USD/JPY Slips Quietly to 1 Month Lows, GBP Outlook

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The FX market may be captivated by the big moves in sterling today but USD/JPY has quietly dropped below 97 to a fresh one month low. The idea of buying USD/JPY, which was was once touted as one of the best trades of 2013 is now looking tenuous. With no U.S. economic data on the calendar today, the latest sell-off in USD/JPY, which marks the fourth consecutive day of weakness for the pair has been driven by the 4% decline in the Nikkei overnight and the drop in U.S. 10 year yields. Concerns about Fed tapering, the recent strength of the Yen and uncertainty surrounding the upcoming Bank of Japan meeting have contributed to the weakness in Japanese stocks and USD/JPY has a negative correlation with the index. The BoJ began its 2 day meeting today with an announcement expected on Thursday – no changes are anticipated. Meanwhile the break of prior 1-month low puts USD/JPY at risk of slipping down to its June lows near 95.

In the U.K., the Bank of England’s Quarterly Inflation Report triggered a significant amount of volatility for sterling. The central bank has adopted a 7% unemployment rate threshold. They said interest rates will not be raised as long as unemployment remains above 7%. The jobless rate is currently at 7.8% and according to their latest forecasts the BoE believes that the unemployment rate will remain above their new threshold until “at least 3Q of 2016.” This puts the first potential rate hike much later than the market had anticipated and for this reason, the initial reaction was GBP weakness. However, at the same time, the BoE also upgraded its 2013 GDP forecast to 1.5% vs. 1.2% in May and more significantly, their 2014 GDP forecast to 2.7% from 1.9%. In other words, the central bank expects easy monetary policy to fuel significantly stronger growth next year. If the central bank’s forecasts for growth are spot on and the momentum is sustained into 2015, we would not be surprised if the unemployment rate falls faster than the central bank currently anticipates. However their decision to estimate that the 7% mark will not reached until late 2016, is their attempt to convey an ultra-dovish monetary policy stance to the market. While sterling as since soared, the combination of dovish forward guidance and a higher GDP forecast means the potential for more extended range trading in the GBP/USD. Gains should be capped at the June highs of 1.5750 and losses should limited to the July lows at 1.48. This may be a wide range but there has significant volatility in the GBP/USD in recent weeks.

Finally, the Canadian dollar extended its losses after the IVEY PMI index printed at its weakest level in 8 months. Not only was this the first contraction in manufacturing activity since November 2012 but the index fell far short of expectations. Economists had been looking for the IVEY PMI index to rise to 57 from 55.3 but instead it dropped to 48.4. Combined with the 10.3% drop in building permits, the outlook for Canada’s economy has worsened, putting USD/CAD at risk of hitting 1.05 in the near term.

Kathy Lien
Managing Director

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