Highlights
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USD looks to have stalled against Europe |
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JPY-crosses on fire as carry trades roar back |
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Stock market gains are needed to keep JPY crosses up |
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Light data week all around; US data focus is on housing |
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Commentary
Brian Dolan, Chief Currency Strategist
The dollar is finishing the week mostly unchanged against European currencies, but sharply stronger against the JPY, as carry-trades surged yet again and the BOJ signaled interest rates are not moving higher in the near future. The currency market was fixated on the bond markets for much of the week, after the sharp rally in global bond yields saw rates move higher globally, with US 10 year rates up over 35 bps over the last ten trading days at their peak. However, the bond yield rally had run it course by mid-week, and subsequent benign PPI and CPI reports saw yields retrace nearly 20 bps from the peak. The lower inflation readings dashed nascent speculation that the Fed's next move would be to raise rates, which in turn supported equities as they rallied strongly back to recent highs. Stock market strength in turn fueled additional JPY-selling across the board, as carry trades recovered. The strong positive correlation between JPY weakness and equity markets remains intact and Forex markets are likely to continue to be driven by stock and bonds next week as little data of consequence is out to drive currencies.
Looking at the USD against Europe (EUR, GBP, CHF), I'm seeing some good indications that the USD's rally is over and set to reverse. For example, weekly candlesticks in EUR/USD and GBP/USD are set to post hammer formations, signaling their downmove is ending. The US dollar index, which is heavily weighted toward Europe, generated a shooting star reversal pattern on daily candles in mid-week. The dollar index also tested major long-term trendline resistance above 83.10 and looks to have been rejected, suggesting the overall USD downtrend remains intact. Benchmark 10 year yield spreads between US Treasuries and other sovereign bonds widened in favor of the USD in the early part of the week, but have since narrowed back to the dollar's detriment, suggesting any interest rate basis for further dollar strength has similarly vanished.
Going forward, I will continue to be closely watching US equity and bond markets as the main drivers for the USD, and these markets pose some risks. Double tops may be forming in the equity indices, and future weakness in stocks would be consistent with higher long-term rates eroding overall economic expectations. Keep in mind that in the space of just 2-3 weeks, market sentiment has swung from one extreme (pessimistic, rate-cutting US outlook) to the other extreme (resurgent economy, potentially higher interest rates). By the end of this week, the pendulum of sentiment was swinging back toward the middle, but this still has to play out in the stock markets. Worth noting for next week is that the focus of US data is on the housing market, and there is little reason to expect positive surprises and plenty of reason to expect more bad news, which would certainly dent the stock market's current euphoria. Even if the housing data should surprise to the upside, markets are unlikely to see it lasting given higher long-term interest rates. The drop in preliminary June Univ. of Michigan sentiment is another early warning sign that the US consumer is not out of the woods yet (notwithstanding solid May retail sales).
Carry trades are benefiting from the rapid recovery of global markets and the relatively short-lived spike in volatility. While volatility remains subdued, carry trades can continue to prosper. But we have reached some extreme levels in USD/JPY and many of the JPY-crosses, for instance, and they look extremely vulnerable to a sharp set-back should stock markets turn south in a hurry. While JPY-crosses continue to grind higher, I'm looking for the dollar to remain mostly offered against Europe (support for EUR/USD, GBP/USD). But if the JPY-crosses should succumb to a downside correction, the European pairs will turn choppy and see increased downside volatility. Overall, I think 1.3250/60 should contain EUR/USD to the downside, while strength over 1.3420/30 is needed to unambiguously signal the end of the EUR/USD decline. In short, for next week, keep an eye on equity markets and trade based on volatility, with low volatility generally USD negative and JPY-cross positive and higher volatility JPY-cross negative and slightly USD supportive.
Data out of the US is very light, with the main points being: June NAHB housing market index on Monday; May housing starts and building permits on Tuesday; and on Thursday, initial jobless claims followed by May leading indicators and the June Philadelphia Fed index. Speakers include outgoing Boston Fed pres. Minehan on Monday; SF's Yellen and NY's Geithner on Wednesday, and Cleveland's Pianalto on Friday, though the scheduled topics suggest no major economic commentary is likely.
Eurozone data is heavily centered on sentiment surveys next week, beginning with the June German and Eurozone ZEW readings on Tuesday. On Wednesday, May German producer prices and April Eurozone construction output are scheduled. Thursday sees the advance June Eurozone service and manufacturing sectors PMI (purchasing manager indices). Friday sees the June German IFO business climate and expectations survey along with April Eurozone industrial new orders.
UK data is also on the light side, but contains a few key reports. To start with, June Rightmove house prices will be released on Sunday night UK local time. Wednesday is the main day for UK reports, with the highlight being the Bank of England minutes from the latest MPC meeting at which rates were held steady, following the May rate hike. The market will be focusing on the extent and timing of further rate hikes; the greater the number of members voting for a hike (max. 4), the more bullish the reaction for GBP. Also, note which side Gov. King came down on. Other reports out on Wednesday, May money supply, mortgage lending data and public sector borrowing. Thursday sees the June CBI industrial trends survey, a private manufacturing output report, released.
In Japan, the Cabinet office will release its monthly economic report for June. On Tuesday afternoon Tokyo time, May department store sales are scheduled. Wednesday morning sees the 2Q BSI large manufacturing and all-industry surveys, along with the BOJ minutes from the April 27 MPC meeting and the April all-industry activity index. Thursday morning sees the May merchandise trade balance.
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