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CBA FX Strategy: Higher Japanese Yields Boost Yen

Posted by Marge Maresca on May 23, 2013 9:06:00 AM

Risk off and correction has been the clear theme across markets following the lead of US markets and Japan overnight.  European indices gapped lower to start the session and extended their losses through the morning. The Euro-stoxx was 2.5% down by mid-morning, bund yields were a couple of basis points lower. In the currency markets the JPY extended its gains, USD/JPY dipped down under the 101 level a little while ago. The risk off moves started late in yesterday’s US session, but really spiralled in the Asian session. The surge in Japanese yields appears to have finally spilled over into wider markets, the Nikkei plunging by over 7% lead by financials. USD/JPY also gave ground, albeit far more modestly, dropping under 102 in the Asian session, a move which has extended through the European morning. Risk off is the overriding theme. Main interest in coming sessions is whether these moves turn into a meaningful market correction.

There has been some top-tier economic news-flow through the European morning as well. The flash Eurozone composite PMI improved a little more than expected, rising to 47.7 in May from 46.9. The manufacturing reading rose to 47.8, services to 47.5. The readings are indicative of ongoing modest contraction in activity through May. But at least the softening of the readings recorded in March and April did not extend into May. The EUR rallied a little through the morning, helped along by these slightly better than expected PMIs. EUR/USD has reached the 1.29 level. EUR/GBP is holding around the 0.8550 mark following publication of unchanged 0.3% QoQ QI GDP growth estimates. The breakdown of the numbers reveals that an inventory rebuild contributed 0.4% to UK growth in the quarter and largely explains the better than expected out-turn. Consumer spending grew by 0.1% QoQ, government spending was flat, GFCF fell by -0.8% QoQ, exports fell by -0.8% QoQ and imports fell by -0.5% QoQ.  The UK economy may have avoided a triple dip recession, but the underlying composition of growth does not provide much grounds for cheer. GBP/USD has held above the 1.50 level so far this morning – the low was 1.5014 in the Asian session – but the pair looks very heavy.

The USD has sold off a touch though the European morning following yesterday’s Bernanke-inspired volatility and overall surge.  The highlight from the FOMC minutes, released after Bernanke’s testimony, was that “many participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate”.  We place little weight on these minutes because Bernanke’s testimony is more up to date and many of the meeting participants do not vote on FOMC policy.  The minutes were from FOMC meeting held on 1 May. USD strength will likely remain a theme in FX markets over the near-term.

AUD and NZD have rallied through the European morning following a drift lower in the Asian session.  The flash estimate of the May HSBC manufacturing PMI was softer than expected, coming in at 49.6.  This is the first time the HSBC measure has been below 50 since October 2012.  While this suggests slightly below trend growth in production (and not contraction as is the case in the US and Eurozone), the softer Chinese data added to the negative AUD and NZD sentiment currently running through the market.  Relatively sharp falls in AUD/JPY and NZD/JPY, triggered by a slump in the Nikkei stock market and broadly firmer JPY, also weighed on the AUD and NZD.  There is little in terms of Australian economic data over the coming week.  As such movements in the AUD will remain a function of broader market sentiment and USD movements.  In the near-term the risks are skewed to further AUD weakness.  With respect to the NZD, April New Zealand trade data is the next release (6.45pm EST/11:45pm BST).  Market consensus is looking for a trade surplus of NZ$515mn (CBA NZ$300mn).  While not typically a market mover, a greater than expected decline in the trade surplus could weigh on the NZD given the current market environment. 

USD/CHF and EUR/CHF have both dropped sharply today in the risk off environment. EUR/CHF has pushed under 1.2450, USD/CHF under 0.9650. Nonetheless, as we noted recently, we expect the weakness in the CHF to persist over the period ahead (see CBA FX Strategy - Further gains for USD/CHF?, published 13 May 2013).  Given the improvement in global financial market credit conditions, safe-haven related inflows into CHF-denominated safe-haven assets may continue to unwind over the months ahead.  When this reversal is combined with the unattractive risk-adjusted return on Swiss government bonds, we expect the CHF to remain under pressure.  Added to this, ongoing deflation in Switzerland, and/or concerns about the strong price growth in the Swiss property market suggests some policy paralysis.  The risk of further Swiss National Bank (SNB) policy action cannot be discounted. The SNB holds its next quarterly Monetary Policy Assessment on 20 June.  Yesterday’s comments by SNB President Jordan suggesting that an adjustment of the EUR/CHF 1.2000 minimum exchange rate and/or negative interest rates remain an option for the SNB provide further weight to our view. 


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