USD/JPY: How Much Further Can it Fall?
09/02/2010 12:01 am EST
More than three weeks ago, we talked about how USD/JPY has a strong tendency to weaken in the month of August. In our special report that outlined the reasons why USD/JPY could break its 2009 lows (published in early August), we pointed out that since 1998, USD/JPY fell during August except for 2006 and 2009. The year 2010 was no different as USD/JPY ends the month down more than 3%. We had said that the “reason why there is strong seasonality in favor of USD/JPY weakness this month is because of the reinvestment of bonus payments received on Toshin investments in July and the repatriation of Treasury coupon payments in mid August. Also, there tends to be more hedging by exporters ahead of Obon week, which is one of the most important holiday seasons in Japan.”
However, this year in particular, there was one other factor pressuring the currency pair lower, which was falling US yields. The combination of demand for JPY due to reinvestment flows and the lack of appetite for US dollars because of the weakening economic outlook pushed USD/JPY to a 15-year low of 83.58 last week and the currency pair now appears poised to test that level once again.
Inching Towards Intervention Danger Zone
Over the past 48 hours, USD/JPY has fallen rapidly despite the Japanese government’s decision to add ten trillion yen to their emergency loan facility. The government is now working overtime to put together a 920-billion-yen stimulus package to support the economy. Yet it appears to be too little too late as investors continue to drive the yen higher. We have long believed that despite open criticism of the yen’s strength and repeated warnings that Japanese officials are watching currencies closely, the central bank would not be inclined to resort to physical intervention. This was our argument throughout July and August when USD/JPY fell from 88 down to 83.58. However, everyone has a bottom line, or a point at which they will eventually cry uncle, and we believe that for Japan, this level is around 80, right above the currency pair’s 15-year low. Never before had the Japanese government let USD/JPY fall below 79.75, which was not only the April 1995 low, but also the record low. Once USD/JPY falls below 83, the risk of intervention will increase substantially and we’ll go from empty threats to a real battle against yen strength. The latest CFTC data shows that long yen positions are at record highs, which is exactly what the BoJ likes to see before they intervene in the currency because it provides the best bang for the buck as the stopping out of these short positions will exacerbate the rally in USD/JPY. The price action in the forex market suggests that investors want to challenge the recent low in USD/JPY, and we believe that this level will be broken. If that occurs, it would open the door for a move down to into the intervention danger zone between 82 and 79.75.
NEXT: Fed Minutes, US Data No Help for USD|pagebreak|
Fed Minutes and US Economic Data Not Much Help
This week’s FOMC minutes and US economic data provided little help for the US dollar. Any optimism that may have come from a better-than-expected consumer confidence survey or the rise in house prices was offset by the Fed minutes, which confirm that the central bank is still thinking about easier monetary policy. According to the minutes, not only did the Fed consider reinvesting principal payments from agency debt and agency mortgage-backed securities (MBS) in longer-term Treasuries (which they announced on August 10), but they also considered reinvesting in mortgages. Although buying government debt was not discussed at the meeting, reinvesting into MBS could be seen as a precursor to that decision. The minutes also showed increasing division within the central bank as some members were worried that the recent decision would send the wrong signal to the market about the central bank’s willingness to resume asset purchases. Others called for an open dialogue on additional measures to ease policy should the outlook for the US economy continue to weaken. Central bank officials were most concerned about the labor market, and their expectations for a stronger recovery in 2011 were offset by the warning that downside risk to the recovery has increased. Aside from the rise in the consumer confidence index, earlier this morning, we learned that house prices increased by 1% in June with year-over-year gains reaching 4.2%, which was slightly weaker than last month's 4.6% report. Manufacturing activity in the Chicago region continued to grow at a slower pace with the PMI report falling from 62.3 to 56.7, the weakest since November 2009. Except for supplier deliveries, all of the underlying components decreased, with the most pronounced decline seen in new orders and production. The slowdown in manufacturing activity in the Chicago and Philadelphia regions points to a weaker manufacturing ISM number for Wednesday. The market will also start to turn its focus to Friday’s non-farm payrolls report with the Challenger and ADP reports due for release tomorrow.
EUR/CHF Hits Record Low
The big story in Europe today was the sharp rally in the Swiss franc. The swissie rose to a fresh record high against the euro and a more than a one-year high against the British pound.
Although the rally in the currency was partially triggered by stronger economic data, demand for a true safe haven remains the primary reason why investors are snapping up the Swiss franc. Unlike the US and Japan, where central bankers are actively engaging in easier monetary policy, the Swiss National Bank is among the few that are considering tightening. Economic data has been relatively steady with the latest UBS Consumption Indicator climbing to the highest level in more than two years. This measure of consumer expectations is a vote of confidence for not only the Swiss economy, but also Switzerland’s currency. It is not hard to imagine why the franc is in demand when business activity and consumer appetite have increased. Of course, the sharp gains in the currency raise the risk of intervention by the SNB, but we expect the central bank to resort to verbal intervention first. Meanwhile, the euro ended the day virtually unchanged against the US dollar following the German unemployment report, which showed a continual improvement in the labor market. A total of 17k Germans fell off unemployment rolls in the month of August, keeping the unemployment rate steady at 7.6%. Although this figure was slightly worse than expected, the upward revision to the prior month’s report made the initial selloff in the EUR/USD very short-lived. German retail sales are scheduled for release tomorrow, and despite the improvement in consumer confidence, there is a good chance consumer spending may have decreased because the latest retail PMI showed a steep fall in consumer demand. For the first time since May, retail PMI turned negative with the index slipping from 57.2 to 48.4. With the World Cup over and the weather far from helpful, consumers have cut back spending. The silver lining, however, is that retailers believe that sales will rebound next month.
NEXT: Latest News on GBP and CAD, Closing Thoughts on Yen|pagebreak|
GBP Shrugs off Improvements in Data
The British pound fell steeply against the US dollar despite relatively positive economic reports. Consumer confidence improved significantly in the month of August, a sign that the improving economy could boost consumption. If you recall, last week’s GDP number showed relatively healthy growth in the second quarter. Therefore, it is not much of a surprise to see the Gfk consumer confidence survey rise from -22 to -18, which basically erases a similarly large decline the prior month. Mortgage approvals also increased from 48.6K to 48.7K, while net consumer credit rose by 0.2B. Although some analysts have highlighted the sluggishness of these reports, we believe that an increase in mortgages is better than a decrease, particularly since that was what the market had anticipated. There is still not much activity in the real estate sector in the UK, but any activity that we have seen has been more positive than negative. Today’s data also showed credit card lending rising the most since February. Manufacturing sector PMI is scheduled for release tomorrow, and this report, along with service sector PMI on Friday, will provide a better look into the current state of the UK economy and whether the weakness in the currency is justified. The break of 1.54 in the GBP/USD puts the next support level below 1.52.
CAD: Weaker-Than-Expected Growth
The Canadian, Australian, and New Zealand dollars all continued to weaken against the greenback, but the degree of the losses reflect the relative economic health of the commodity-producing countries. The Canadian dollar, for example, sold off the most on a pip basis after weaker-than-expected second quarter GDP figures. After growing by a downwardly revised 5.8% in the first quarter, the Canadian economy expanded by only 2.0% in the second quarter. As our colleague, Boris Schlossberg, said this morning, “Today’s news suggests that despite robust demand for its commodity products, (the) Canadian economy may be experiencing the spillover effects from the slowdown in growth of the US economy as the whole North American block faces a difficult second half of the year. Today’s weaker-than- forecast GDP results are only the latest miss in a string of recent economic disappointments from Canada. The country reported weaker retail and wholesale sales as well as softer CPI data in the month of August.” On a percentage basis, the New Zealand dollar fell the most after news that South Canterbury Finance collapsed. The New Zealand-based financial company filed for receivership last night, forcing the New Zealand government to pledge to repay all of the company’s 13,000 depositors. Like in other parts of the world, when a bank fails, taxpayers are left to foot the bill. The Australian dollar, on the other hand, ended the New York trading session only marginally lower against the greenback thanks to a series of stronger economic data. Retail sales and building approvals rose significantly in the month of July, while the current account deficit shrank by more than 60% in the second quarter. These latest reports show that the Australian economy continues to run on all cylinders, and we believe that this strength will be echoed in this evening’s second-quarter GDP number. Aside from Q2 GDP, Australia also has manufacturing sector PMI on tap.
JPY: Government Wants to Give Time to Absorb Announcements
The Japanese yen strengthened against every major currency except for the franc as traders continue to challenge the resolve of the central bank. The latest comments out of Japan suggest that they may not be ready to resort to intervention, but will become increasingly willing to do so if USD/JPY continues to fall. Clearly the increase in monetary stimulus failed to stem the rise in the yen, and it is possible that the Japanese government may want to see how the market responds to their new fiscal stimulus plan before stepping in and selling yen. Last night, the minister for national strategy said it is too early to determine how markets will evaluate the steps outlined by the central bank and government yesterday to counter the strong yen and improve the economy. Finance minister Noda said the BoJ and government’s measures will start to take effect and showed its readiness to take “bold action on currencies” if needed. Fiscal stimulus would have probably been more effective if the announcement was a surprise, but all of this pregame talk has unfortunately undermined its potential impact on the currency market. Although vehicle production decreased in July, housing starts and small business confidence edged up slightly. No major economic reports are expected from Japan this evening.
By Kathy Lien, currency analyst, KathyLien.com