The euro has come under increasing pressure amid fears politicans are still ill-equipped to deal with the debt crisis and specifically a Greek default (something we’ve long thought inevitable). Policy makers across the region seem united that something decisive needs to be done to firewall Greece (and Portugal and Ireland). Unfortunately the prescription as to how to actually do this still varies radically from country to country making a consensus difficult to forge. There are plenty of other spanners in the works too, such as the German constitutional court and election/parliamentary risks (shrinking government majorities) across the block.
It’s fairly straightforward to argue that by European standards the steps taken thus far have been radical and will be the precursor for more reforms/integration across the single currency block going forward; but this is all rather meaningless if the German’s are not willing to fold their austerity card and back up the EFSF with more sizeable amounts of tax payers cash and the other dissenters fall into line. While markets remain stuck in the current vacuum the risk of an uncontainable event is ever present which should of course keep pressure on the single currency and the region’s financial markets.
Our EUR view has been bearish for some time and we still believe there are substantial downside risks even after the decline we’ve seen since the September ECB meeting which to us was the trigger to sell (http://wp.me/p1G1Fr-cc). EUR/USD1.3000 is the next psychological draw but looking at the longer-term charts an eventual drop back towards the base of the down channel from the 2008 highs does not look unreasonable. This comes in at 1.1340 currently. It’s worth noting that since inception the average rate of EUR/USD has been around 1.2750 and if working on the pre-financial crisis era levels are more like 1.1700.
Looking at the other crosses we also expressed a preference for short CHF positions, specifically against the dollar – our idea being this was effectively a carry neutral EUR/USD with a sweetener thanks to SNB’s EUR/CHF currency floor and its view that the CHF should weaken against the euro over time (http://wp.me/p1G1Fr-bU).
Our EUR/USD view fits well with our expectations for more prolonged gains in the dollar index (DXY). Price action here has played out as we expected. Not only should the dollar gain from broader risk aversion, stemming not just from eurozone fears but broader growth risks including a stagnating US and volatility emanating out of emerging markets recently. Fed policy has also turned more supportive, specifically the decision to ‘Twist’ rather than embark on another futile round of quantitative easing, the benefits of QE2 becoming more dubious by the day. DXY has yet to hit our first objective of 80.00 – although it’s not too far now – with the higher targets of 82.59/83.55 what we’re really aiming for and even those 2008/2010 highs above 88.70 are not that fanciful if US recession risks become clearer (http://wp.me/p1G1Fr-cj).
With this in mind we’d keep a close eye on this week’s September non-farm payrolls. The market is looking for a 50k gain up from flat in August. A good number (100k plus) could trigger a short-term shakeout of dollar longs as the market looks a little stretched on a daily basis, but we’d view such a pullback as an opportunity to add to USD exposure. Ultimately economic conditions will remain challenging both in the US and outside and stock market volatility will persist all of which should underpin the dollar’s recovery.
Lastly we take a quick look at the JPY. While the Japanese unit has hit decade/record highs vs. the Euro vs. the dollar the cross has been flat lining of late. JPY bulls will not that this is despite modest efforts from the Japanese to increase funds available for currency intervention – a policy that has been deployed rather ineffectively thus far. We’d certainly not hold out much hope of the JPY weakening up against the EUR but risks in USD/JPY look better balanced. A more aggressive unwind of risk should see the USD outperform, simply for the fact that the yen is no longer the funding currency of choice among global investors, that crown now falls to the dollar. It’s probably worth looking back at those big risk off moves in emerging markets earlier in the noughties and the impact this had on the JPY to get a sense of what could happen to the USD against some of the EM crosses. Of course we have already seen some large moves already here, but the potential is far greater.
Sterling we will cover in more depth later in the week but Hades view remains negative as per our last update (http://wp.me/p1G1Fr-d2).
View: SNB’s currency floor creates a carry neutral EUR/USD proxy, widens options for many others
The Japanese may have fired off the first salvo, persuading the balance of the G7 to support intervention to weaken the JPY following the Tōhoku earthquake back in March but it has been left to the Swiss to act with any real aggression in the so called ‘Currency Wars’ with a landmark step this morning, enacting a floor in EUR/CHF at 1.20 and offering unlimited amounts of CHF to defend this marker. The statement also pledged a readiness to adopt further measures should economic and deflationary risks warrant. Brave stuff.
Pressure had been building on the Swiss for some time. Clearly the franc is massively overvalued in both nominal and real terms and earlier – more orthodox – steps have proved ineffective. The minimum exchange rate option then is probably the only viable method of restraining the currency over the medium-term. There will of course be speculation about the resolve of authorities to defend this statement; Hildebrand came close to being forced out after earlier measures led the SNB to a US$21bn loss. But this policy is far more aggressive and the stakes immeasurably higher. More probable is that alternate safe havens should see a chunk of the otherwise Swiss destined flow (including gold and the high yielders).
Of course geography means targeting a rate vs. the EUR is the logical choice, though it also might reflect SNB expectations that the EUR itself is too rich – the statement noted that the SNB was aiming for a substantial and sustained weakening of the Swiss franc. Pegging oneself to a currency that ought to be cheaper could mean a return to more normalised levels of exchange is quicker that first appreciated. That said the BIS suggest the CHF is 34% overvalued in NEER terms so normal still might not mean fair.
At this point we have reasonable confidence that the SNB policy will take some of the heat out of the CHF, even if this leaves the pair range trading above EUR/CHF1.20. In some respects it could even find itself a beneficiary of the carry trade, CHF being cheaper to short than EUR. It would be ironic if USD/CHF now became the route by which the market expresses its bearish EUR/USD ideas. Looking at the USD/CHF chart a 0.9401/45 target does not look unreasonable with this in mind.
Examining SNB resolve in the broader global context is equally interesting. We’ve already seen those free floating emerging currencies vex over hot money inflows, most vocally Brazil but also places like South Africa where the macro story is hardly compelling enough to warrant the level of exchange rate gains the country has seen. A peg or quasi peg might look alluring to such players.
Equally this type of policy might be right for the Japanese – even if the yen is nowhere near as overvalued as the likes of CHF, BRL or the antipodean currencies. More relevant for the Japanese is the policies of its direct competitors, most of which operate some form of dollar peg. As we’ve noted before one only has to look at the market share grabbed by Korean corporates to realise the scale of the problem. Taking the moral high ground gets you nowhere in such instances. Free floating currencies are only viable in a world of freely floating currencies. A JPY currency floor would certainly focus minds on this type of anti-competitive behaviour, particularly at a time when the Fed and other central banks (UK specifically) are perceived to be mulling more quantitative easing (or similar) with the repercussions this ought to have for the dollar and its associates (CNY, KRW etc). PM Noda take note.
- SNB euroquake, the analysts react – part two (ftalphaville.ft.com)
- Two Opposing Views On The SNB Intervention, Or Rather One View (Goldman’s) And One Cartoon (zerohedge.com)
It’s been another case of the tail wagging the dog with stock market falls triggering a further round of ‘unprecedented’ steps from the Federal Reserve, this time Bernanke stating that the Fed aims to hold interest rates at current levels until the middle of 2013 in an effort to support the weaker than expected economic recovery. Furthermore the central bank noted that it would “continue to assess the economic outlook” and be ready to respond “as appropriate”, effectively opening the door for a further round of quantitative easing. This doesn’t necessary preclude an earlier hike should growth surprise on the topside - the language left room for this, as did the three dissenters in the 7-3 vote – but such a scenario appears somewhat optimistic currently. All of this has provided a much needed shot in the arm to struggling asset markets – S&P jumped 4.74% on Tuesday following Monday’s 6.66% decline (bulls will remember the S&P’s March 2009 low was 666 too) but the dollar’s negative reaction looks the more telling outcome of the meeting.
Effectively Federal Reserve policy continues to provide good reason to sell the greenback which should exacerbate existing (some would say already acute) imbalances in global currency markets and keep the fire burning under commodities as investors continue to look for inflation hedges, gold the most obvious beneficiary. Dollar debasement is effectively the game and it’s difficult to see much in the way of upside given the risks this policy also encourages. By increasing global imbalances the Fed is likely to increase the frequency of periods of market volatility over the medium-term.
The obvious beneficiaries in the first instance should be commodity currencies, the already rich AUD and NZD set for new highs if markets can stabilise, NOK, RUB and BRL should also emerge as interim winners. This policy ought to also reinforce the yen’s position as the dominant safe haven currency (its status as the premier funding currency was already long gone) as well as the CHF, much to the ire of a powerless SNB. The Euro’s status is more fluid thanks to the ebb and flow of the debt crisis there which has been calmed for the moment with another quick fix, ECB purchases of Spanish and Italian debt.
The dollar index itself should remain under pressure based on the charts. Technically the first target for the DXY is the earlier July lows at 73.42/44 which guards the April base at 72.69/72. Once this area is cleared the market would be set for a run at the record low touched back in 2008 at 70.70. A more realistic long-term target looks the base of monthly channel support around 67.70 which would mark an 8.5% devaluation from the 73.90 area. Resistance firms up at 75.38 with 76.67/70 the more significant reversal market for dollar bears to keep in mind now. A reversal through here would imply the longer-term bias has finally shifted. From current levels rallies back in to the 74.70/75.06 zone should be faded if not already short.
European and US stresses starting to have a more notable impact on currency markets with the SNB on Wednesday surprising by cutting its target interest rate from 0.25% to ‘as close to 0.0% as possible’ in a move designed to soften the CHF and this has been followed up in Asia with new Japanese steps – the BoJ announcing a further expansion of its asset purchase plan and more forcefully intervening again in the forex market, forcing USD/JPY back towards 80.00.
Japanese authorities have been keen to weaken the JPY ever since March’s earthquake with a view to cushion the blow faced by exporters, which prompted the first coordinated G7 intervention since authorities moved to shore up the Euro back in 2000. But recent yen price action has not been a Japan specific affair but rather driven by others ills, specifically the European debt crisis and US debt/growth stresses. A successful turnaround of the longer-term JPY trend then requires not just steps from Japanese officials but a resolution of the fundamental risks emanating from Europe and the States. It can’t be solved by intervention.
The real issue for Japan is probably the on-going dominance of exchange rate pegs in Asia which places disproportionate stresses on the convertible currencies. The Chinese are clearly the prime offenders but the list is lengthy. One only has to look at JPY/KRW and the divergent fortunes of Sony and Samsung during the recovery to see our point. The JPY itself is not particularly overvalued as the chart below highlights, the Swiss have a far more compelling case and both look cheap compared to the mighty AUD. What really stands out is that before the financial crisis the JPY was cheap, a function of it’s then unique funding currency status.
Japan has never been renowned for its radical solutions – which would be needed to have a sustained impact on the JPY – and it’s doubtful we’ll see anything now given the dire state of the country’s politics. More intervention might be forthcoming but with risks in global markets on the up we don’t see this as a game changer currently. The liquidity provided by the BoJ then should be viewed opportunistically, with higher levels in USD/JPY offering attractive entry levels. We’d also note the EUR/JPY downtrend remains in place below the 113.90/114.50 resistance band. These trades should work on a number of levels, firstly risk aversion should encourage further repatriation from Japanese investors, both from the unwind of higher beta carry trade and stock bets but also from narrowing rate differentials, a consequence of falling UST yields. Secondly, slowing US growth could prompt the Fed into taking fresh action. Any further round of quantitative easing (the only tool as its disposal) would clearly be a dollar negative. Euro problems compound the pressures, the EUR’s previous safe haven status being vastly reduced by the peripheral debt crisis and growth data from the core looks to be softening up too.
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