Happy October: End of POMO

As October is the Fed’s POMO – Permanent Open Market Operations – last month (as it is mine in Hambros), we will see how the equity market will deal in a period with no QE. The NY Fed released yesterday its purchase operations for the month of October (as you can see it below), stating that the central bank will buy approximately $10bn worth of Treasury securities on an outright basis.

Starting October 28th (the first day of the next FOMC meeting), the equity bulls will start to rely on fundamentals once again. As we say, will this time be different?

20140830_POMO_0(1)

(Source: NY Fed)

The market has switched to a risk-off mode for the past couple of weeks with the S&P 500 struggling to trade above the 2,000 level. As you can see it on the chart below, the index (purple line)  is down 2.2% from its September’s high of 2,018.21 (Sep 19th) and AUD/JPY (black bar) is back below the 96.00 level (down 2% as well) and has been fluctuating within a 100-pip range for the past week.

 AUDJPY-01Oct(1)

(Source: Reuters)

Earlier this morning, both Germany and UK released a lower than expected manufacturing PMI, coming in at 49.9 (vs 50.3 expected) and 51.6 respectively (vs 52.5 expected). France reported its budget deficit forecasts for the next few years, and the government sees deficit falling to 4.3% of GDP in 2015 (from 4.4% this year), 3.8% in 2016 and eventually somewhere below  the 3% threshold in 2017 (optimistic?).

EUR/USD was little sold this morning after the macro news (1.2584 is today’s low) and is now trading back above the 1.2600 level. Cable hit its 1.6160 support, the 76.4% Fibo retracement of 1.6050 – 1.6526 (as we reported yesterday) before coming back to 1.6200.

GBP01Oct(1)

(Source: Reuters)

This afternoon, the market will watch West fundamentals with Mortgage Applications, ISM Mfg PMI and ADP National Employment  in the US and Canadian PMI. We don’t see any major developments in the FX market as the market is now focused on tomorrow’s ECB meeting and Friday’s NFP.

The JPY and some overnight developments…

The latest development that we found interesting lately was certainly USDJPY breaking out of its [four-month] 101 – 103 range on August 20. Despite US LT yields trending lower (10-year trading below 2.40%) and the BoJ showing no interest of increasing QE even though the economy printed dismal figures (except a strong CPI), the Yen has weakened by almost two figures in the past couple of weeks against the greenback and is now trading slightly below 105.

We were a bit surprised by this breakout as we thought until lately that the JPY had no reason to depreciate against the US Dollar (especially with a quiet BoJ and US LT yields expected to remain low in H2 according to analysts). Our thoughts was that the Yen depreciation mainly came from the carry trade positions (‘risk-on’ sentiment) with AUDJPY trading at new highs at around 97.50 (which corresponds to June 2013 levels), and we first assumed that the risk-on situation isn’t fully established and the market was just looking for ST opportunities and that any major ‘bad’ news could potentially trigger some massive carry unwinds as we saw previously (aka Yen appreciation).

However, after a few chats with some FX strategists (who we all thank for their kind answers), a first important thing to notice is the decrease in the 6-month (daily) rolling correlation between AUDJPY and S&P500 from 67% back in mid-February this year down to 47% today. In other words, the Japanese Yen sensitivity to risk-off moves has fallen as you can see it below in the Bloomberg Spread Analysis.Audcorr

(Source: Bloomberg)

Secondly, traders and investors are becoming more confident on a BoJ move later on this year, and further easing by JP policymakers (after Japan dismal figures: July household spending collapsed 5.9% YoY, Q2 GDP shrank by annualized 6.8% erasing Q1 gains, Housing starts down 14.1% in July…) is the main driver on Yen weakness according to analysts.

Eventually, another factor to look at would be Japanese institutional investors switching from bonds to stocks (and international stocks and bonds); we saw strong demand for French OAT from Japan last week. For instance, as you can see it below, GPIF, Japanese 1.2-trillion-dollar retirement fund, reduced its domestic bonds holdings by almost 10 percent in the past 3 years and has gradually increased its holdings of Japanese equities and International Bonds and Stocks. In June this year, it reported that it held 53.36% of domestic bonds and 17.26% of domestic stocks, down from 62.64% and 12.37% respectively back in 2011 (Abe’s effect). As a reminder, GPIF has a 60% target for domestic bonds and 12% for Japanese stocks, with 8% and 6% deviation limits respectively for those assets.

Gpif

Having said that, the 105 level could potentially act as a psychological resistance at the moment, next important level on the topside stands at 105.44, which corresponds to January 2nd high. USDJPY looks a bit overbought as you can see it on the chart below, and we will look for lower levels to start considering buying some more.

JPY-2-Sep(1)

(Source: Reuters)

Aussie pausing as expected…

The late US Dollar rally (USD index flirting with 83.00, its highest level since July 2013) hasn’t impact the Aussie (that much) and AUDUSD is still trading within its 5-month 0.92 – 0.95 range. The RBA left its cash rate steady at 2.50% (as expected) and looks unlikely to change it for some time, which is what we were assuming (see our article RBA is giving up…). The BBSW rates, which correspond to transparent rates for the pricing and revaluation of privately negotiated bilateral Australian dollar interest swap transactions, are trading quite flat with the 1-month and 6-month bills paying 2.66% and 2.69% respectively.

Despite AU annual inflation approaching the high of the RBA [2-3] percent inflation target range (Trimmed mean CPI came in at 2.9% YoY in the second quarter), AU policymakers noted slack in the job market and rising house prices.

The trend on AUDUSD looks bearish at the moment; we will try to sell some if the pair pops back above 0.9300 ahead of US employment reports on Friday. I’d put an entry level at 0.9330, with a tight stop loss at 0.9360 and a target at 0.9210.

Figures to watch this week:

AU GDP YoY (sep. 3rd): expected to ease back to 3.0% in the second quarter, down from 3.5%.
AU Trade balance (Sep 4th): expected to come in a -1.51bn AUD in July.
US Non-Farm Payrolls (Sep 5th):  expected to print at 225K in August, above the 200K level for the for the seventh consecutive month.

Risk-ON and US Dollar strength persist…

While tensions in Syria are still elevated with a second American ISIS fighter killed in a battle, Gazprom beginning accepting payment in Rubles and Chinese Yuan (via the ESPO – Eastern Siberia Pacific Ocean – pipeline), Ebola outbreak causing enormous damage to West African economies (economic growth expected to plunge by 4% in the region according to the African Development Bank), Argentina’s black market peso completely out of control tumbling to over 14 / USD (14.45 according to Argentine newspaper Ambito), French jobseekers surging to record high of 3.424 million (with PM Manuel Valls blaming the ECB to do more as QE was the solution to everything) and IMF head Christine Lagarde put under a formal probe for negligence in a corruption investigation… AUDJPY continues to climb and is now trading above the 97.00 level for the first time since June 2013 and the S&P500 closed above the 2,000 for the second time in history.

AUDJPY(1)

(Source: Reuters)

While European bourses have been also climbing during the same period with DAX and CAC40 both up approximately 6.5% for instance, yields on all German bonds out to 3 years are now negative (see current German yield curve in green) with the 10-year Bund 90.1bps and French 10-year OAT yield trading at all-time-low at 1.25%. The orange curve represents the German yield curve 1 month ago, and the histogram tells us the change over the past month).

image001(1)

(Source: Bloomberg)

Euro: the single currency still remains under pressure and is now trading below the 1.3200 level against the greenback, down 8 figures since May meeting (Draghi’s ‘ready to act next meeting’). It seems that the market is expecting more easing measures at the ECB meeting next week (September 4). As growth is weakening, the ECB will be much more intolerant of low inflation (flash August Inflation is expected to fall to 0.3% YoY from 0.4% the previous month) and high unemployment rate (currently stands at 11.5%). As a reminder, ECB staffs reduced its annual inflation forecasts in Q3 from 0.9% to 0.7% for the year 2014 and from 1.3% to 1.2% for 2015. With the 5Y5Y Euro inflation swap – ECB’s preferred measure of MT inflation – falling below the 2% level, investors are predicting another cut in the last quarter of this year therefore raising expectations of further measures from the ECB Governing Council. In addition, we saw this morning that loans to private sector fell by 1.6% in July (vs. -1.5% consensus) while M3 money supply grew by 1.8% from a revised 1.6% in June.

After Draghi delivered a dovish speech at the Jackson Hole central bankers’ meeting concerning the falling expectations of future EZ inflation, we heard yesterday that the ECB appointed money manager BlackRock to advise a program to buy ABS in order to revive the faltering Euro-area economy (announced at the June meeting). We would put public QE (sovereign bonds) option on aside for the moment, however we would opt for further updates concerning the ABS program and a potential rate cut. Otherwise, the next important date for the EZ will be on September 18, the first tranche of the so-called TLTROs.

The next support on EURUSD stands at 1.3150 (yesterday’s low), followed by 1.3100 (September 2013 low). Another interesting development to watch is EURCHF, which is now trading below the 1.2060 key support. The next support stands slightly above 1.2020 before the floor of 1.2000 (which remains our target in the coming weeks).

GBP: Sterling, the once used-to-be market’s darling, has fallen more than 6 figures since its mid-July high of 1.7191 and is now trading slightly below 1.6600. It broke its 200-day SMA on August 19 for the first time in more than a year, bringing in more participants in Cable’s bearish trend as the market likes trending market. If we have a look at the CFTC’s Commitments of Traders (see below), we can see that the net speculative positions fell from above 56K on July 1st to 13K+ reported on August 19th. We expect a pause at current levels in the coming days between 1.6550 and 1.6600.

COT-GBP(1)

(Source: OANDA)

UK strong GDP 2nd estimates (0.8% QoQ, 3.2% YoY) two weeks ago didn’t manage to bring investors’ interest on the British pound as annual inflation came in much cooler than expected in July at 1.6% YoY (vs. 1.8% eyed) shattering expectations of an early rate hike from the BoE. The implied rate of the Short-Sterling March 2015 futures contract is trading at 89bps, down from 1.15% in the beginning of July.

JPY: We will finish this article with a quick update on Japan and the Yen. Despite US yields running low, below the 2.40% level (trading at 2.33% at the moment), USDJPY broke its strong resistance at 103 to trade at 104.43 (Monday’s high) before edging back below the 104.00 level. We heard lately from Japanese Vice Economist Minister Nishimura that the Japanese economy may need more time than expected to swallow the sales tax hike (April 1st) and that the government may have to be more vigilant for the second planned one (October 2015). As a reminder, Japan GDP shrank by 6.8% (annual pace) in the second quarter and erased Q1 gains. The market is bearish on the JPY against most of the currencies and traders are quite confident that the government and especially the BoJ will do ‘whatever it takes’ to sustain Abe’s ambitious goal.

If we have a look at the recent figures, we saw that industrial production slid 3.4% MoM in June (biggest decline since the March 2011 disaster). JP trade balance deficit widened to 964bn Yen for July (vs expectations of a 702.50bn gap Yen) and the country reported a second current account deficit in June (399.1bn Yen) and the first January-June deficit in 29 years.

Important July figures to watch overnight: Core Nationwide CPI, expected to remain steady at 3.3%, Unemployment rate (also to remain steady at 3.7% according to consensus) and Preliminary Industrial Production (expected to tick up to 1.0% MoM after June’s decline).

Based on our last couple of discussions we had with some traders, it seems that the market is looking for buying opportunities on USDJPY. Pivot point is seen at 103.50/55, where there is talk of lots of buy orders.

How long with the Risk-ON?

It seems that the low volatility in the FX market in addition to a strong risk sentiment both brought back carry traders’ interests for the past couple of weeks.

If we have a look at the graph below, we can see that the AUDJPY broke it 96.00 resistance to trade at 96.50 on Friday afternoon (up 7% since March 1st at that time), before edging down a bit. At the same time, the equity market (S&P500 – red line) reached a new record high at 1,897.28 and is now trading 40 points lower.

AUDJPY-SP

(Source: Reuters)

Is the risk-on trend going to continue in the coming days?

Firstly, this week started with an agitated session in Asia despite the Shanghai Composite was closed for a market holiday. After it reached a lower March high of 15,164.39 on Friday, the Nikkei index was down 1.7% with USDJPY down 100 pips and finding support slightly above the 103.00 level on Monday UK/US trading sessions.

This morning, the US Dollar remained under pressure against most of the currencies, with the USD index trading back below the 80 level. Although the US March employment report came in line with expectations last Friday (192K vs con. 200K) and February’s job creation was increased 22K to 197K, demand for the greenback is still weak as traders and investors have been guided to look at a ‘wide range’ of variables. As you can see it on the chart, the index managed to find support around 79.75; a level that the market seem to consider as a buying opportunity.

USDX

(Source: Reuters)

Tomorrow, the Fed will release the minutes of the March FOMC meeting (18th-19th) and should give us more details on the ‘qualitative’ guidance.

Euro: The ECB policymakers’ threat of unconventional action didn’t manage to push the Euro to lower levels, and the single currency found support at the high of the support band 1.3640 – 1.3680. EURUSD soared 50 pips this morning and is now trading around 1.3800. It mainly came from a Dollar weakness, which pushed the single currency to the high of the 1.3300 – 1.3800 range as the Dollar index is heavily weighted towards the Euro (57.6%).

Sterling: After underperforming a bit last week, Cable (Purple bar) surged 100 pips this morning boosted from strong Feb Manufacturing (1.0% MoM vs. 0.3% exp.) and Industrial (0.9% MoM vs. 0.3% exp.) production data. The pair is now trading at 1.6750; the next resistance on the topside stands at 1.6770. The 2-year UK-US yield, one indicator that we like to watch quite a bit (orange line), is up 5 bps since Friday’s low of 0.219%.

CAbrr

(Source: Reuters)

Yen: As expected, the BoJ kept their monetary policy unchanged at the conclusion of its 2-day meeting despite a series of missed indicators (PMI, GDP, Industrial production…). According to BoJ policymakers, the Japanese economy can ‘swallow’ a sales tax hike that started on April 1st without adding more stimulus on the table. As a reminder, the BoJ 2014 Monetary Base Target stands at 270tr Yen (which was decided to be kept steady unanimously overnight) and was double after the central bank introduced its Quantitative Qualitative Monetary Easing (QQME) last year (April 4). However, the policymakers’ decision to increase the monetary base target will depend on the level of the inflation rate which has been constantly rising to higher levels (Overall Nationwide CPI printed at 1.5% in February).

USDJPY is one of the biggest movers, down 2% since Friday high of 104.12. The pair is now trading at 102.20, testing its support band of 102.00 – 102.20. The next support on the downside stands at 101.75.

USDJPY

 (Source: Reuters)