Daily FX Market Roundup 05-23-13

Dollar and the Lack of Safe Haven Demand
EUR – Lifted by Stronger PMIs
Is the USD/JPY Rally Over?
GBP – To Remain Weak and Sensitive to Risk Appetite
AUD – Bounces Off 11 Month Lows Despite Weak Chinese Data
NZD – Trade Report Expected this Evening
CAD – Oil Prices Remain Unchanged but Gold Rebounds Nicely

Dollar and the Lack of Safe Haven Demand

The U.S. dollar traded lower against all of the major currencies today and its persistent underperformance during the North American trading session was interesting as stocks recovered and 10 year bond yields rose back above 2% after dropping below 1.97%. The dollar barely budged with most of its recovery against the Yen happening during the European session. The dollar did not benefit from safe haven demand or the recovery in risk appetite. So what’s going on? The U.S. dollar is generally currency that performs well during risk aversion but investors had been gradually increasing their exposure to dollars since the beginning of the month and when they de-levered, they sold the greenback.

The weakness in the U.S. dollar had nothing to do with fundamentals as economic data from the U.S. surprised to the upside. Jobless claims dropped more than expected, house prices increased and new home sales beat the market’s forecast. After rising to 363K the prior week, jobless claims fell to 340K, a number that is consistent with a continued recovery in the U.S. labor market. House prices rose 1.3% in March after rising an upwardly revised 0.9% in February. New Home Sales increased 2.3% which was slower than the pace the previous month but only after the sharp upward revision. Overall these better than expected U.S. reports should help to support U.S. yields and the greenback. While we haven’t seen the financial markets react, the implications for Fed policy is clear which is that good data will make the central bank more confident in dialing back asset purchases this year.

EUR – Lifted by Stronger PMIs

The euro rebounded against the U.S. dollar today on the back of stronger than expected PMI numbers. The contraction in the manufacturing and service sector eased in May, boosting the Eurozone’s PMI Composite index to 47.7 from 46.9. Germany also saw improvements in both parts of its economy and together this is probably the best possible outcome the ECB could have hoped for. While the central bank only cut interest rates at the beginning of the month, we are finally beginning to see the benefits of a weaker currency and with time, the recent rate cut will also lend support to the economy. Unfortunately comments from European officials suggest that they are still very worried about the economic outlook and think that more stimulus could be necessary. According to ECB member Praet, the central bank is looking at all possibilities including reviewing the quality of asset backed securities for possible purchases. ECB member Nowotny expects the economy to contract in 2013 and inflation to decline, which suggest that he also supports new stimulus. However he went on to say that the central bank never pre-commits and their decision will in large part be affected by the new economic forecasts published in June. Final German first quarter GDP numbers is scheduled for release tomorrow and no revisions are expected. Instead, our focus will be on the IFO report, which could see improvement given today’s PMI numbers.

Is the USD/JPY Rally Over?

The biggest move in the FX markets today was in the Japanese Yen. The 7% decline in the Nikkei overnight kicked off a wave of deleveraging in the financial markets and a broad based rally in the Yen. Now the burning question on everyone’s minds is whether the USD/JPY rally is over? First and foremost, it is important to understand what triggered the sell-off in USD/JPY. The 10bp surge in ten year U.S. Treasury yields yesterday caused a gap higher in JGB yields which in turn triggered the sell-off in the Nikkei and hence USD/JPY. Weaker Chinese manufacturing PMI numbers added salt to the wound by exacerbating risk aversion and the slide in USD/JPY. Previously we said there are 3 criteria for a continued rally in USD/JPY 1) rising U.S. bond yields 2) new highs in the Nikkei 3) Japanese purchases of foreign bonds. U.S. bond yields increased sharply on Wednesday and while Fed policy should keep yields in an overall uptrend, they are lower today. The Nikkei has collapsed and according to the Ministry of Finance’s weekly portfolio flows report, Japanese investors were net sellers of foreign bonds last week and the amount they sold completely undoes the buying over the past 3 weeks. So this reversal in USD/JPY is not just technically driven. It has fundamental support and could extend down to 100 and possibly even 98.50. However we believe that losses will be contained to this level due to the divergence between U.S. and Japanese monetary policies. The recent increase in JGB yields will only give the Bank of Japan greater conviction to ease whereas the recent uptick in U.S. yields should eventually attract Japanese interest.

GBP – To Remain Weak and Sensitive to Risk Appetite

While the British pound traded higher against the U.S. dollar today, it continued to slide against the euro. The second release of first quarter GDP numbers confirmed that the economy expanded 0.3% in the first 3 months of the year. Private consumption and government spending was slightly weaker but imports and exports were revised higher. There was not much in the way of new information in the latest GDP release. After yesterday’s surprisingly large decline in consumer spending, we are looking at the possibility of even weaker growth in the second quarter. This may explain why U.K. policymakers remained dovish despite upticks in the latest PMI numbers. With no major U.K. data on the calendar tomorrow, we expect sterling to remain weak and sensitive to the market’s overall risk appetite.

AUD – Bounces Off 11 Month Lows Despite Weak Chinese Data

After falling to fresh multi month lows against the U.S. dollar, the Australian, New Zealand and Canadian dollars ended the day sharply higher. Their recoveries have been impressive but the AUD, NZD and CAD need to see more gains before key resistance levels are broken. Disappointing Chinese manufacturing PMI numbers caused the initial slide in the 3 currencies as there was no major economic reports scheduled for release from Australia, New Zealand or Canada. According to HSBC, manufacturing conditions China returned to contractionary conditions ending a 6 month stretch of expansion. Economists had not been looking for a slowdown so when the index showed a contraction, the AUD and other commodity currencies traded sharply lower. However a recovery began in the European trading session and continued into North America. There was no specific catalyst but the rebound in U.S. stocks supported the currencies. New Zealand trade numbers are scheduled for release this evening and given the rise in business and service PMI, we believe there is scope for an upside surprise that could fuel further gains in the NZD/USD. No economic reports are expected from Australia or Canada.