One is about U/Y. That 101.20-30 area is being defended so stubbornly, why? Who? I mean even if you are a long term Yen bear and see much higher level for U/Y in the future why would you stubbornly buy there instead of taking advantage of the risk aversion in stocks and general dollar weakness to let it go and accumulate it at much cheaper levels? All I can think of is some protecting big barriers all the way down to 100.00 and below so is it likely we could cascade lower if those bids finally get taken out? Or is it more likely to find just more stubborn bids all the way down?
My other question is concerning the sell-off in equity and their impact on currencies. For now, only the Chf and Yen seem to benefit much and it doesn’t seem to spill to high yielders / Commodity currencies. Just because it is not seen as altering or having an impact on their central bank monetary policy at this stage? Because it isn’t intense enough yet to force investors out of their profitable currency carry trades? Could this change? I’m thinking mostly in terms of the kiwi here… I mean if the equity sell-off intensify could this cause the kiwi to drop a few hundred pips?
Last the Euro! Am I right to say bond traders/investors are kind of front-running future ECB QE? But knowing QE is at least a couple months away they don’t yet see the need to hedge their Euro exposure by selling Euros but that this could change at some point?
Next, isn’t the ECB somehow cornering themselves with those talks of negative rates/QE? What I mean is that by building market expectations for more action at some point (in order to keep yields low and putting downward pressure on the Euro) they are forcing themselves to act at some point otherwise if it becomes clear that they are not going to do anything yields and the Euro may end up much higher than if they would not have done any of that talking in the first place thus causing more damage than good? I guess they could just do nothing if they think the outlook is good enough but with still low growth, low inflation and high unemployment I’m not sure it would be the right policy….
I think with the USD/JPY, it can want to drop, but as you say, there is some buying supporting the 101.20 area. There are various reasons I can explore further.
Since there are two currencies in a pair, we can break it down into two components: the USD component and JPY component, we can break down the analysis into those components.
There I also the general risk appetite / risk aversion component as well.
So lets start with the USD:
The market believes the U.S. economy is making progress from a few years ago and the Fed believes so and is winding down QE. The Unemployment rate has dropped from around 7.8% in December 2012, to 6.7% currently. So all else being equal, that along with the winding down of Fed QE, and anticipation of rate hike cycle starting in fall 2015, that warrants a USD/JPY higher than the 78.00 level that it was in the fall of 2012.
Then the JPY component:
BoJ raised inflation target to 2%, and committed to a massive QE program in order to reach that goal. So all else being equal, that would warrant a USD/JPY higher than the 78.00 level.
That combination of forces led to USD/JPY rising from 78.00 to 105.00 or so.
But the market may have gotten a bit too bullish as they were pricing in too much bullishness in the U.S. economy, and/or expected imminent BoJ QE. So that unwinding led the market back down to 101.20 or so. I was worried about Japanese economy in February when the weaker Q4 data came out. And the data from Q1 2014 has been on the weak side, even with the front loading of demand pre the sales tax hike.
My theory was that the BoJ would not do imminent QE (more QE before July) as they would wait to gauge the effects of the sales tax hike, also due to some Kuroda comments back in December when he said something like that. So I thought that combined with that disappointment, and the weaker economy, it would lead the market unwinding the bullish Nikkei and bearish JPY bets, so the Nikkei would drop and the JPY would rise. That was my theory. And USD/JPY is trying to break out to the downside. But it has been supported around 101.20 or so as you have mentioned.
I think part of the reason it has been supported is because the USD/JPY has been consolidating since the beginning of the year, so there was time for the excessive positioning to be unwinded. It possible that a large portion of the bullish USD/JPY bets on imminent QE, etc were pared back in the consolidation from January to April 2014. And if that profit taking did not cause a huge downmove, then so be it. It is possible that profit taking in an uptrend does not cause a huge retracement, and only causes a consolidation in a range.
Another reason is that there is still an attractive JPY bearish scenario. There is monetary policy divergence between the BoJ and other central banks. They still have massive QE every month, may do more by the end of the year, while other central banks are forecasted to begin raising rates in 2015. And if the USD/JPY falls too much, and the JPY strengthens, that can cause the BoJ to be worried that they may miss their inflation targets and the stronger JPY is not conducive to Japan growth. So weak Japan econ data and inflation, should normally be a recipe for a weaker JPY. The only reason I thought the JPY would rise was because the market was expecting that weak data to spur imminent QE, and the BoJ would disappoint, so all the people buying USD/JPY on expectation of more imminent QE by the BoJ would be forced to pare back their positions.
And also if there is a multi year bull market in risk appetite, and BoJ is still doing QE in 2015, that means the JPY can be used as a funding currency for the carry trade, so that risk appetite provides another reason to stay bullish on USD/JPY for the medium and long term, and another reason not to chase USD/JPY breakouts lower.
But again, there is still the macro argument that the weaker Japan data and if the JPY rises, that would spur more BoJ action, and thus cause the JPY to weaken.
My overall forecast was for USD/JPY to go in the range of 95.00 to 100.00 and to look for a buying opportunity there, due to the reasons mentioned above. I was not expecting a massive and sustained drop in USD/JPY. Just a moderate 500 pip drop or so to work off the excessive expectations. That was the insight and scenario I felt I had an edge on in the short term. What will happen 6 months or 1 year from now, I cannot predict that.
Some of the risk aversion in equities are due to valuation concerns in the market, rather than anything wrong with the US economy. The market is still anticipated decent growth. The Fed is not worried by the drop and will not do any further stimulus measures. So the USD is not going to fall due to the Fed delaying the winding down of QE is the markets current expectation.
That would be by answer to your question.
Yes, you are correct that the equity sell off is not anticipated to have an effect on the central bank monetary policy. No central bank is going to add stimulus just because of the correction in equity valuations. There is no reason to panic. Bond yields are still low supporting the recovery. Back in 1987, the market believed the Fed would add stimulus, but that was a bigger equity drop, and bond yields were surging in the months prior. In the current scenario, the retracement is a healthy correction and bond yields are still low supporting the recovery.
AUD and NZD have been resilient to the equity sell off. I would anticipate this break down in correlations to sustain itself. The market does not believe the equity sell off in the U.S. has anything to do with the RBA or RBNZ monetary policy. Nor does the market believe it has anything to do with global growth. The market still anticipated U.S. growth to help support global growth this year.
With the EUR, there has been huge demand for the Eurozone debt, especially from the periphery. Some of that demand probably came from inside the Eurozone, but a sizable portion probably came from international investors. And they got a double benefit from the bonds rising in value, and the EUR rose a few % over the past year or so. So they made money as the bonds rallied in price and as the EUR rose. So that is the current markets expectation and that seems to be supporting the EUR, as well as the lack of any ECB action. I think the ECB knows that it is important to try to explain to the market it’s thinking on policy action, etc. Very few central banks would want to blindside the market with an unexpected rate increase, or decrease, or a massive QE program. So they generally start with the verbal intervention and comments and see what that does. If it wasn’t for the ECB rhetoric about QE, the EUR/USD may have already been above 1.4000 ( it is obviously bouncing back up there the past week). Draghi verbal intervention in the summer of 2012 worked marvelously in leading to saving the EUR and reducing the bond spreads. He didn’t have to use the OMT program at all. The mere verbal intervention and having the program in place if needed did the trick.
It is possible the ECB is cornering themselves. If they do not do any rate cut or QE, the EUR can continue to grind higher slightly. But it would have probably done that anyways, whether they mentioned the rate cut/QE or didn’t. So they figured if they are truly discussing rate cuts or QE, they might as well mention that to the market to show transparency in their thinking. If the EZ inflation rate picks up, that would support the EUR grinding higher on the closing out of short EUR bets. But if it doesn’t, then I think the market will eventually have a monetary policy divergence, where the ECB is saying rates will be at current or lower level for extended period, into 2015, 2016 or 2017, while the central banks are hiking during 2015 – 2017, which could lead to EUR selling.
You are right that with the high unemployment and low inflation and low growth, that is the standard macro recipe for a weaker currency. I believe even Draghi said that a 10% rise in the currency is responsible for a drop in the inflation rate of -0.50%. So the inflation rate would be +0.50% higher, if the EUR were to drop 10%. And that would help EUR exports, etc. They are just a more conservative central bank in some respects. They only have one mandate – price stability, while the Fed has the more flexible dual mandate of full employment and price stability. So the Fed spearheaded the effort of QE at the end of 2008 or so and continued it. The ECB is more reluctant to do it, since the structure of the Eurozone makes it harder with all the different national governments. And also I have been reading that the market for the Asset Backed securities in the Eurozone is nowhere near as large or developed as it is in the United States.