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Making Sense of Divergent Moves in FX and Equities

U.S. stocks performed extremely well today with the S&P 500 closing in on record highs and the NASDAQ hitting 12 year highs.  Unfortunately the strength of equities has not carried over to currencies.  In the past, a rising stock market was indicative of improving risk appetite, which helped to lift higher yielding currencies but today, pairs that would normally benefit from higher stock prices are trading lower. The steepest loss was seen in the NZD/USD but the AUD/USD and USD/JPY also saw losses.  EUR/USD ended the day with gains but was well off earlier highs.  The only currency that trailed equities higher and held onto its gains was the GBP/USD.  The divergence in currencies and equities may be confusing to some traders but U.S. assets are still in demand.  For the most part investors are still buying dollars and most likely taking some of those funds and investing into U.S. equities.  Today’s rally in stocks was attributed to Bernanke’s pledge to keep monetary policy easy.  However we are a bit surprised by this credit because the Fed Chairman didn’t say anything new.  Instead, we feel that investors are starting to believe that the market and the economy can handle less stimulus and therefore the violent reversals that in June are no longer necessary.

While Bernanke’s comments yesterday were more dovish than most investors anticipated, it is important to realize that Bernanke said nothing to change the prospect of a reduction in asset purchases this year.  There is still a major divergence underway between U.S., ECB, BoE, BoJ and RBA monetary policies that will only intensify when the Fed tapers in September. Under this environment, we continue to expect the dollar to strengthen with current levels being a potentially attractive opportunity to go long.  In fact the FOMC minutes showed some members supporting an even more aggressive timetable that would end asset purchases this year.  We doubt this is likely but it gives investors a sense of how committed policymakers are to lowering the amount of stimulus in the economy.

Despite the rise in jobless claims, data in other parts of the world show growing vulnerabilities that could prompt easier monetary policy abroad. Diverging paths of growth are another reason why we feel some traders will reset their long dollar positions during this pullback.  Jobless claims rose to a 7-week high of 360K up from 344K for the week of June 29th.  While this may worry some traders, jobless claims in general have been low and unless next week’s number increases by another 20k, claims pose no major threat to the outlook for the U.S. labor market or the dollar. Continuing claims also ticked up from 2.953 million to 2.977 million while import prices dropped for the fourth month in a row by 0.2%, a confirmation that inflationary pressures are muted.  We feel that the outlook for the dollar is bright and that the recent sell-off in the greenback can be viewed as a bargain opportunity for some traders.

EUR – The Ugliest of Them All?

At first glance, the rally in the EUR/USD today makes it appear that the currency pair has turned a corner, but a quick look at the intraday charts reveals a strong intraday reversal.  Of all the major currencies, we feel that the euro has the greatest downside opportunity against the dollar.  While many people have been focused on selling A$ and we also feel that it is headed lower, the record amount of short positions makes us wary of where the demand to sell will come from.  Positioning in the euro on the other hand has just turned negative, leaving plenty of room to downside.  Recent disappointments in Eurozone data validated the central bank’s dovish bias and if this trend of weaker growth continues and the economy fails to regain momentum soon, the ECB could be force to ease.  The Eurozone’s industrial production report is scheduled for releasetomorrow and given the sharp decline in German and French industrial production, we feel that IP could fall more than the current -0.3% forecast.  Although U.S. jobless claims rose more than expected, the possible distortion from the July 4th holiday means that the U.S. recovery is on track. The outlook for the Eurozone on the other hand is grim.  So while the EUR/USD is trading at 1.31 at the time of publication, we believe that the downtrend in the currency pair will resume with the potential for steeper losses that could make the euro the ugliest duckling of them all.

Sterling is Day’s Best Performer

Not only did the British pound trade higher against the U.S. dollar, but it was the day’s best performer.  Sterling held onto nearly all of today’s gains, rising almost 1% against the greenback.  What was surprising about the move is the lack of catalyst. There was no U.K. economic reports or market moving comments from policymakers. Bank of England member Miles spoke this morning and all he talked about was the Funding for Lending Scheme.  He said FLS is an insurance against a sharp rise in funding costs and the reason why it hasn’t been used extensively is because banks funding costs have declined since the program began in August of last year. U.K. Chancellor Osborne said the economy is still dependent on monetary stimulus and indicated that central banks are “very focused on communicating the future path of interest rates.” While he didn’t mention the BoE specifically, Mark Carney’s decision to provide a detailed statement after last month’s monetary policy meeting indicates that he wants more transparency for the central bank and to provide more guidance to the market.

AUD – Case for RBA Easing Grows

After a 3-day rally, the Australian and New Zealand dollars resumed their slide against the greenback.  In yesterday’s note we said the outlook for the AUD and NZD are grim given the recent weakness of Chinese and Australian data.  Last night’s Australian economic report contained weakness beneath the headlines.  While job growth increased 10.5k in the month of June, all of the gains were driven by part time work as full time jobs declined 4.4k.  The unemployment rate also rose to 5.7% from an upwardly revised 5.6%.  The combination of weaker domestic and external conditions could prompt the RBA to cut rates again.  Economic data was even weak in New Zealand.  The country’s business PMI index dropped from 59 to 54.7.  Although new housing prices rose at a slower pace in May, the Canadian dollar rose strongly against the greenback and we may finally be seeing a catch up move in the loonie.

JPY – Japanese Investors Buy Foreign Bonds

It was a mixed day for the Japanese Yen, which strengthened against the U.S., Australian and New Zealand dollars and held steady against the rest of the majors.  As expected, the Bank of Japan left monetary policy unchanged.  Given the recent stability of JGB yields, the central bank did not feel that additional stimulus was necessary.  BoJ Governor Kuroda is a firm believer in Abenomics and feels that the current level of asset purchases will be enough to support the economy.  Whether he is right remains to be seen but for the time being, BoJ policy remains steady.  For the first time since May, Japanese investors were net buyers of foreign bonds.  After selling ¥965bn worth of foreign bonds the week prior, the Japanese bought ¥973bn worth of foreign bonds last week. It is far to early to call this a shift in trend but we could finally be seeing Japanese investors diversify, which is a critical factor in a renewed USD/JPY rally but we will need to wait a few more weeks to see if this trend continues.

Filed in: Commodities

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