USD/JPY and its Struggle to Rally

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Daily FX Market Roundup 08-16-12

USD/JPY and its Struggle to Rally
Dollar –Higher Yields Offset Weaker Data
EUR – All Eyes on PMIs
GBP – Aiming for June Highs?
CAD – String of Data Misses Could Worry BoC
NZD – Earthquake Damage Minimal
AUD – Gold and Oil Unchanged

USD/JPY and its Struggle to Rally

U.S. 10 year yields are at a 2-year high, the Japanese are buying foreign bonds in substantial quantities, shouldn’t USD/JPY be trading much higher? This question has befuddled investors around the world and we will attempt to address the reasons why the currency pair is having such a difficult time to rallying. At the beginning of the year, one of the most popular trades was buying USD/JPY and despite the recent pullback in the pair, the latest IMM data show speculators still net short the yen with positions near but slightly off its 6-year highs. This implies that speculators have not given up on the USD/JPY rally but their patience could be wearing thin.

The summer doldrums are playing a serious role in the lack of upward movement in USD/JPY. Throughout this week, Japanese traders have been off for the Obon Holiday and will return to the markets on Sunday night / Monday morning. As a result, they haven’t had the opportunity to react to the latest push higher in yields. There was very little momentum in Treasury yields in July or the first week of August so it wasn’t until this week that yields started to rise again. When Japanese investors return to work and notice that 10 year Treasury yields are at 2.8%, it will be interesting to see if they jump back into USD/JPY. Also, the latest increase in demand for foreign bonds in Japan were primarily from banks who fund their investments in foreign currencies that they own already, making the FX impact nominal. The recent sell-off in the Nikkei isn’t helping either and neither are the recent disappointments in U.S. data. Friday’s U.S. economic reports add to concerns about whether the Federal Reserve is looking taper asset purchases prematurely, which has also weighed on equities, risk appetite and in turn USD/JPY.

However few will argue that U.S. yields are headed higher over the next 6 months and now that they have started to rise again after pausing for over a month, we should finally see USD/JPY move upwards. While we could be wrong, we still believe that monetary policy direction supports a further sell-off in the yen and gains in the U.S. dollar. Next week’s FOMC minutes could provide more clarity on the U.S. central bank’s plans for tapering.

Dollar –Higher Yields Offset Weaker Data

It was another volatile day in the foreign exchange market with the dollar falling sharply after disappointing economic reports only to recover strongly to end the day higher against the euro and Japanese Yen. Broad based weakness in U.S. data was offset by a new 2-year high in U.S. 10 year Treasury yields. Earlier this week we said uncertainty about the outlook for the U.S. economy has led to the volatility in the foreign exchange market. Unfortunately today’s economic reports only adds to the question of whether the Fed is making the right move by planning to taper asset purchases this year. Consumer confidence in the U.S. retreated from a 6 year high in August with the University of Michigan Consumer Sentiment index dropping to 80 from 85.1. The details of the report showed less optimism about current conditions and the future outlook for the U.S. economy. Its no surprise that sluggish job growth, the threat of a reduction in stimulus and stocks declining in the month of August has made Americans less optimistic. Non-farm productivity also rose 0.9% in the second quarter after dropping 1.7% in Q1. Originally, productivity in the first quarter was reported to have grown by 0.5% but now we have learned that it declined, leaving the U.S. economy with a net loss in productivity in the first half of the year. At the same time, unit labor costs increased in the second quarter, which means workers are becoming less productive and yet the cost of labor has risen, an undesirable development for the corporate sector. Housing starts and building permits rebounded in the month of July but the increase in both were less than expected. Starts rose 5.9% compared to a 7.7% forecast while permits rose 2.7% vs. a 2.9% forecast. The coming week will be an important one with the FOMC Minutes scheduled for release on Wednesday and Federal Reserve officials gathering in Jackson Hole for the annual monetary policy symposium on Thursday and Friday. While any comments made from policymakers at the meeting will be interesting, Fed Chairman Ben Bernanke won’t be attending. Two months ago, he dismissed the significance of the meeting by saying, “There’s a perception that the Jackson Hole conference is a Federal Reserve system-wide conference; it’s not.” So don’t expect any fireworks from Jackson Hole.

EUR – All Eyes on PMIs

The euro ended the week not far from where it started. Since the beginning of the month of the currency pair has fluctuated within a 200-pip range between 1.32 and 1.34. While we have seen both sides of the range tested this week, we have yet to see a breakout. Aside from the summer doldrums, uncertainty about the outlook for the Eurozone and U.S. economy has capped the moves in the currency. The first half recovery in the U.S is beginning to slow while the first half slowdown in the Eurozone is beginning to ease. However there is very little confidence on whether these trends can continue which explains why the currency pair is trapped in a range. Better than expected Eurozone trade and current account numbers failed to lift the euro because the improvement was widely expected after similar increases in Germany and France. Consumer price growth on the other hand dropped 0.5%. The outlook for euro now hinges on next week’s PMI numbers, which will give a fresh perspective on the Eurozone economy. Manufacturing and service sector activity is expected to grow at a stronger pace in the month of August. It is also worth mentioning that yield spreads in Europe are compressing with Spanish-German spreads falling to their lowest level since 2011. This is a sign that investors have grown more confidence about peripheral Europe.

GBP – Aiming for June Highs?

It was a breakout week for the British pound but contrary to our expectations, the U.K. retail sales report and not the Bank of England minutes drove the currency pair sharply higher. Every little piece of event risk this week played its part in supporting the currency pair’s move. The decline in jobless claims was nearly double market expectations, retail sales jumped 1.1% and the decision on the new unemployment threshold was not unanimous as Martin Weale voted against the move. This left the central bank with a slightly less dovish bias and economic data supporting a stronger recovery. The BoE has a relatively pessimistic forecast on when 7% unemployment rate will be achieved but if economic data continues to surprise to upside, this target may be reached sooner rather than later. The rally in sterling suggests that investors are positioning for a stronger recovery and with fundamental data supporting the move, we believe there’s a reasonable chance that the June high of 1.5750 will be reached. In the coming week, we don’t have much in the way of market moving data for the U.K. that could threaten the GBP/USD rally. Revisions to Q2 GDP numbers are on the calendar along with Public Sector Finances but no major surprises are expected.

CAD – String of Data Misses Could Worry BoC

Another day of disappointing economic data from Canada drove the Canadian dollar lower against the greenback. Manufacturing sales plunged in the month of June, falling for the third time in four months. Economists had anticipated a continued recovery but unfortunately weak external demand hampered sales of motor vehicles, jewelry, silverware and basically 16 out of the 21 categories tracked by Statistics Canada declined. The slow recovery in the U.S., China and Eurozone has taken a big toll on Canada’s economy and this piece of data adds to a string of weaker releases in Canada. If you recall, the latest IVEY PMI report released earlier this month showed the manufacturing sector contracting for the first time since November 2012. It is these weaker reports that may have convinced foreign investors to sell Canadian dollars. According to the latest International Securities Transactions report, foreign investors cut their Canadian bond holdings by a record C$19 billion in June. The Bank of Canada won’t be happy with these results and could be tempted to drop its hawkish bias. The Australian and New Zealand dollars on the other hand traded higher against the U.S. dollar. No data was released from Australia but the recent rally in gold prices is lending support to the currency. The NZD underperformed the AUD today after an earthquake temporarily halted trading on the exchange last night. While the epicenter was in the small town of Marlborough, tremors were felt in the capital of Wellington. Thankfully the damage was minor and similar to the July 21st quake that left the NZD unscathed. We still believe that the NZD is poised to outperform the AUD in the medium term.

Kathy Lien
Managing Director

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