The USD continues to struggle, down against both the Euro and the Japanese Yen. EUR/USD is looking to break above 1.34, a point which over the last year has been an area of strong technical resistance. It will be interesting to see if pair can find fresh sellers here or will grind higher. On the Yen front, technical speculators are short USD/JPY with a target of 93. These are interesting short term trades but appear to be quite risky. The actions of the Federal Reserve other next few months will set the medium term trend for both these pairs. If the US economy continues to pick up steam and the Fed does decide to taper this year, both these trades could be caught on the the wrong side of some powerful macroeconomic fundamentals. Specifically, growth differentials between the advanced economies will likely remain in favor of the US. Accordingly, the Fed is likely to tighten before both the BOJ and the ECB. Should US joblessness fall below seven percent, a reduction in monthly asset purchases by the Fed seems likely.
It is curious that EUR and CHF remain at such elevated levels, given that the Eurozone is still mired in recession and continues to face significant headwinds. With unemployment near a record high of 12 percent, record low interest rates, and a fiscal crisis for several major national governments, it would appear as though Europe has run out of counter-cyclical treatments to apply. John Taylor of FX concepts cites the Eurozone's modest current account surplus as grounds for being long the EUR. But surely capital flows will overwhelm international payments registered in the current account. And with rates set to rise Stateside, USD denominated assets are becoming more attractive. Furthermore, the Swiss Franc continues to be 56 percent over valued in PPP terms. The Swiss economy, though one of the healthiest in Europe also appears to be slowing, with the jobless rate moving up for the first time in five years. Weak external demand for Swiss exports, and a sky high CHF with the associated deflation, finally seem to be taking their toll. I expect the SNB to keep overnight rates at zero ad infinitum, and will stand prepared to purchase Euros in unlimited quantities to maintain its 1.20 floor on EUR/CHF .
The biggest news in emerging markets continues to be Mexico. While analysts continue to be largely bullish, Mexican economic performance has moderated this year, along with the US, its major trading partner. A report today for the Bank of Mexico summarized trends in inflation and growth. The national statistics agency reported annualized inflation at 3.47 percent for the second quarter, or 47 basis points above the central bank's target. The Bank also lowered its 2013 growth forecast to between two and three percent, done from the 3-4 range it had estimated at the beginning of the year. The bank cited weaker export demand and fiscal consolidation by the central government as the main headwinds to growth. On the whole, given the inflation outlook, rates seem to be on hold for the medium term. On FX specifically, the fact that foreigners have not fled Mexican fixed income is a promising sign. Structural reforms by the new government continue to move along. The widely anticipated energy reform proposal form the new administration is expected to be friendly to foreign direct investment. In PPP terms, MXN is still close to 25 percent undervalued. While USD/MXN is probably in for some Fed driven volatility, I target 12.30 by year end. However, given the fact that I am both a USD and MXN bull, I prefer funding my long MXN carry trade with CHF or EUR.
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