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Are US Investors in Denial?

It was another busy and active day in the foreign exchange market with the U.S. dollar trading lower against all of the major currencies.  Most of the action was in the Japanese Yen but the recovery in U.S. stocks and the moves in the dollar also received some attention. The sell-off in the dollar, decline in U.S. Treasury yields and rise in the S&P 500 suggests that investors were happy to see retail sales increase but felt that the rise in spending was not strong enough to boost the case for tapering asset purchases.  The much touted article by Jon Hilsenrath that kicked off the sharp end of day rally in U.S. equities comes to a similar conclusion but from a different angle. He quotes Jan Hatzius, chief economist of Goldman Sachs as saying “The fundamental economic outlook really hasn’t changed much, but we are getting more worried about Fed policy.”  According to the latest economic reports, the recovery in the labor market is finally fueling momentum in consumer spending.  Retail sales increased 0.6% in the month of May, up from 0.1% in April but excluding autos and gas sales, retail sales rose 0.3%, down from 0.5% the previous month.  Sales in April were also revised down from 0.6% to 0.5%.  In other words, today’s report on consumer spending was not unambiguously positive for the greenback.  As we said in yesterday’s note retail sales needed to exceed 1.5% to save USD/JPY.  Even the drop in jobless claims from 346K to 334K failed to lift the dollar because the meltdown in the Japanese Yen crosses was just too strong.

U.S. investor appetite remains surprisingly resilient in the face of major losses in Asian markets.  Perhaps investors are starting to look at individual countries as isolated entities unaffected by global developments – it is hard for us to believe this mentality is sustainable but that’s what we are seeing in the markets right now. If the Nikkei continues to decline overnight, the dollar will most likely extend its slide against the Japanese Yen but could remain steady against the euro.

A number of U.S. economic reports are scheduled for release tomorrow and if the data surprises to the upside, investors could find themselves with more reasons to ignore the volatility in the other markets and to remain in denial.  While Hilsenrath’s article is negative for the dollar, it isn’t overwhelmingly positive for stocks either because his conclusion that the Fed is no way near raising interest rates is based on the thesis that the U.S. economy is not strong enough to handle it.  Producer prices, first quarter current account balance, the Treasury’s International Capital Flow report, Industrial Production and the University of Michigan’s consumer sentiment reports are all expectedtomorrow so keep an eye on the U.S. dollar because it will be in play.  Of these releases, we feel that the UMich survey could be the most market moving as it would give us a sense of whether Americans have been affected by the turn in stocks and the slowing U.S. recovery.

JPY – When will the BoJ Cry Uncle?

While the Japanese Yen crosses ended the day off their lows, the Yen is higher against most of the major currencies. With USD/JPY falling almost 1000 pips from its peak on May 22nd to its low today, the question that many FX traders are asking now is when the Bank of Japan will cry uncle.  Both Japan’s BoJ Governor and its Finance Minister are new members of Shinzo Abe’s government.  Granted Kuroda formerly served as the head of Asia Development Bank and Aso was a former Prime Minister, both men may be struggling to deal with the volatility in Japanese markets. On an absolute level, USD/JPY is still well off its record low of 75.57 but we haven’t seen this type of volatility in the Nikkei since 2011, shortly after the earthquake and tsunami that devastated Japan. At the time, USD/JPY and the Nikkei was “saved” by G7 intervention but even though Abenomics will most likely be discussed at the next G7 meeting, the Japanese can’t expect any help from their global partners because this time, they only have themselves to blame for denying Japan additional stimulus this week and sending their markets into a downward spiral. Last night’s Ministry of Finance flow of funds report show Japanese investors selling foreign bonds once again. With the Japanese continuing to repatriate their funds, their actions are driving USD/JPY lower and not higher.  Stocks have also peaked in Japan and U.S. bond yields are lower, all of which have contributed to USD/JPY losses.  So while Abenomics is suppose to be positive for USD/JPY, so far, we have not seen its expected effects on Japanese investments, JGBs and the Nikkei, critical factors that contribute to the trend of USD/JPY.  With today’s move the currency pair has fallen as much as 8% from its May 22nd high so how much additional losses are needed before the BoJ cries uncle and verbally or physically intervenes to drive down the Yen?  Based on the percentage move and how quickly it has occurred, the BoJ should be at least trying to talk down the currency now.   However they have only defended their actions and part of the reason may be because last week’s CFTC data showed speculators net short and not long Yen.  The BoJ is a street smart central bank that likes to wait for short USD/JPY positions to build up before verbally or physically intervening in its currency to get the most bang for their buck.  At 95, many investors may have abandoned their long USD/JPY positions but at 90-92, we may start to see some investors short the currency and that is what the BoJ wants to see.  For the sake of the stock market, we think the Japanese government should act now but their stubbornness and over confidence in current policies could be clouding their judgment.

EUR – Cautious ECB Monthly Report

The euro ended the day marginally higher against the U.S. dollar as all of the action today was concentrated in the Yen crosses and commodity currencies. The only notable release from Europe was the European Central Bank’s monthly report in which the ECB said it will not change its low interest rate policy any time soon. In the report, it claimed record-low rates were appropriate to support growth. The report introduced with, “The monetary policy stance will remain accommodative for as long as necessary.” The report expressed optimism that inflation would remain low despite the record low rates. It also said it expected low inflation in the area to result in a higher domestic demand in Eurozone member states. The ECB predicts higher exports due to a recovery of the global economy but it warned that there were still many risks that can prevent a sustainable recovery in economy, despite the recent improvement in business climate. “The Governing Council continues to see downside risks surrounding the economic outlook for the euro area. They include the possibility of weaker than expected domestic and global demand and slow or insufficient implementation of structural reforms in euro area countries.” The council believes risks to the outlook for price developments are balanced over the medium term with upside risks and downside risks from weaker economic activity. Price developments should remain in check with price stability over the medium term. Eurozone CPI is the only piece of data on the EZ calendar tomorrow.

AUD – Stronger Data Drives Short Covering Rally

The Australian, New Zealand and Canadian dollars rebounded against the greenback today with AUD and NZD enjoying the strongest recoveries.  While Australian economic data surprised to the upside, the primary driver of the rally in both of these currencies is short covering.  AUD and NZD have become deeply oversold in recent weeks and due for a much needed recovery.  A total of 1100 jobs were created in the month of May, which doesn’t sound like a lot but it is when considering that economists had been looking for employment to drop by 10k.  While the data was far from unambiguously strong – full time work declined but part time work increased and the participation rate dropped to 65.2% from 65.3%, it was still good enough to encourage some short AUD traders to take profit.  Canadian data on the other hand continued to surprise to the upside as the New Housing Price index rose 0.2% in the month April.  The RBNZ’s downgrade to GDP growth Thursday morning (in New Zealand) failed to have a lasting impact on the NZD.  Tonight, we have the business PMI index scheduled for release and it will be interesting to see if New Zealand businesses have grown less optimistic in the face of a rising currency.

GBP – No News, No Volatility

The British Pound also ended the day unchanged against the euro and U.S. dollar.  George Osbourne’s 10-month old lending plans have not been as effective as economists thought. As Mark Carney comes to office in July he may have to consider new ways to boost lending. While borrowing costs have diminished since Osbourne and Bank of England Governor Mervyn King announced the program and their annual Mansion House speeches a year ago, credit is still shrinking. Former member of the BOE Monetary Policy Committee, Adam Posen, said the Funding for Lending Scheme has been “disappointing.” He said the lending plan is not working properly because it involves banks that are still not back up on their feet from the previous crisis. He said, “You have to try to go around the banking system,” and thinks that the BOE should purchase other securities besides UK government bonds. The BOE said in its quarterly report that higher inflation expectations could lead to inflation becoming more persistent but most signs are consistent with expectations remaining closely knit to the target. The report writes, “The prolonged period of above-target inflation could cause inflation expectations to become less well-anchored.” The report reveals evidence that financial market measures of inflation expectations have become a little responsive to growth in the economy. There are some who believe that prices and wages have gone up due to higher inflation expectations.

Filed in: Commodities

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