Japan, the Yen and the Aussie

Three days ago, we saw that Japanese GDP contraction in the second quarter was revised to an annualized 7.1% QoQ (vs. 6.8% previously), shrinking at its fastest pace in more than five years, due to a deeper decline in consumer spending and a bigger fall in capital expenditure (money used to purchase, upgrade, improve or extend the life of LT assets). In addition, the Ministry of Finance reported that the country showed market a current account surplus of 416.7bn Yen in July (slightly less that 444bn expected and 30% down compare to July last year) as the income from foreign investments (up 2.8% to 1.853tr Yen) outweighed the trade deficit (964bn deficit Yen in July, August one to be released on Sep 17th).

While the unemployment has fallen quite sharply since Abe’s election (4.5% in Dec 2012) to 3.8% in August, real wages have constantly been declining over the past few years (they fell by 3.8% YoY in May, the sharpest decline in years). One explanation of the fall in real wages we read lately (The Economist, Feeling the pinch) was that Japan’s labour market is divided between two sorts of employees, regular ones who are usually highly paid and protected [against being fired] and the non-regular [low-paid] ones. If you have a look at the figures, non-regular workers accounted for 36.8% of all jobs in June, a high number compare to historical standards and therefore confirming that most jobs created since Abe took office were non-regular workers.

This definitely explains weakening figures in household spending. We saw that July Household Spending fell 5.9% YoY, twice what economists expected, printing in the negative territory for the fourth time in a row. As a reminder, Japan is a consumer-driven economy (61% as a percentage of GDP in 2012 according to the World Bank); therefore the BoJ will watch closely those figures in order to avoid another dismal quarter.

However, according to the Bank of Japan Deputy Governor Kikuo Iwata, the economy is ‘gradually recovering’ and it is all about the sales tax increase effect. Moreover, with the BoJ now monetizing debt at negative rates (T-Bill 12/08/2014 has been trading in the negative territory for the past few days as you can see it in the chart below), Iwata added that he didn’t see ‘any difficulties in money market operations’.

sg2014091052862(1)

(Source: Bloomberg)

Quick review on USD/JPY

The recent surge in the stock market (Nikkei up 1,000 pts over the past month, closing at 15,788.78 earlier this morning) mainly coming from ‘more QE coming soon’ speculation combined with demand for international securities (Bonds, Stock) from Japanese funds have both played in favour of the depreciation of the Yen lately since it broke out of its 101 – 103 range on August 20. In addition, with US yields starting to ‘surge’ (10-year yield up 20bps over the past two weeks and now trading at 2.53%), USDJPY was sent up to 106.85 during today’s trading session, breaking its resistance of 105.44 (Jan 2nd high) and trading to levels seen back in September 2008. If the depreciation continues, the next MT target on the pair stands at 110.

Aussie updates…

AUDJPY (black bar) eased a bit from last week’s [16-month] high of 98.65, down more than a 100 pips (carry trade unwinds combined with AUD selling from corporate and macro names), taking the equity market (red line) with ‘him’ (S&P closed below the 2,000 level at 1,988).

AUDJPY-10-Sep(1)

(Source: Reuters)

The AU benchmark (S&P/ASX) index came back to a 3-1/2 week low after Westpac’s index of consumer sentiment reported a 4.6% decline in September, bringing the Aussie below the 0.9200 support against the greenback.

AUDUSD is also trading below its 200-day MA (0.9180) for the first time in five months. Market has turned bearish on the pair as the failure to hold the 0.9180 – 0.9200 support area has opened up further retracements levels: 0.9075 (61.8% Fibo retracement of 0.8658 – 0.9756), followed by 0.9030. Australia will report employment figures overnight (2.30 am), which traders expect to be disappointing, therefore sending the Aussie to lower levels.

AUD-10-Sep(1)

(Source: Reuters)

Watch the 2-year yield spreads!

Yesterday evening, while most of the people were watching the World Cup first game’s kick-off, BoE Governor Carney and UK’s Chancellor of the Exchequer George Osborne both gave a speech at the Mansion House. The topic on the table was their concerns about the UK housing market as a rate hike would stress mortgage debt and therefore threaten the recovery. Until now, investors and traders were pricing in a rate increase somewhere in Q2 next year; however, Carney surprised the market by stating the Official Bank rate hike ‘could happen sooner than markets currently expect’. It immediately shifted the UK rate curve higher, with the 2-year now trading at a 3-year high of 0.852%. If we have a look at the chart below, we can see that the UK-US 2-year spread (in red) rose 10bps sending Cable (in yellow) to the roof. After it nearly reached its strong psychological resistance at 1.7000 on May 6, the British pound had entered into a bearish momentum against the greenback until it test its support at 1.6680 (mid-April lows) a few times. Despite strong UK fundamentals, the market is more concerned about the rate ‘neutrality’ debate and which central bank will consider starting raising its benchmark rate early next year.

Cable-2Y

(Source: Reuters)

However, this week’s strong employment data in addition to Carney’s hawkish speech played in favour of the pound which hit its psychological 1.7000 resistance against the US Dollar yesterday. We reached our target on EURGBP at 0.8000 based on our previous article (Some overnight developments), which has also been driven by the 2-year UK-EU yield spread (in orange, reversed scale RHS) as you can see it below.

EG-2Y

(Source: Reuters)

With the FOMC meeting next week, we assume that the volatility will remain low and especially in the FX market. Carry trade currencies (especially the Kiwi) should continue to outperform in this market. We saw yesterday that a currency that will remain under pressure will be the Swedish Krona (SEK) after the CPI came in at -0.20% YoY in May. If deflation continues to stagnate at around 0%, the Riksbank will have to intervene later this year but cutting its benchmark by another 25bps (it currently stands at 25bps), therefore impacting the currency.

FOMC minutes review, what’s next for the Dollar-Bloc currencies?

Yesterday, the Fed released its minutes of the last FOMC meeting (March 18-19) and we saw that the US policymakers were less hawkish than expected, easing rate hike speculation. Despite the last two NFP good prints and unemployment rate standing slightly above the ‘once-to-be’ 6.5-percent threshold (6.7% in March), the recovery is still fragile according to Fed officials who surprised traders and investors by showing that the central bank was more supportive of keeping its Fed Funds rate at low levels (0-0.25%).The US Dollar index broke its support at 79.75 and is now trading at 79.40, boosting most of the currencies.

As you can see it below, the US 10-year yield (orange) eased by 7 bps to trade at 2.65%, pushing the price of Gold (purple) back to 1,320 and helping the Yen (green) to continue its ‘strengthening episode’. Since last Friday’s high of 104.12, USDJPY has depreciated by 2.4% and seems on its way to test its support at 101.20. At the same time, the 10-year yield is down 15bps from 2.80%.

USYields

(Source: Reuters)

Is there more room on the upside for the Dollar-Bloc currencies?

AUD: The Aussie continues its positive momentum with Australian March employment report smashing expectations of a 5K increase to print at 18,100 (Jobless rate edged down by 0.2% to 5.8%). The Australian Dollar is now trading above 0.9400, levels we saw back in October. We believe that the inflation figures coming up at the end of the month (April 23rd) will determine the stance of monetary policy and if Governor Stevens could threaten the market once again of a rate cut if he judges that the Aussie is ‘uncomfortably high’. If we have a look at the chart below, the last ‘Aussie recovery’ was stopped after a 10% increase when it hit its 200-Daily SMA at around 0.9750 with the RSI indicator (14 days, 30-70) showing an overbought signal. In the second recovery episode, the pair is up 9.3% since the end of January and seems on its way to test the 0.9500 level. However, the overbought RSI may have been perceived by traders as a good time to start shorting the pair.

AUD-10-APr

(Source: Reuters)

NZD: The Kiwi also appreciated sharply against the greenback and is up 8.65% since the end of January, trading at 0.8700 (August 2011 level). The Reserve Bank of New Zealand raised its Official Cash Rate (OCR) by 0.25% at its last meeting in March after holding it at a historical low of 2.5% for three years. Traders have been looking at the Kiwi as an interesting buying opportunity after Governor Graeme Wheeler announced that he expected to ‘raise the benchmark interest rate to about 4.5% in the next two years’ in order to curb inflation. Moreover, the unemployment rate declined to a 5-year low of 6.0% in the last quarter of 2013, while the economy expanded by 3.1% (down from 3.5% in Q3) and NZ’s current account deficit narrowed to NZD 7.55bn (or 3.4% as a share of GDP) through the twelve months through December (lowest ratio since Q1 2012).

The RBNZ will probably leave its OCR unchanged on April 23rd, which could hurt the Kiwi in the short term as some traders will start considering to take profit after the sharp appreciation. We would stay aside of the Kiwi at the moment and wait for further reaction from RBNZ policymakers on the strong exchange rate. The next resistance on the topside stands at 0.8840, which is the pair’s all-time high (Aug 1st 2011).

Kiwi

(Source: Reuters)

CAD: The surprise came from Canadian macroeconomic figures that completely reverse the bearish trend on the Loonie against the greenback. In its last meeting back in January, Bank of Canada lowered its inflation forecast stating that it expected the total inflation rate to remain at 0.9% in the first half of 2014, down from its previous forecast of 1.2%. As policymakers stated that they expected inflation to remain ‘well below target’, Governor Poloz turned the monetary policy to a dovish stance and the market was starting to price in a rate cut in one of the following meetings (currently at 1% since September 2010). However, the sudden increase in CPI (from 0.7% in October to 1.5% in January, then 1.1% in February) in addition to the better-than-expected indicators (GDP figures, Retail sales, Trade balance, Employment report…) brought back traders’ interest on the Loonie.

However, We think that the bearish trend on USDCAD is coming to its end and we will see 1.0800 as a good level to start buying the pair for a bounce back towards 1.1000 at first. USDCAD broke it 100-daily SMA yesterday (1.0900) and found support at 1.0850; technical indictors RSI is starting to show some oversold signals therefore some investors will see the 1.0800 – 1.0850 range as a buying opportunity.

USDCAD

(Source: Reuters)

Quick Review on the Aussie (ahead of the employment figures)

As we mentioned it in our last post (here), Australian fundamentals surprised traders last week and pushed the Aussie higher against most of the currencies. AUDUSD broke its 100-day MA at 0.9080 last Thursday and hit a 3-month high at 0.9133 on Friday before it ended the week below the 0.9100, helped by the better-than-expected employment reports in the US (Non-Farm payrolls came in at 175K in February vs. 149K cons.).

Below, there is a chart that we like to watch quite a bit every morning at the office: the AUDJPY spot rate (black bar) overlaid with the S&P500 index (red line). By simply looking at this chart, it gives me an idea of the Asian session and tells me if it is worth reading what went on overnight. As you can see it on the chart below, the Aussie was up 4.5% last week, sending the US equity market to new highs (S&P500 was up 2.5%, and hit a record high of 1,878 on Friday).

(Source: Reuters)

However, Chinese’s figures over the weekend scared the carry traders and brought back the AUDJPY below the 94.00 level after its (almost) 5% increase. China’s exports unexpectedly fell 18% YoY in February, swinging the trade balance into a deficit of $23bn (vs. $32bn surplus in January). In addition, the annual inflation rate declined to 2.0%, its lowest level in 13 months.

We believe that the bounce we saw on the Aussie may have offered new short entries, as gains were expected to be limited by traders. Even if the RBA has kept its cash rate steady at a historical low of 2.5% since August last year and rising inflation rate has dashed rate cut hopes in the short term, policymakers were clearly not comfortable with the ‘Aussie recovery’ we saw last fall (September-November). Therefore, the Australian dollar is sort of capped on the topside, which gives traders good opportunities to start shorting the pair as soon as it comes close to the 0.9150-0.9200 area.

(Source: Reuters)

The market is now getting prepared for Australian employment data early tomorrow. A 15K increase in employment is expected, however the market seemed to have been a way too ‘optimistic’ in recent months.  As a reminder, the Australian economy lost 3,700 jobs in January, pushing the unemployment rate from 5.8% to 6%, its highest level in a decade.  The pair is now trading below the 0.9000 level, and the next support stands at 0.8900 on the downside. The pair will probably test it before the release of the figures overnight, and if we don’t see some really strong fundamentals tomorrow, AUDUSD could be sent back to the 0.8800 in the short term.

We are still bearish in the long term, as weakening signs of its main trading partner China will push Glenn Stevens to go for another rate cut session (Q2-Q3). In addition, with the Fed tapering this year and the board expected to start raising rates in mid-2015, the 10-year AU-US yield spread will continue to narrow and put the Aussie under pressure. The graph below (daily period) shows the 10-year spread (in purple) overlaid with the AUDUSD spot rate (in orange). Our MT target on AUDUSD stands at 0.8500, a level we saw back in the summer 2010.

(Source: Reuters)