Weekend Update: EUR/JPY the One To Watch

A boring week last week as EUR ground lower and USD/JPY slid back to 94 as the Yen was bought of safe haven demand.  Sterling also managed to get above the 1.52 level against the US dollar, closing at 1.5204 Friday afternoon.  Soft US data earlier in the week was counterbalanced somewhat by firmer numbers on Friday. Initial unemployment claims came in a bit high at 357K, versus the 335K median analyst estimate. Chicago PMI was also a bit soft, registering 52.1, nearly for points lower than the figure expected by analysts. Quarter one GDP was also a bit light, with the US economy growing at a 0.4 percent clip in Q1 on an annualized basis.  This disappointed markets which were expecting a 0.8 rise in output for the first three months of 2013.  On the bright side however, personal spending was up, coming in at 0.7 percent, beating analyst expectations by 0.1.  Finally the University of Michigan poll of consumer sentiment also can in slightly higher than expected, 78.4 versus 74 estimated.  

The week therefore was mixed bag with in terms of data with a slight to moderate bias to the downside.  Certainly, hard numbers like GDP ought to trump intangibles like sentiment, and movement by the markets reflected that.  Crucially, the week PMI and GDP numbers was supportive of EUR/USD, further evidence that USD is no longer a safe haven asset.  

In the coming weeks, all eyes will be on central banks.  The Fed will almost certainly continue its current 85 billion in asset purchases for 2013.  But actual tightening of policy will not occur until as late as 2018.  For reason discussed earlier on this blog, and as later elaborated on by Chairman Bernanke himself, the Fed will most likely tighten policy by allowing its portfolio to run off and raise interest paid on excess reserves.    

The BoJ's new team took office this week, and the markets are waiting for specifics on how Governor Kuroda will achieve the new two percent inflation target.  The contours are known. The BoJ will print money to finance asset purchases, nonetheless, a word of caution must be given to the Yen bears.  If fiscal and monetary stimulus actually manage to get Japanese growth going again, the Yen could very well rally significantly against other majors.  Since the market already expects the BoJ to expand its balance sheet, further money creation by the central may well be already priced in.  However, any potential economic gains are not.  This scenario would see capital inflows to Japan, as local investors shift bias back to domestic investments and European oand US funds try to cash in on a BoJ fueled Nikkei rally.  I'm still short JPY, but I have cut my position substantially, due to this specific concern.  Its possible that USD/JPY goes back to being a buy on dips, but it will be of paramount importance to watch the market's reaction to both the BoJ and national government's policy initiatives.  Specifically, any rallies in Japanese equities which coincide with Yen gains will put a serious question to the short JPY trade. 

In Europe, both the ECB and the Bank of England will be in the spotlight.  The ECB continues to face challenges as a key player in the resolution of the European sovereign debt crisis.  On the easing front to stimulate a sagging European economy, the ECB run out of ammunition.  Interest rates are rapidly approach their zero bound.  One day libor for EUR is already at a paltry 0.3 percent.  On the other hand, the ECB's commitment to continue to purchase bonds of countries which enact fiscal reforms, and the ability of the European Council and the IMF to enforce these reforms, will set the tone for EUR going forward.  In Britain, focus is on the incoming BoE Governor Mark Carney, and any expansion of the current QE program in an attempt to jump start a British economy in deep recession.  Sterling has weakened substantially, and has decoupled from EUR to some extent. Shorterm, movements will be driven by British economic data and the BoE.  Longterm, the picture is very uncertain. Sterling is almost certain to become irrelevant as a reserve asset, however a recovery in Britain should help GBP.  Finally, the SNB remains steadfast in its defense of its 1.20 floor for EUR/CHF.  The rapid appreciation in the Franc has wreaked havoc in both the Swiss real economy and its financial sector.  Therefore, it remains highly unlikely that the SNB would allow franc appreciation.  

In sum, Europe and Japan remain the big players on the central bank front as their respective economies recovery.  Crosses like EUR/JPY is therefore the one to watch.   
         

News: Euro Crosses under Pressure as Specs Get Short

The news wires have been a buzz in the last few days with Cyprus news and fresh European weakness.  The general theme is that the Euro no longer faces an existential crisis, but must now navigate a prolonged series of fiscal crises which pose a threat to growth.  Indeed, news of yet another insolvent sovereign, or the reversal of progress in countries which have already received rescue packages has certainly weighed on confidence.  More importantly however, the necessary fiscal consolidation of periphery countries has definitely put a significant dent in short term aggregate demmand. 

On FX, a story is emerging which appears strikingly similar to earlier analysis here on FX Fusion.  Namely, the Euro rally from earlier this year was due to a pricing out of catastrophic tail risk, but the rally would fade as the reality of medium term growth concerns got priced in.  This would be followed by a broad recovery in the Euro in 2014.  The last part of this story has yet to come true, but I remain confident that those who go long EUR/USD later this year (not yet!!!) will be pleased in 2014.  

Right now however, focus remains to the downside as investors seek assets denominated other currencies with limited exposure to Europe's short term woes.  EUR/AUD bears are back in force.  Focus is also on EUR/NZD and surprisingly EUR/MXN.  Traders see further downside in these pairs as well.  Traders are steering clear of EUR/JPY, EUR/CHF, and EUR/GBP.  The Yen, Franc, and Sterling all have decidedly dovish central banks, a factor which may well outweigh any softness in the common European currency.  

EUR/MXN is an interesting animal.  I profited greatly by selling this pair during June and July of last year, only to give back nearly 80 percent of my profits post Draghi 'whatever-it-takes.'  Now EUR/MXN is poised to punch through last summer's low.  If I jump back on the bandwagon, I will do so by selling EUR/USD with at target of 1.26, and a stop at 1.30.(I remain long EUR/CHF)  Otherwise, I still look to get long the EUR against USD and JPY later this year, for now.  

News: FOMC Stays the Course, MXN Higher

Its full speed ahead at the Federal Reserve as Mr. Bernanke showed no sign of letting up on asset purchases until the current open ended QE program, where the central bank purchases 80 billion is Federal and federally insured mortgage-backed securities, has achieved its objective of lowering unemployment to 6.5 percent.  Some pairs whip sawed a bit during Bernanke's comments, especially when the Chairman stated the FOMC is constantly monitoring the proper level of monthly asset purchases and that the gross number may be reduced if the recovery firms up.  However, overall tone of the press conference conveyed a steadfast commitment to the extraordinary measures taken since 2008 to boost the economy and repair broken credit markets.  USD was marginally lower against most majors, but the general interpretation of the news can be 'risk-on.'  Indeed, USD/JPY was up on Bernanke's reaffirmation of QE programs.  EUR/CHF, another indicator of risk sentiment, also bounced.  

South of the border, the Mexican Peso continues its bull run.  Techs had been hoping to get long USD/MXN at 12.39 given that the pair had been well supported at this level in the past few days.  This trade again shows the danger of relying of technical indicators or 'charting,' especially when your trade goes against the countervailing longterm trend driven by the fundamentals.  Thompson Financial was suggesting clients buy at 12.39 and target 12.80, the 200 day moving average.  This is sloppy analysis.  Its crazy to hope for a near 100 percent retracement of the Peso's recent gains, especially in a risk-on, recovery focused environment.  Fading the pop can be a viable strategy, but this is not the way to do it.  All in all, I'd look for further downside on USD/MXN as the spec longs run for the exit as the week ends.  I sold at 12.35 with a target around 12.2 this afternoon.  I also have a larger offer at 12.43.  

On a more personal note, I am spending the weekend in Montreal, so I am hoping for a rally in USD/CAD this Friday.  I am long CAD/CHF, though, so whatever exchange rate I end up paying, I am most likely fully hedged!  



    

Commentary: Cyrpus Sets Dangerous Precedent

Somewhere in the Fox News echo chamber the real lessons about Cyprus has been lost.  No United States is not 'becoming like Cyprus.', The US is not teetering on the edge of debt crisis, or on the verge of national bankruptcy.

Equally inane are the talks of 'confiscation' or 'theft.' Governments have the right to levy taxes.  A bank levy is no more theft than an income tax.  And then again, theft is a matter of perspective.  If anyone has a case of theft to report, it is the taxpayer in the core of Europe who is being asked to help finance the recapitalization of the banks of a remote island in the Med which comprises 0.02 percent of the EU's economy.    

The real danger afoot in the Cyprus affair is that even the European Union, a 27-member bloc comprised of respectable governments and wealthy nations, losses can still be imposed on depositors, bank runs can still occur, and entire national economies can suffer liquidity crises when ATM machines run out of notes.  

Certainly, finance ministers back on the Continent are just in the desire to make Cyprus pay for the excesses of its bloated banking sector.  This could be accomplished by structuring the larger assistance package to repaid with future income tax receipts and a savings from a broader austerity program.  The effect would be the same.  The average Joe in Cyprus would still experience pain every paycheck when more tax was withheld.  The difference is that he wouldn't think twice about depositing his earnings in a bank.  With the current plan which hits bank deposits only further undermines the system EU policy makers are trying to save.     

Midweek Position Summary

Portfolio Composition: 

Long EUR/CHF 42.5 Percent 

Long MXN/JPY  12.5 Percent 

Long CAD/CHF  12.5 Percent 

Cash                   32.5 Percent

I continue to play my long North America, short Japan and Europe.  MXN continues to hold its gains from earlier in the week, though is off its high.  I look to go short USD/MXN at 12.48.  All in all, MXN should continue to make fresh highs as long as sentiment continues to improve as the recovery gains momentum.  Shorting CHF (or GBP for the more aggressive trader) is the best way to play European weakness. EUR still faces the tough fundamentals discussed at length here at FX-Fusion, but it will continue to be buoyed by good news coming out of sovereign debt talks and further steps towards fiscal and broader monetary and financial integration.  EUR/USD bears have been pressuring 1.30 as of late, but have been quick to take profits for fear of a big short squeeze  a la the August 2012 "whatever it takes" comments from Draghi.  For this reason, and for the fact that the Eurozone will eventually begin to benefit from the global recovery and further economic reforms in national economies, EUR/USD is  close to bottoming out, with further downside limited to 1.25

CHF on the other had is still at historic highs after investors sent the Franc soaring in 2011 in a rush to "safe haven" assets.  The SNB has reiterated its commitment to enforcing the 1.20 floor for EUR/CHF, and over the past year has accumulated over CHF 400 billion in foreign exchange doing so.  CHF remains starkly over valued in PPP terms, and the demand for safe haven assets is dwindling.  This reality has yet to be priced into CHF, which in my opinion is poised for rapid Yen style depreciation.  

In sum, medium term, North America is the place to be as the US leads the global recovery among advanced economies.  I will look to get long the EUR against JPY or even USD later in the year after the austerity programs have made their way through the European economy and Europe returns to growth.  

  

Commentary: ZAR is a still a Sell

South Africa's Rand has been under pressure for months.  After seesawing with other emerging market currencies over the summer as the Europe went through hell, USD/ZAR has been testing the 9.00 handle since October.  In recent days, this pair appears to have gained a foothold over this key figure, closing in New York today at 9.1998 per greenback.  Further Rand selling in Asia, despite broad USD sogginess, pushed the Rand down another 400 points as of 3:17 AM GMT.  

South Africa faces tremendous economic challenges, and no political will to confront them.  The ruling African National Congress, which has won every election since the end of apartheid with over 60 percent margins, continues to essentially govern as a single party dictatorship.  The results have been widespread corruption, unaccountable leaders, and mediocre governance.  To thrive, South Africa needs to become a functioning multi-party democracy. Alas, to date, oppositions groups are too fractured and disparate to ever challenge the ANC's choke hold on power.  

On the numbers side, the fundamentals remain dismal.  The current account deficit remains dangerously high at close to seven percent of GDP, despite considerable commodities for export.  Government finances are a wreck as well, with a budget shortfall of 4.2 percent of GDP.  Total public debt is manageable at the moment coming in at 41.2 percent of GDP.  However, the falling Rand has prevented South Africa from taking advantage of ultra low interest rates in advanced economies by issuing bonds denominated in foreign currencies.  Instead South Africa is forced to borrow on the expensive local market; debt service reached nearly 3 percent of GDP this year, almost three quarters of the annual budget deficit.  

Tradewise, South African exports remain weak due to lack of demand in its main export market, Europe.  Finally, labor unrest plagues the mining industry, as miners frustrated by low pay and an accountable government have walked off the job.  Demonstrations have turned deadly as miners have clashed with both police and members of rival trade unions.  This major disruption in a key export sector further weakens South Africa's vicarious balance of payments position.   In sum, South Africa looks to be poorly positioned to take advantage of an increased demand for commodities during the global recovery.      

In a recent report, the Wall Street Journal noted that some investors believe that these realities had already been priced in, and that the Rand can't fall much further.  The Economist's Big Mac index, and other more sophisticated measures of purchasing power parity also show the Rand as been significantly undervalued.  However, the significant downside risks continue to weigh on the Rand, and in an environment of weak sentiment, South Africa really needs to show tangible progress on addressing government incompetence and corruption, reaching equitable resolutions to labor disputes, and shoring up government finances.  Admittedly ,the last can wait until external factors improve.  Nobody should begrudge the RSA for running a budget deficit in the face of weak international demand for its exports.  But allowing the former two to fester for nearly twenty after the end of apartheid is inexcusable.  Income distribution was actually slightly more equitable under white rule than it is today.    

The Wall Street Street Journal and Big Mac index be damned.  The Rand is still a strong sell. 

Doing the Rounds: MXN Soars as Investors Cheer One and Done Rate Cut

Normally rate cuts are followed by bout of softness in the currency issued by the central bank.  This is especially true for emerging market currencies, whose central banks have much less credibility with foreign investors than say the Fed or the RBA.  But the Mexican Peso, a new investor darling, has bucked this trend, instead surging higher on the back of local rate cut last Friday.  What is the secret to MXN's success?  For starters, a booming export sector excellently positioned to take advantage of the recovery north of the border.  Second, very low national debt levels, under 40 percent of GDP, and a budget that will be in balance by the end of year.  Finally, the Peso still offers excellent real yield;  Mexico finally seems to have achieved a long term trajectory of low and stable inflation.  

Many traders now speculate that fear of a string of cuts had kept the MXN has making new highs this year, with USD/MXN especially well supported at 12.6.  The certainty of a one and done cut has given the Peso new legs to run higher.  I got in at 12.53 and will continue to ride the wave, probably trading around a core position as the current momentum downward slows.  In sum, MXN continues to be an excellent way to "buy American" as Europe muddles along and Asia faces continued uncertainty.  

Commentary: Analyzing the Reaction to Today's Jobs Numbers

Its official, North America is the new center for growth among developed economies.  A surprise to the upside in Non-Farm Payrolls sent the greenback soaring against everything against its North American counterparts.  Just a few short months ago, good jobs numbers would have sent the dollar tumbling as risk was bought on the back of an encouraging new data point.  The USD, as predicted by this analyst, has made a transition from being a safe-haven asset to a 'growth currency'.  In short, as evidenced by today's moves, North America is the anticipated center of growth for advanced economies in the medium term.  It is time to go long USD/JPY, CAD/JPY, MXN/JPY, and possibly USD/CHF.  Selling the Euro also remains a viable short term play, though I still expect a recovery after a further dip in EUR/USD. 

Not even a major central bank could damper the bullish mood.  Despite a rate cut of fifty basis points, the Peso actually managed to appreciate to new session highs after whip-sawing nearly 1000 points in the opposite direction during the minute after the announcement.  To be sure, this awesome volatility can probably be accounted for the market's ability to digest Banixo's one and a half page policy statement which accompanied news of the cut.  While highlighting major downside risks to the World and Mexican economies, namely fiscal consolidation in the US and on going uncertainty in Europe, the central bank sought to calm markets by insisting that the cut was not a 'beginning of an easing cycle.'  Furthermore, the bank reaffirmed its commitment to maintaining its inflation target of three percent.  In general, the bank tried to communicate the cut as a chance to promote robust growth given the slowing of core CPI to 2.88 percent in the last quarter.  

As an investor, I am not sure whether to be even more bullish the MXN, or if this recent development is a cause for concern.  Certainly, the carry for long MXN trades is now less attractive, however, the considerable resilience shown by the Mexican currency despite a reduction of its key policy rate to record low indicates an incredible improvement in overall sentiment. 

Doing the Rounds: Techs Target 1.28 as USD Surges

Despite the recent bout of risk aversion, 2013 has been a good year for investors long the S&P 500 or other risk sensitive assets or indices.  Indeed, the stock market continues to beat back negative news about the looming sequester, with the Dow Jones industrial average poised to finish the week up despite Tuesday's steep sell off.  So the lovely  Gingers Rogers is correct in declaring "We're in the Money." However, perhaps more astute of the late great star is the observation that "the long lost dollar has come back to the fold."  USD has been the week's winner, gaining against virtually everything except the Yen.  

EUR/USD is pressuring the 1.30 handle, dipping below this morning.  This latest move has got the techs targeting 1.28.  This analyst predicted a dip to 1.27 based on the fundamentals, but certainly did not expect it to come this soon.  The expectation of such a quick retreat for the common currency, especially as expressed by activity in the options market, has me reexamining my year end target. Let me reiterate that the tail risk which had been priced out of the market is now bumping up against the reality that Europe still has a long way to go before returning to growth.  Europe is making the choice to endure short term pain via various national austerity programs in order to hopefully regain credibility in the sovereign debt markets for some of its weaker members. The Eurozone deficit is currently 3.3 percent of GDP, with growth for 2012 coming in at -0.9 percent. Europe also has a slight current account surplus, a rare achievement in advanced economies. By contrast the US GDP grew by 1.5 percent, but the government budget is still 7.0 percent of GDP in the red.  Similarly, the current account deficit continues to remain high at 3.0 percent of GDP.  In sum, the US is growing, but the growth is coming at a heavy price.  Slow improvement in sentiment across the Atlantic, combined with necessary structural reforms to some national economies and a continued progress in normalizing sovereign debt markets will make EUR an attractive long later in the year, but not yet.     

AUD/USD is continuing to test new lows, though has been met with fresh buying at the 1.0180 level.  The pair continues to be under pressure from China growth concerns and uncertainty surrounding monetary policy.  Many analysts believe that the RBA could ease further, especially if growth faces headwinds from a broader slowdown in Asia. The Aussie has been an investor favorite for the past year, as it offers yield as well as an AAA sovereign credit rating.  

The loonie also continued its slide, with USD/CAD consolidating its gains above the 1.0275 level, touching as high as 1.0330.  The near 30 percent discount at which Canada must sell its oil continues to weigh on the Arctic nation's currency, as do broader growth concerns.  

Emerging market currencies largely followed the broader market, with nearly everything selling off against the dollar with exception of the Thai Baht.  The MXN has also shown some resilience.  USD/MXN is well off its highs earlier in the week, and failed stay above 12.8 this morning, despite a brief spike up to 12.85, means there are still plenty of bargain hunters out there looking to go long the Peso.  Aggressive traders may want to short the USD against high beta currencies such as the ZAR or INR if they think risk sentiment will improve next week, which are near there weekly lows this afternoon.  

Longterm, MXN remains a buy.  Expect more short-term pain for the EUR, but this will be followed by a robust recovery later in the year.