Hopes and Fears

Amidst hopes and fears
Kuroda remained sanguine
No changes were made

The FX markets are a mixed bag this morning, with the yen reacting to the lack of BOJ activity by rallying sharply, but Aussie and Kiwi having both fallen almost as sharply.

The yen story by now is well-worn, with the market hoping for (although no analysts were expecting) further action by the BOJ to help moderate the recent JGB volatility.  There were calls for increased purchases of ETF’s or a tenor  extension of credit lines that banks use to fund themselves.  However, despite a sixth consecutive month of upgrading their economic assessment, the BOJ made no policy changes.  The Nikkei gave up some of yesterday’s gains and the yen recouped all of yesterday’s losses.  Is this the end for the yen move?  Not the one that calls for a much weaker yen.  At this point, my belief is that there is little desire to do much ahead of the Upper House elections in July, after which PM Abe should command a much more powerful position and will be able to launch his third arrow a bit more accurately.  Until then, I expect that we will see more range games, with 100 remaining hard to breach, but solid support at 94-95.  Longer term, nothing has changed in my view for the yen to trade to, and through, 110, but for now, not so much.  The only caveat to this range trade is the US Treasury market.  If we see 10 year yields start to break out to 2.50% or beyond, which seems feasible to me, I think Japanese investors will start to become more aggressive in their international portfolios, taking advantage of the better yield environment.  And that will lead to a weaker yen regardless of any further BOJ activity.

As to AUD and NZD, I think we can look to their classification as commodity currencies for a rationale as to their declines overnight.  Looking at the screen, pretty much every commodity is lower with the exception of Sugar and Soybeans, both of which are barely higher and neither of which is a critical component of the export baskets for the two nations.  CAD, too, is softer, although not as aggressively, and emerging market currencies, like ZAR and MXN are much weaker.  This price action doesn’t seem to be love for the dollar, rather it appears to delineate a discomfort in holding assets in this space.  What has been the key driver in the strength of these currencies, both EMG and commodity over the past two years?  The hunt for yield!  It has helped that most of these countries were in better fiscal shape, and that most were showing better macroeconomic performance than the US and Europe, but in general, investors were just responding to the combined efforts of the Fed, BOE, ECB and BOJ, who drove interest rates to zero throughout the US, Europe and Japan.  However, recent price action in the interest rate space has been quite a change in these countries.  Bond prices are falling as investors get concerned that 1.5% to 2.0% may not be a sufficient return for 10 years, while short term traders try to prepare for the eventual exit of many of these extraordinary monetary policy measures.  So can we be that surprised that there is a shift from EMG or commodity currencies to the G3?  I think not.  The key to remember with emerging market currencies is that despite improvements in many markets, they do not have the underlying liquidity that is available in the G3.  So when investors are leaving en masse, the movements in these currencies can be quite exaggerated relative to what you might see in the euro or pound or yen.  For those of you who are payables hedgers in this space, we are likely to see some pretty good opportunities going forward.  MXN at 13.50-14.00, or BRL at 2.20, or INR at 59.00 can all be terrific levels to lock in low expense ratios.  And remember, in almost every case the points will be favorable as well.

Finally, looking at the US story today, the data is virtually nil, just Wholesale Inventories (exp 0.2%), and SPU’s are lower by about 1% so pointing to a weak opening.  European bourses have fallen across the board, so it is starting to look like a classic ‘risk-off’ day.  To me, bond prices are the key, giving us the best indicator of market sentiment, so as long as Treasuries continue to soften, look for the dollar to perform well, even against the yen.

Good luck