The Summer’s Arrived

For FX the summer’s arrived
And with it the dollar has thrived
The only except
The euro has kept
Some strength since it simply survived

While the calendar doesn’t claim summer for another three weeks, it is clear that the market’s version of summer is upon us.  Price action and trading activity remain relatively muted in the major currencies, although there remains significant volatility in Japanese equity markets, which fell another 3.7% overnight.  All eyes remain on the Fed to see whether QE3 will start to be mitigated, and that continues to be the biggest potential driver of markets for now.  This week we get some data in the US that has the opportunity to move prices, beginning with ISM later this morning and culminating in the employment report on Friday.  We also hear from both the BOE and the ECB about any policy changes, but nothing is expected from either.

Today ISM

51

Construction Spending

1.00%

Tuesday Trade Balance

-$41.5 billion

Wednesday Non-farm Productivity

0.70%

ISM non-mfg

53.8

Factory Orders

1.70%

Thursday MPC rate decision

0.5% (unchanged)

ECB rate decision

0.5% (unchanged)

Initial Claims

345K

Friday Unemployment Rate

7.50%

Non-farm Payrolls

168K

The euro has performed quite well over the past several weeks despite unimpressive economic data from the Continent and generally improving sentiment in the US.  I think the most likely explanation is that we continue to see a reduction in the existential fears that had permeated the market for so long.  The thing is, much has been made of Signor Draghi’s more recent aggressive action, cutting rates at the last meeting and discussing negative deposit rates, but with a mild uptick in Eurozone data lately, it seems far less likely that he will act further at this point.  This is especially true since Chancellor Merkel has been backing away from much of her earlier determination to see Europe more tightly integrated.  As I have written in the past, the nations of Europe have an inherent conflict in the idea of a shared currency and the desire to remain sovereign nations.  How does a nation retain its sovereignty if it accedes its powers of fiscal, as well as monetary, policy to an outside entity?  That question continues to bedevil the European leadership, and as long as it does, it should prevent the euro from strengthening significantly.  That doesn’t mean we can’t rally a bit in the short term, but unless the Fed completely reverses course and increases the monthly purchase rate of securities, I have to believe the euro will not be able to trade back even to 1.35.   So to me, for receivables hedgers, above 1.30 continues to be an attractive level for hedging.

The story in Japan remains one of greater concern over Abe-nomics and its ability to achieve its desired ends of 2% domestic inflation without destroying the Japanese economy.  It is clear that the early euphoria has ended as evidenced by the Nikkei’s declines over the past 2 weeks.  While equity prices there are still much higher than before Abe’s election, the recent decline has been sobering.  What will the future bring?  In my view this consolidation is a healthy correction of an extraordinary move, and will soon be over.  There is no indication that either Kuroda or Abe are ready to throw in the towel on this effort, and as long as they are printing money, the yen has further to decline.  Will it be a straight line from here?  Of course not.  But my view of 110 USDJPY in December remains on track.  Receivables hedgers, these levels are still quite attractive!

It was interesting reading about Emerging markets this morning as almost every article mimicked my discussion on Friday over the recent sharp declines in these currencies.  Naturally, we have seen many retrace from their worst levels, notably ZAR, which is stronger by more than 1% and MXN, which has at least stabilized.  But BRL has fallen almost 1.5% from Friday’s levels to its weakest point in more than a year, as the central bank there is forced to raise rates to fight higher inflation despite slowing growth.  Overall, the dollar’s broad strength has been most evident versus these currencies rather than the majors of late, but I have a feeling the majors are going to catch up soon.  Much will depend on Friday’s payroll data, and I have a sneaking suspicion we are going to see a strong number, something like 225-240K, which will reignite talk of the end of QE3.  And that, my friends, will result in a much stronger USD against all currencies.

Good luck
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