View: JPY response to ‘Risk on’ phase should worry BoJ, SNB style Peg worth debating
Despite solid gains in US and European markets over the past few months that Asia heavyweight Japan has enjoyed rather limited luck with even the BoJ’s efforts to continue on the central bank easing bandwagon given short shrift by the market. The performance of the JPY specifically must be worrying for Japanese officials, particularly its unresponsiveness to the ‘risk on’ mood which in the past has provided exporters with some much needed breathing space. Indeed, USD/JPY has been stuck sub 80.00 throughout Q3, in stark contrast to price action in Q1 where a similar ‘risk on’ phase was enough to push the pair up around eight big figures back towards 84.00. The implications if the mood shifts don’t look particularly encouraging with this in mind, particularly given the ineffectiveness of the BoJ’s preferred tools of verbal then physical intervention to contain unwarranted/undesirable JPY appreciation.
Full report below…
View: Close Short Bono, short EUR/USD, tighten DAX stop. EUR/JPY longs appealing
The market moves of the past week have been interesting, particularly the performance of Eurozone assets which once again have proven rather resilient to local pressures even as global markets sold off on the back of these very drivers. We have a few positions looking for a worsening of things here but they are not really performing as expected, in fact Spanish 10-year bond yields are now off 17bps from the recent intra-day highs and spreads to bunds have tightened back to (a still stressed) 475bps. While mid-term the path is to higher yields, at this point taking profits on shorts might be prudent and we close our short recommendation from May 3rd accordingly at 6.19% (+37bps).
Full report below…
View: Yen intervention provides buffer to run EM catch up theme, Europe the principle risk
We mentioned a couple of times last week that one way to profit from the improving risk backdrop was to look at some of the Emerging currencies, specifically the MXN, ZAR, PLN and some of the regional Asia crosses vs. the JPY. After this morning’s intervention from the BoJ (market chatter suggesting they sold JPY3trn) we’d be tempted to book profits or at least tighten up any trailing stops in the latter cross rates. While we thought the idea looked timely given JPY price action over the last few weeks, particularly when contrasted against the marked improvement in risk appetite (which is often JPY negative) and murmurings from Japanese officials, and the fundamental rationale for looking for stronger Asia currencies of course still stands, such swift gains are always worth booking. We’d also add that on recent occasions BoJ intervention has only happened on one day (in part to avoid the tag currency manipulator), it would be unusual for this to change in such close proximity to the G20.
Any proceeds could perhaps be used to provide a cushion for playing the broader EM FX catch up theme into the end of the year or at least create some insulation against the data flow this week (US specifically) which looks to be behind some of the profit taking we’ve seen early on Monday. We think the calendar could be key in determining whether the market can actually buy into the idea US soft patch is over in a lasting fashion and as such maintain bullish momentum in the market overall. The Chicago Purchasing Managers survey and ISM releases will be more important than usual in our view, perhaps eclipsing the jobs reports if they comfortably beat consensus (we’re still somewhat sceptical of this but that has been the recent bias) and of course on top of this we have the Fed meeting, although we don’t expect any surprises from this.
Risk as ever still emanates from Europe, periphery bonds continue to trade badly reflecting a clear lack of conviction in the much hyped ‘solution’. It was quite a straight forward process to pick the plan to pieces so this isn’t particularly surprising. We prefer playing risks here by positioning against the euro, a EUR/USD1.4000+ handle just doesn’t seem to do justice to the plethora of risks at work across the block. We still like short bunds too, technical picture still pointing to higher levels, this stands while cash yields hold above 1.96%.
- Will the BOJ follow in the SNB’s footsteps? Unlikely. (tradingfloor.com)
- Please Welcome The Latest Currency Peg (zerohedge.com)
View: Break of DXY support significant, EM crosses look the most constructive option now
The break up in the dollar we saw during September looked a positive development for the greenback, but the pronounced failure of the key support area at 75.75/76.00 on Thursday was significant from a technical perspective and rules out any test higher in the immediate future. Indeed, the natural instinct of the market now should be to take the index to test down towards the 73.50 area which proved such solid support throughout June, July and August.
With bulls gaining confidence more widely, lured by hopes of a Santa rally, the obvious whipping boy is the USD. The Fed as ever remains firmly attached to dovish rhetoric, even if the widely anticipated ‘twist’ has only limited real impact, which will keep interest rate differentials blowing in a hostile direction – at least until the ECB cuts rates. It is also probably too early to become attached to the cyclical story with the downside risks to US growth substantial enough to offset what remains a dire picture for Europe (we’d stress the recent breakthrough on the debt crisis had nothing at all to do with fostering growth, if anything austerity focused policies in club Med and elsewhere have become even more closely linked to the support mechanism of the EFSF). This backdrop will probably be viewed as a success by the Fed, a weak dollar perceived to be one of the indicators that are supportive of recovery, alongside higher equity valuations. Bernanke has said as much.
In a world of ‘the least bad currency is king’ we’re left looking for more viable substitutes to be long. Despite the debt crisis solution in Europe we still find it difficult to come up with a constructive reason to buy the EUR and our gut still tells us to use rallies as an opportunity to sell, although we’d prefer to wait for a confirming technical sell from our indicators. GBP is being dragged along on the euro’s coat tails for the time being but we think this rally is poised to turn and would look to the first instalment of Q3 GDP due on November 1st as a potential trigger. There were plenty of disruptions in Q2 but any rebound is likely to be tepid. Median estimates see q/q growth at 0.3% and only one respondent in the Bloomberg survey is calling for a negative print. On a y/y basis the trend will slow further. Consumer confidence remains depressed thanks to a weak labour market and rising inflation, fiscal policy is also biting so the outlook for the fourth quarter is hardly inspiring too.
As we noted in our report yesterday though (http://wp.me/p1G1Fr-hk) the best opportunities in the FX arena appear to lie elsewhere, we like short USD/MXN for the time being while EUR/PLN and USD/ZAR also offer opportunities to bet on improved risk appetite lasting. The big macro bet of Asia currency appreciation took a big knock during the recent panic phase but the fundamental arguments for this remain solid too and the regional JPY crosses might also be a nice way of positioning for any BoJ intervention for an added kicker.
View: Those that missed equity rally still have opportunities in bonds, EM FX
Better US numbers and the long awaited Eurozone deal combined to lift stocks to new multi-week highs on Thursday, the S&P erasing its decline for the year and passing up through the 1,254/55 resistance marker and 200-DMA in the process. This latter point will be taken by some as confirmation that the correction of the summer has now been consigned to history.
While we’ve harboured a clear bearish lilt over the past few months and take a questionable view towards both the health of US the US economy and Europe’s so called ‘solution’, after a rather dire year there is a clear incentive for investors to put money to work aggressively to secure some sort of bonus pool – irrespective of fundamental risks that linger both near-term and looking ahead to 2012. In these highly correlated markets it makes taking a strong view on other instruments a little problematic. It doesn’t bode particularly well for our call for a stronger US dollar for instance short-term, although we would think downside is limited in DXY nonetheless, and the herd is also likely to rekindle its addiction to commodities if this more bullish tone can hold.
So what looks the best placed to catch up in this highly correlated world we live in? Shorting bonds still looks good to us, particularly bunds as per our October 10th (http://wp.me/p1G1Fr-ec) and 19th notes (http://wp.me/p1G1Fr-fy) which picked up on both risk to credit quality of the euro bailout and equally importantly an increasingly bearish technical picture, the base in yields here far more credible than seen in stocks. We have a first target of 2.35% here but this is a minimum objective.
A more interesting play might be EM crosses which sold off heavily and have been slower to recover than those fast equity markets. In central Europe the zloty is still some 9.5% weaker than levels it spent the first half of the year at, having barely retraced a third of its loss since July. The local economy is of course exposed to the fortunes of the eurozone and there are fiscal pressures, but domestic demand is robust and it remains an attractive investment destination. The ZAR should also be a potential beneficiary of a lasting change in mood and veering to the Americas the MXN looks an attractive recovery play at these levels (13.15) looking for a move sub 12.00. Some of the Asia crosses vs. the JPY might be a nice way of capitalising on the shift too. The yen was quick to strengthen as investors’ unwound risk but has shown no sign of reversing, instead touching record highs vs. the dollar this week. Intervention talk has been picking up with recent performance likely to be alarming to officials. And as ever many Asia currencies look fundamentally undervalued.
- EU Plan to Save the World: Analysts React (blogs.wsj.com)
- High Yield Hedge Capitulation, Risk-Appetite Back, Or Just More Illqiuidity? (zerohedge.com)
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)
Liquidity pressures have forced the ECB to step into the market again, the bank announcing new six-month measures to try and ease money market tensions at this afternoon’s rate setting meeting (rates were held at 1.50%) in addition to the no doubt more distasteful step of returning to support peripheral bond markets – Portgual and Ireland benefitting in the first instance. Trichet claimed the bank had not previously ceased its purchase programme – stating he had never personally said it was dormant, but this just look like semantics to us. The bank has never been comfortable with this course of action and the fact that the ECB is back in the market (and not with unanimous support from the council) speaks volumes about the scale of the crisis enveloping the region and the steps needed to provide even a small perception of control.
The timing of today’s meeting is a little unfortunate given the moves from the Swiss National Bank, Bank of Japan and Central Bank of Turkey this week. While action during the first financial crisis was very much a global affair, what stands out now is the unilateral nature of these steps, The Turks noting the action was designed to protect against the risk from peripheral Europe and a US slowdown despite currently solid local macro fundamentals and already competitive exchange rate (earlier monetary policy moves having weighed heavily on the TRY). This is not that surprising, sovereign balance sheets have been trashed over the past three years, significantly weakening the hands of governments desperate to stimulate growth. Deleveraging, which was the only real solution, will never fit into the electoral cycle. The imbalances that contributed to the crisis are also still very much present, indeed in many instances exaggerated. One just has to look at Germany and the level of Asia FX reserves to see how the much criticised export driven model has survived.
There is a real risk now that these unilateral steps are repeated elsewhere as authorities look to build protection against the feared slowdown in global growth. Many indicators are already alluding to this, for example JP Morgan’s global PMI index (above) is now only marginally above the 50.0 level and Citi’s global economic surprises index (below) has been printing negative surprises ever since the Japanese earthquake, a sign the market is behind the curve. If one throws the probability of the odd sovereign default into the mix (peripheral Europe), the probability of a US downgrade and prospects for further tightening in China the temptation to try and get that first mover advantage can only increase.
It’s difficult to envisage a scenario where there is a clean resolution to current problems. If the Fed embarks on new policy stimulus it will likely be dollar negative, exaggerating tensions between the free floaters and the pegged currencies. Hopes of faster Chinese appreciation which might allow more flexibility across Asia doesn’t fit well with slowing global growth either. A round of competitive devaluations and a plethora of new tensions (i.e more obvious protectionism) looks like a logical next step, a multilateral solution will be near impossible to forge if this begins, if it’s not already. One only has to look at the European situation to understand how difficult it is to find a consensus and the debt ceiling clash in the US is even more glaring.
We’ll dare to name a few potential – if not that radical – flash points: Japan/Korea, BRL heading an EM block vs. the dollar and the classic CNY vs. USD, something US politicians might actually be able to unite on.
- ECB acts to ease euro zone tensions (theglobeandmail.com)
- Yen Plunges as Japan Intervenes in Market First Time Since March (businessweek.com)
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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