Highlights
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G7 meeting set to unleash fireworks next week |
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JPY is unlikely to be singled out by G7, opening door to more weakness |
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EU Finance Ministers meet late next week |
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Commentary
Brian Dolan, Director of Research
G-7 update: The official communiqué contained no surprises and did not single-out the JPY for any mention, as was largely expected. The language regarding the risks of carry trades was dropped and there was no other reference to the carry trade. The standard currency paragraph read as follows: "We reaffirm that exchange rates should reflect economic fundamentals. Excess volatility and disorderly movements in exchange rates are undesirable for economic growth. We continue to monitor exchange rates closely, and cooperate as appropriate. In emerging economies with large and growing current account surpluses, especially China, it is desirable that their effective exchange rates move so that necessary adjustments will occur." The inclusion of language singling out China was new since the last statement in Essen, but not the first time it was used. The statement also stated that "Japan's recovery is on track and expected to continue" and that this would be recognized by investors. Separately on Saturday, the IMF released a report indicating that China would 'improve' its exchange rate mechanism and that reducing its trade surplus was a 'major objective.' It seems unlikely that China will enact any major changes immediately, but it does hold out the prospect for further, and possibly faster, Yuan appreciation going forward.
On the sidelines of the meeting, US Treasury Sec. Paulson said it wasn't his job to comment on the carry trade, but also added that the Japanese are confident that growth is on a sustainable path. Paulson also urged China to allow more appreciation of the Yuan "now." ECB president Trichet said the Japanese agree that the JPY should reflect economic fundamentals, referring to the strong growth outlook there. According to Trichet, Fin. Min. Omi and BOJ Gov. Fukui said the "fundamentals were very encouraging in Japan and this should be reflected in the (foreign) exchange market." An anonymous MOF official later said that strength in the Japanese economy did not warrant a weakening of the JPY. Fin. Min. Omi later hedged this by saying that "It is more accurate to say that the EUR is strong" since it's been rising against both the USD and JPY. Finally, in an interview on Saturday, ECB member Wellink said that "a strong EUR is in the interest of Europe" and that "We don't have a problem at this moment with the EUR."
The lack of any G7 mention of the JPY as well as generally positive EUR comments certainly suggests that the upside remains viable for EUR/JPY, with market positioning as the only likely restraining factor. Market analysts are unanimously predicting additional gains to around 165 in EUR/JPY, and I always get contrarian when such one-sidedness in sentiment appears. We're potentially looking at a classic 'buy the rumor/sell the fact' scenario. The initial response at the Sunday open should be to see EUR/JPY continue to rise, with upside moves in both EUR/USD and USD/JPY expected. However, additional gains might be limited by profit-taking from speculative players who went into the G7 meeting long, as well as further comments from MOF officials in the Tokyo session. Any corrections lower are likely to be looked at as buying opportunities and the only limiting factor will be the speed and degree of any corrective/profit-taking selling. I would prefer not to get involved in the expected initial move higher, and instead look to buy in on any dips toward 118.00-30 in USD/JPY, 1.3380-3430 in EUR/USD and 159.60/160.10 in coming days. The market is very long in all those pairs and the possibility of a shake-out is similarly high.
Original comments from Friday April 13, 2007 are below.
The JPY is on the ropes once again, with the market essentially thumbing its nose at the G7 over the prospect that they'll do anything more than pay lip service to JPY weakness. The US dollar also remains soft against all other currencies, as continued JPY cross-buying spills into other dollar pairs, driving them higher against the dollar. It's difficult to say how much further the dollar should weaken against non-JPY currencies, given that the US economy, outside of housing for the most part, remains on relatively solid footing. The release of the most recent FOMC minutes further dented the prospect of a near-term rate cut by the Fed, but the bulk of the market seems to be convinced that a cut sometime later this year is the most likely outcome. Don't forget, though, that there are still plenty in the market calling for a further rate hike from the Fed as well. In the meantime, uncertainties about the US growth outlook and the overall market dynamic of dollar selling looks set to continue to hold sway.
Turning to the JPY and the G7, without US or Japanese consent, more forceful action from the G7 seems out of the question. The most likely outcome of the G7 communiqué, which will be released on Saturday, will be a repetition of the Essen statement in which the G7 cautioned markets about excessive bets on continued JPY weakness and underestimating the strength of the Japanese expansion. There is always the risk that the language in the joint statement might be tweaked a bit, but unless the US and Japan signal they're prepared to join the Eurozone in market intervention, any JPY strength should be short-lived. Indeed, Friday's price action in the JPY showed no hesitation on the part of aggressive players to continue to sell JPY on any strength. Going into the weekend's G7 meeting, speculative players have been adding to risk (increasing JPY short positions) based on the outlook the G7 will take no material action, while real money asset managers have been reducing risk.
US Treasury Sec. Paulson, hosting the G7 gathering in Washington, will hold a press conference tonight at 19:15 EDT/23:15GMT and his comments could prove pivotal in the highly unlikely event he changes his earlier stance that the JPY's value is a market function. I say 'highly unlikely' because Paulson appears to be a strong supporter of free-markets, especially financial trading markets, and is disinclined to intervene outside of a financial market crisis. The major risk from Paulson is a more vocal iteration of the 'strong dollar' policy.
That leaves market positioning as the most likely driver of the JPY after the G7 meeting. It's a very tough call, since many speculative types are significantly short-JPY and the prospect of profit-taking could limit immediate further JPY-selling. At the same time, longer-term asset managers, especially Japanese investors, remain JPY sellers on any strength. I'm inclined to look for an initial pop higher in USD/JPY that should be capped by profit taking and option interest around the 120.00/20 level, followed by a pullback into the 117.20/50 area. Only a sustained (daily close) break over 120.50 would open up another phase of JPY weakness that should see to the recent prior highs at 122.40/50.
Looking at the dollar itself, the dollar index looks set to close below its lows set back in early Dec. 2006. Given what I see as a misinterpretation by the currency market on the direction of US interest rates (specs say lower US rates, I say steady to a tweak higher), I'm still inclined to favor a dollar recovery. US Treasury yields have recovered from the lows seen in early March , which matched their lows of early Dec. when the dollar index also saw its lows. The difference this time is that the spreads between the US and European benchmark yields have narrowed in favor of European currencies, leading to the pressure on the US dollar. This leads me back to market positioning (short dollars/long EUR, GBP, AUD & CAD) and the risk of the market re-assessing its current Euro-optimism/US pessimism. Put together, I think we have the recipe for a dollar recovery. Whether this is on the back of a sharply higher USD/JPY on the lack of G7 resolve, leaving a steady to lower dollar vs. Europe, or a steady USD/JPY (based on longs taking profit and JPY sellers waiting in the wings), or a sharp bout of profit-taking selling in EUR/USD, Cable, Aussie, etc., or some ugly combination of the two, I favor being short Europe against the dollar. I see no reason for the JPY to strengthen outside of market positioning, but I think European/Australian/Canadian currency strength at the moment is significantly overdone and ripe for a correction. We shall see.
US data begins on Monday morning with March advance retail sales, April Empire manufacturing, Feb. net long-term TIC flows, and Feb. business inventories in the morning, followed by the April NAHB housing market index in the afternoon. Dallas Fed president Fisher will also speak on fiscal and the economy in the late morning. Tuesday sees March CPI, housing starts and building permits and industrial production and capacity utilization. Also on Tuesday, ECB pres. Trichet and NY Fed pres. Geithner will deliver speeches on "the Euro and the US dollar—pillars in global finance" in the NY afternoon. Wednesday has only weekly MBA mortgage application data scheduled. Thursday sees the release of initial weekly jobless claims, March leading economic indicators, and the April Phila. Fed index. On Friday, the only events are a speech by US Treasury Sec. Paulson will deliver a speech on China in the NY afternoon, followed by a separate speech on the US outlook from the Fed's Mishkin.
Eurozone data begins on Monday with final March German CPI and March Eurozone CPI. Tuesday sees the April Eurozone and German ZEW surveys of economic sentiment and the Feb. Eurozone trade balance. On Wednesday, Feb. Eurozone construction is due. Thursday has March German producer prices and Italian Feb industrial orders as the main data events. Friday sees March French consumer spending.
Japanese data begins with final Feb. industrial production and capacity utilization on Monday afternoon Tokyo time. Tuesday afternoon sees March consumer confidence and Wednesday afternoon sees final Feb. leading economic index and final March machine tool orders. On Thursday morning the Feb. tertiary industry index is to be released along with Tokyo and nationwide department store sales in the afternoon. Friday morning sees the Feb All-Industry index reported.
Key UK data events are March PPI on Monday morning; March CPI/RPI on Tuesday morning; Bank of England MPC minutes on Wed. morning along with March unemployment; Friday sees March retail sales.
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