USD and JPY still only with half an eye on risk deleveraging
Head of FX Strategy
Summary: An intensely ugly day for global equities yesterday finally saw the JPY sharpening its claws, but the transmission into JPY volatility from asset markets still feels remarkably different than it did in years past. Today, pity ECB president Mario Draghi, who will have a tough time spinning a positive story on the bank's pulling of the asset purchase plug.
A particularly ugly day for asset markets yesterday: the comeback attempt on Tuesday from new lows for the cycle in the major US indices was all for naught and fresh selling yesterday took global equities to new lows for the cycle, with the exception of China, where authorities are mounting a heroic effort to staunch the bleeding. In FX, we got a bit more of the expected USD and especially JPY strength in such conditions, but the move still feels half-hearted as the narrative here is challenging to navigate.
JPY crosses come under pressure when the mood is very negative, but are very quick to bounce again on the least sign of a relief in the pressure. Some of that may be the inability of US treasuries to find a more profound bid. Yesterday’s five-year US Treasury auction saw rather weak demand, given the carnage in equities and USDJPY is bouncing strongly off the overnight lows.
The Bank of Canada turned a deaf ear to all of the wailing asset market deleveraging sirens and moved ahead with the expected 25 basis point rate hike and said it could either pick up the pace of hikes or slow down the pace, depending on conditions and wanting to avoid the idea that it is on a predetermined course of hiking at every other meeting.
This is taking a page straight from Fed chief Powell’s playbook. The initial interpretation looked a bit too hawkish when this is really about taking back more flexibility and, as with Powell, removing excessively clear forward guidance from the equation. Still, Governor Poloz said that “The economy is running at its capacity and it is no longer needing stimulus”. The bank also expressed relief on the signing of the new USMCA trade deal with the US as an important step in reducing uncertainty. The BoC raised Canada’s growth forecast for Q3 to 1.8% from 1.5% and expects Q4 growth of 2.3%. USDCAD tried to dip below the key 1.3000 level but bounced back above, given the weak oil prices and risk asset deleveraging that tends to favour the USD.
The European Central Bank faces a challenging narrative today as its forward guidance has it on a preset path of winding down asset purchases over the next couple of months to zero by and then looking forward to a first rate hike sometime around mid-next year. But how does the ECB spin the situation if the economy continues to lose altitude and as the FT points out, Draghi will face intense questioning on Italy and Brexit at today’s press conference. I don’t envy Mario’s hot seat today. Hard to see how his comments catalyze any fresh moves in the euro.
In EM, the Mexican peso has been particularly weak, partly on weak oil prices, but also as the market mulls the style and intentions of the incoming “left populist” president, Obrador, who has received such a strong mandate from the election that he has wide freedom to make significant decisions. A key test lies just ahead on the issue of the partially built and financially troubled Mexico City airport and whether the project will be saved or an alternative plan will be sought. Obrador said that “we can’t refinance this project” in a Facebook post, which could be seen as a sign that the Mexican government could prove less committed to honouring contracts, with particular focus on Obrador’s attitude towards foreign involvement in Mexican energy projects once he finally assumes office on December 1.
In South Africa, finance minister Mboweni’s budget announcement yesterday was seen as showing a surprising lack of fiscal discipline. The market was positioned for more austerity and the ZAR weakened sharply. South Africa is on thin ice with international markets, given its large external debt load, and with its current account deficit largely driven by fiscal deficits.
Don’t look now – but USDCHF is about to hit parity again – can it hold the pair back one more time? We have our doubts as the USD continues to strengthen against European currencies. If US bond yields avoid a push lower and we see any relief on the Italian budget showdown (and perhaps even if we don’t), the parity level will have a hard time containing this pair. Next level here 1.0300+
The G-10 rundown
USD – the dollar strength is still in evidence, though not overwhelming and the yen overtakes at times when risk deleveraging really bites. But if US treasury yields continue higher – or even maintain current levels through further sell-offs of risk assets, it could continue to feed the USD liquidity shortage story and drive further USD gains.
EUR – not sure how Draghi tries to spin the situation at today’s conference – ECB’s hands are tied in my view on any signalling for offering the market more support as such a move would be too political, and EU inflation – the ECB’s supposed sole mandate – has been rising in recent months.
JPY – JPY bid is only in evidence when risk deleveraging really picks up. Maybe it’s a wash for now: risk asset relief and bond market weakness are JPY negative while only risk off and a strong bid in bonds is more distinctly JPY positive. Positioning is an additional angle and suggests more risk of JPY strength.
GBP – sterling is toying with the pivotal zone in EURGBP as we await further Brexit developments. GBPUSD broke to a new local low below 1.2922, setting up the risk toward the sub-1.2700 lows again.
CHF – the bid for CHF is more directly linked to core-Italy yield spreads, with general risk-off likely a less important factor here. The Germany-Italy yield spreads for 10-year debt are near their highs for the cycle as we await the official Italian response to the EU’s request to amend its 2019 budget. See USDCHF comments above.
AUD – a complete lack of volatility in AUD here is likely a product of the EU/Italy focus and China’s maintenance of the CNY floor. That situation feels binary – i.e., if China allows the CNY to float, AUD may drop very quickly.
CAD – Bank of Canada is reasonably “hawkish”, but as we indicate above, this is more about a desire for more policy flexibility.
NZD – the AUDNZD rate bobbing back into the pivot zone and even then some on a bigger than expected trade deficit late yesterday. Still, the pair hasn’t quite turned higher again – full pull back well above 1.0900 needed for that.
SEK – the weaker SEK here is partially a response to the less than hawkish Riksbank, but also the concern that the Eurozone economy is weakening and Sweden is an economy considered leveraged to external demand in the rest of the EU. Still, SEK is awfully cheap. SEK bulls will want EURSEK to stay south of 10.50.
NOK – Norges Bank just out as of this writing and “outlook not substantially changed” fits our predicted stance from the bank. Norway’s short rates had crawled back higher ahead of today since the disappointing September 20 meeting, so there will be little to drive immediate NOK interest from a rate perspective after this meeting, especially given budding worries about the Eurozone economy and the chunky recent sell-off in oil prices. Still, NOK looks too cheap versus the euro in the longer run.
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