Time for Catch Up in USD/JPY?

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Daily FX Market Roundup 11-05-13

Time for Catch Up in USD/JPY?
Buying Dollars Cautiously
Europe Doesn’t Want to Become the Next Japan
GBP Soars to 1 Month High vs. EUR
NZD Headed Higher after Strong Employment Gains
AUD: RBA Concerned About Strong Currency
CAD: IVEY PMI on Tap

Time for Catch Up in USD/JPY?

Over the past 3 months, USD/JPY has been consolidating in an increasingly narrow trading range but with equities and Treasuries pricing in earlier action from the Federal Reserve, we think that it is time for USD/JPY to catch up. Ten year Treasury yields rose 6bp today to its highest level since October 14th and we believe this should gradually create more demand for USD/JPY, pushing the currency pair above 99 and on its way to 100. On October 14th USD/JPY was trading right around current levels but back then, the move in USD/JPY was not supported by less dovish comments from the Fed or stronger U.S. data. Yields were moving lower and stocks were on their way to new highs. Now the tables have turned with 10 year U.S. yields quietly moving higher after bottoming at 2.5% last week. If U.S. data continues to surprise to the upside and more Federal Reserve officials warn about the risks of overly easy monetary policy, yields could extend higher and at some point, USD/JPY will have to follow. The currency pair has the strongest correlation with the Nikkei and 10 year Treasury yields. If the Fed continues to grow less dovish and they eventually will USD/JPY should be trading much higher. The problem is the Nikkei, which peaked back in mid-October. With U.S. stocks backing off all time highs, Japanese equities have also lost upside momentum. However if they start to turn higher as U.S. yields climb, it would be the perfect mix for a stronger USD/JPY rally. Even though we believe the Federal Reserve will wait for March to taper and the Fed is suggesting the potential for an earlier move, the reality is that they will most likely be reducing asset purchases within the next 4 or 5 months. Therefore it should only be a matter of time before investors start rushing back into dollars and by mid 2014, we expect USD/JPY to be trading comfortably above 100. Mid 2014 may seem a long time from now, but the trajectory of USD/JPY is clear and we view any dips in the pair as opportunity to come in at lower levels. Meanwhile given the Bank of Japan’s comfort with the current level of monetary policy and their belief that the economy is well positioned to handle an increase in the consumption tax, we don’t expect the Yen portion of the pair to threaten our overall outlook. The Bank of Japan is scheduled to release the minutes from its October monetary policy meeting this evening but it is not expected to have any impact on the Yen.

Buying Dollars Cautiously

The U.S. dollar appreciated against the euro, Swiss Franc, Australian and Canadian dollars today but weakened against the British pound, Japanese Yen and New Zealand dollar. The lack of consistency in the price of the greenback contrasts with the rise in Treasuries and decline in equities that imply that investors are positioning for tapering by the Fed before March 2014. A surprise uptick in service sector activity during the U.S. government was shutdown and optimistic comments from more Federal Reserve Presidents has many market participants rushing to position for a more aggressive timetable to reduce asset purchases by the central bank. Last week the Fed’s less pessimistic views on the economy caught the market by surprise and since then stronger than expected data has supported their views. So even if investors don’t believe the economy is ready for a reduction in stimulus, economic data and comments from Fed officials suggest otherwise. In the month of October, when the dysfunction in Washington paralyzed the government, many economists believed that growth took a big hit but based upon both the ISM non-manufacturing and manufacturing reports, the government shutdown had virtually no impact on the economy. Both the service and manufacturing sectors gained momentum and the data would have been stronger if U.S. debt troubles did not hang over the markets throughout October. The ISM non-manufacturing index rose from 54.4 to 55.2 last month and more importantly, the employment component of report surged from 52.7 to 56.2. The U.S. is a service based economy and the uptick in the employment subcomponent leads us to believe that non-farm payrolls could surprise to the upside on Friday. Good data is the key to keeping the dollar bid but the currency is struggling to rise consistently because investors remain skeptical about the improvements in the economy. Nonetheless, the consistency of comments from Federal Reserve Presidents should not be ignored. Now that the quiet period before the FOMC meeting has ended, policymakers are out in force sharing their views on the economy and monetary policy. Their comments are moving the dollar because investors are still trying to wrap their heads around the Fed’s less pessimistic outlook. Most of the Federal Reserve Presidents that we have heard from are not very dovish including FOMC voter Rosengren who is generally one of the most dovish members of the central bank. He sees the U.S. achieving 3% growth fairly soon which is optimistic and given the expected upturn, he also warned about the costs of QE. With one more dove in the central bank biting the dust, more investors are buying dollars on the view that the Fed could taper before March 2014.

Europe Doesn’t Want to Become the Next Japan

The euro ended the day slightly lower against the dollar on the back of stronger U.S. data. There has not been much in the way of Eurozone data so far this week but the reports that we have seen confirms that the region faces ongoing challenges. Producer prices grew less than expected in the month of September with annualized PPI growth in the region dropping to -0.9% from -0.8%. This was the weakest level of PPI growth since January 2010. While the decline was not a major surprise because it came on the heels of an equally dismal consumer price report, it highlights the severity of falling inflation or more accurately, the risk of deflation in the region. Deflation is not as much of problem in the core economies than in the peripheries but Europe certainly does not want to become the next Japan and for this reason the European Central Bank could feel motivated to cut interest rates before the end of the year. In order to combat deflationary pressures, the ECB will also allow the EUR/USD to weaken further and they could engineer weakness in the currency by talking it down. Eurozone retail sales, German factory orders and revisions to PMI services are scheduled for release tomorrow. Unfortunately the steep declines in German and French consumer spending in September will weigh on the overall index, leading to a steep decline in Eurozone retail sales. Weaker data would compound the losses in the euro and raise the chance of additional easing by the ECB.

GBP Soars to 1 Month High vs. EUR

Sterling benefitted significantly from stronger than expected service sector activity. Following this last PMI report, we now know that activity only slowed in the manufacturing sector during the month of October. Both services and constructed expanded at a faster pace, raising hope that the U.K. economy is not losing momentum but rather pausing after a strong summer. Economists had been looking for the U.K. PMI index to decline but instead it rose to 62.5 from 60.3 the previous month. The increase alone would have been lifted sterling but the new business component also rose to its highest level ever while the employment index rose its strongest since 1998. This upside surprise drove GBP/USD above 1.60 and EUR/GBP to a one month low. According to our colleague Boris Schlossberg, “Overall the composite PMI data suggests that UK economy is growing at a torrid 1.5% q/q pace which translates to an annual rate of 6%. If UK could maintain such momentum it would easily produce the best growth in the G-4 universe and would force the BoE to reconsider its relatively dovish stance. The growth in employment would be particularly important given the BoE policy guidance to become more restrictive once the rate falls below 7%.” Looking ahead, industrial production is scheduled for release tomorrow and a rebound is expected in September after the drop in August. Another round of good data could send sterling to its strongest level against the euro in 9 months.

NZD Headed Higher after Strong Employment Gains

It was a mixed day for the commodity currencies with the New Zealand dollar soaring, the Canadian dollar edging lower and the Australian dollar ending the day unchanged. Investors snapped up the NZD after the country’s strong employment report. The level of employment rose by 1.2% in the third quarter, pushing the unemployment rate down to 6.2% from 6.4%. New Zealand only releases labor market numbers quarterly but we have seen significant increases in job growth this year. What made the report even more encouraging was the fact that both the participation rate and average wages increased. This data will harden the Reserve Bank’s desire to raise rates next year, which is very positive for NZD. While stronger gains may be seen against the crosses (take a look at AUD/NZD), the NZD/USD could also revisit its October highs. With the gap between Australian and New Zealand monetary policy widening, we expect AUD/NZD to retest 1.12. Last night’s RBA statement was more dovish than investors had anticipated. While the losses in AUD/USD were small, the RBA’s concerns about the exchange rate suggest that they are in no rush to raise rates. In fact, some economists believe they could cut rates one more time before dropping their dovish bias. Australian trade numbers are scheduled for release this evening followed by Canada’s IVEY PMI report on Wednesday.

Kathy Lien
Managing Director

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