Highlights
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Mortgage-back market in US unnerves investors, raises risk fears |
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JPY crosses make new highs, but look to be setting up for a reversal |
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FOMC meeting on Thursday; housing data and durable goods are key |
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RBNZ looks to have intervened in Kiwi during late NY Friday afternoon |
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Commentary
Brian Dolan, Chief Currency Strategist
The US dollar is finishing the week lower against European currencies and slightly higher against the JPY, which means the JPY-crosses continued their relentless gains higher. New highs were reached in all the major JPY carry trade pairs: NZD/JPY, AUD/JPY, GBP/JPY, EUR/JPY, CHF/JPY and USD/JPY (CAD/JPY only managed to test prior highs). Despite the new highs in the JPY-crosses, I'm getting the sense that a shake-out lower is increasingly likely and I'll explain later in this update.
There was little in the way of data to move the market during the past week, and what data there was failed to move the market in the expected direction. For example, softer German business sentiment (IFO) failed to dent Euro strength, while better than expected US May LEI and June Philadelphia Fed Index failed to support the USD toward the end of the week. This suggests the market was more intent on adding to carry-trade positions and exiting USD longs versus Europe. Among the biggest gainers on the week was GBP, which rallied from about 1.9750 to just shy of 2.000 during the week, after the MPC minutes revealed maximum dissent, including BOE Gov. King, on the vote to hold rates steady. Markets now fully expect another rate hike by the BOE at its next meeting on July 5, potentially followed by yet another rate hike in 3Q.
US equity markets finished about 2% lower on the week, but more importantly look to have formed the double-top I cautioned about last week. A larger decline is suggested by an S&P decline below the recent low at 1485/90. US Treasury yields bounced around in a choppy range between about 5.05-5.20 and look set to close right in the middle at 5.13 on the week. US Fed Funds futures began to price in yet again a minor prospect of a US rate cut later in the 3Q or 4Q. The US yield curve steepened abruptly during the week in what is usually taken as a sign of uncertainty or increased risk perceptions. The immediate cause is the lingering fear that the weakness in the mortgage-backed security market that triggered major losses at several prominent funds may only be the tip of the iceberg. The result was a flight to quality, buying short-term US Treasury issues and selling longer-term notes, resulting in the 2-year/10-year spread widening to its largest in some time.
Taken together, weaker stock prices and increased credit risks suggest an overall increase in financial market volatility and risk-aversion, which is usually a trigger to unwinding of riskier trades, namely the carry trade. But developments in those other markets have yet to spill-over into the carry trade, as new highs were made on nearly a daily basis over the last several weeks. This may be due in large part to semi-annual bonus payments being delivered to Japanese workers during the month of June. With fresh cash in hand, Japanese savers and investors have been aggressively sending JPY offshore (JPY selling) to higher yielding destinations. Another contingent is actively speculating on further spot price appreciation through margin trading accounts. The seasonality of the cash flows suggest that the pace of JPY-selling is likely to slow abruptly as June draws to a close and one-time off-shore investments have been made.
Add it all together, and I remain on alert for a spate of carry-trade unwinding. From the charts, I would note that NZD/JPY, which carries the highest yield differential, posted a bearish engulfing pattern on the daily candles over Thursday and Friday. Also, USD/JPY looks to be posting a shooting star pattern with Friday's failure to hold over 124.00, though I'd prefer it had a longer tail above. Both patterns suggest a reversal lower from recent price highs.
(As I was writing this report on Friday afternoon, it appears the RBNZ stepped into the market and intervened again, selling NZD/USD and sending Kiwi about 50 pips lower, and NZD/JPY about 60 pips lower. If confirmed as intervention, the RBNZ action may also contribute to a potentially wider-scale carry trade liquidation.)
Going forward, it would seem that widely anticipated 2Q rebound in US GDP, estimates are now focused on a 3.5-4.0% annualized 2Q GDP reading, has been fully digested and markets are already looking ahead and concluding the prospects remain uncertain. Most of the 2Q rebound in GDP has already been attributed to narrower trade deficits and inventory adjustments and so is not viewed as a sustainable improvement in US output. In the meantime, higher energy prices and rising long-term interest rates are likely to generate greater headwinds for individual consumers, with the housing market hanging like a millstone from the overall economy's neck.
US data next week begins with May existing home sales on Monday. Tuesday sees the April US home price index, June Richmond Fed index, May new home sales and June conference Board consumer confidence. Wednesday has weekly MBA mortgage applications and May durable goods orders. Thursday sees final 1Q GDP and weekly jobless claims, followed by an expected steady FOMC rate decision in the afternoon. Friday finishes up with a heavy slate: May personal income and spending, May PCE core inflation readings, June Chicago PMI, May construction spending and final June Univ. of Michigan sentiment. Fed speakers include Gov. Mishkin speaking on globalization over the weekend. US Treasury Sec. Paulson will be interviewed around noon EDT Wednesday at a conference hosted by the New York Stock Exchange.
Eurozone data starts out on Monday with the July German GfK consumer confidence survey. Tuesday sees May German import prices and April Eurozone current account balance. German June flash CPI estimate is due sometime from Wednesday to Friday, with the exact release time still to be announced. Wednesday also sees French June business confidence. Thursday's highlights are June German and May French employment reports along with June Italian CPI. Friday sees May German retail sales, May French PPI, and June EU consumer and business confidence surveys.
Japanese data begins on Tuesday morning with May corporate service prices. Wednesday morning sees May retail trade reports followed by small business confidence in the afternoon. Thursday morning has the important preliminary May industrial production report scheduled. Friday morning sees May jobless data, household spending, June Tokyo CPI and May national CPI, followed by May housing starts and construction orders in the afternoon. The following week will see the release of the 2Q BOJ Tankan sentiment surveys.
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