Head of FX Strategy
Summary: The Japanese yen remains firm and could rise further as long as global yields continue to head lower. The trend could even accelerate on any fresh volatility in risk assets.
Trading interest
A Bloomberg article out this morning highlights tight conditions for USD liquidity with a look at the currency swaps market, where there are signs of strain as basis swaps make lending in USD expensive. The article offers examples that illuminate the difficulties for foreign bond investors – particularly Japanese investors, to realize attractive returns or any returns at all on a hedged basis. Aggravated USD liquidity shortages are a wrecking ball for global assets - particularly in emerging markets.
The leader of Italy’s Lega party, Matteo Salvini faces a tough path to snap elections due to the need to pass a budget this fall – according to an FT article (paywall), “No election has been held in the early autumn since 1919.” Parliament is out of session but returns inside of two weeks, when it will hold a no-confidence vote. Italy’s yields spiked versus core EU yields (10-year Germany-Italy spread rose about 30 bps) on Salvini announcing he would like new elections as the market anticipates existential EU strain linked to Salvini demands for more generous fiscal outlays. While the timing of an election is uncertain, Lega’s popularity has risen in the polls sufficiently to indicate that a centre-right majority coalition might be possible with Berlusconi’s Forza Italia and the Brothers of Italy party.
Late last week we suggested markets are at pivotal levels after the partial recovery from last week’s latest US-China trade tension escalation. Within G-10 currencies, AUDUSD is our basic proxy, where the focus remains lower as long as we remain below the 0.6825-50 area. Remarkably, the Japanese yen continues to grind higher and didn’t need much support from bond markets as USDJPY scrapes new lows. With Trump threatening sanctions and intervention on any major trade partner moving to ease monetary policy, the BoJ policy mix looks unmovable for now. A continued run lower in USDJPY toward at least 100.00 looks possible. Concerns that the EU will remain slow to respond to the growth slowdown and the risks to the economy from Brexit could keep EURJPY on a downward trajectory to the 110.00 area.
The economic calendar for the week ahead is rather light, but a few interesting points, including tomorrow’s German ZEW survey for August – after July saw the worst Current Situation component since 2010. Also tomorrow we have the US July CPI data. Wednesday sees Germany’s Q2 GDP estimate (expected negative) as well as the EU GDP estimate. Thursday’s Norges Bank meeting is the central bank highlight of the week in G10. More discussion of individual calendar highlights in the G10 rundown below.
Chart: EURJPY
EURJPY saw its lowest weekly close since early 2017 last week and could continue to grind lower as the BoJ look set to maintain course while the rest of the world eases and the EU is in a world of hurt with the risk of a recession that could risks further aggravation from a hard Brexit. Not much in the way of support in the longer term chart here until down towards 110.00.
The G-10 rundown
USD – firm outside of the G3 and versus the CHF, but could fall versus the hard charging JPY. US CPI up tomorrow and Retail Sales on Thursday, but economic data is not in the driver’s seat for the USD outlook – liquidity and trade issues are paramount.
EUR – the euro not much of a safe haven currency – interesting data points through tomorrow’s German ZEW and interesting to watch how the market treats Italian debt as a new election looms eventually.
JPY – remains firm and if risk appetite, at key levels entering this week, fades again, the currency could continue to drive higher, driven by strong bond markets/falling yields.
GBP – EURGBP cleared new highs above 0.9300 this morning and GBPUSD staring down 1.2000 as no relief in sight for hard Brexit risks, with the EU side showing no signs of backing down.
CHF – playing copycat to JPY moves and hard Brexit risks are adding a bit of extra fuel to the CHF strength. EURCHF looks heavy as long as it stays below 1.10.
AUD – heavy below 0.6800 again in AUDUSD as the ongoing collapse in iron prices has added a new negative angle on the Aussie over the last week on top of the US-China trade tensions. Key employment data release on Thursday sets the tone further.
CAD – Canada was overdue a weak employment report after an absurdly positive April data point of +106.5k and that’s what we got at -24.2k for July – hard to use the data series for much. More supportive was the hourly wage figure, which rose to a robust +4.5% year-on-year in July – the highest since the financial crisis. But can CAD stay ahead of a firm US dollar? 1.3300-25 is the decisive area in USDCAD.
NZD – surprisingly little follow-on weakness in NZD after Adrian Orr’s dovish broadside. Still looking for downside risks via AUDNZD and NZDUSD/NZDJPY, etc.
SEK – Swedish CPI up on Wednesday as the focus this week on EURSEK cyclical top above 10.80 if risk appetite worsens.
NOK – market suspects the Norges Bank could see its determination to maintain a hiking bias softened at this Thursday’s Norges Bank meeting and weaker oil prices are providing pressure as well as EURNOK last week the highs since the global financial crisis above 10.00.
2024: The wasted year
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
