Competitive Devaluation: Leave Shame And Principles At Home!
From Nic Lenoir of ICAP
The Bank of Japan is back pounding the QE/debasement/Keneysian madness table: this time they don't buy bonds, they buy REITs and ETFs. Did you hear that Mr. Bernanke? You no longer have to wait for a business to be insolvent to buy (bail?) it. More and more countries are in the pool. Central banks joining the game range from Peru with a few millions worth of USD, Brazil, to Japan committing to $300Bn of FX intervention with the first $20Bn unsterilized, to the Fed where estimates for QE 2.0 range from $300Bn to $500/750 Bn every quarter. Commodities love it obviously and last night Japanese quantitative escapade did not leave Copper or Gold insensitive as they scream to new (recent or all time) highs.
There are a few points worth noting this morning however. With the bank of Australia leaving rates unchanged and the bank of Japan back doing whatever it can to get USDJPY off the lows, the USD should not be trading that weak this morning. EURUSD strength is understandable. We had indeed pointed out that buying EURUSD volatility or calls on the pair against similar structures for the USD index should perform well given that the ECB is just about the only central bank not debasing. In that sense EUR should bear the brunt of USD weakness and massively outperform other currencies. But beyond EURUSD, there seems to be little reason to be selling USD based off last nights events. It is a relative value game, and a lot of people seem to have forgotten about it. We don't know what the Fed will do even though certainly a lot is priced in already, but we had two central banks implicitly supporting the USD by their actions last night.
Technically there is a double top triggered in AUDSD and a gap/resistance at 0.9651, not to mention the former bullish channel support now resistance at 0.9665. I believe that short term you are supposed to sell here to play further weakness down towards 0.9465/0.9407, with a stop if we reintegrate the bullish channel. USDJPY is clearly trying to shape a bottom here around 83.30 as well and it seems a good point to be adding or initiating longs, though my favored trade in the space is long USDJPY and 10Y treasuries against 10Y JGBs.
I will conclude with an open question which I hope will draw some interesting feedback from the FX-dealer community. Most macro funds are trying to get long USDJPY, with macroeconomic models pointing to a fair value closer to 110/115 than 83. The QE argument does not really hold since Japan has been doing it for 30 years and USDJPY has not rallied, so pricing in US QE as a rationale for USDJPY weakness is clearly wrong. It is definitely a catalyst for DXY weakness, but not USDJPY. Last but not least, many argue that below 80 Japanese exporters are basically broke. This is not a joke, their competitiveness is taken out so much that would basically have to file for bankruptcy, and recent numbers out of Japan are clearly highlighting that the pain is starting to be acute. In that context you might ask: who is selling USDJPY frantically in the face of the BOJ which is buying unsterilized? My hunch is China. With a pegged but not freely trade currency, China unlike Korea does not have to waste to much time and effort to buy USDCNY (not to mention they are naturally long from the trade balance...), and in fact implicitly benefits from USD weakness for its European exports. Also China stands to be the greatest beneficiary from Japanese exporters going belly-up, both from a competitive standpoint and for the pure satisfaction of getting pay back. Make no mistake, recent public relations between Japan and China are bad, and the bitterness is absolutely not a hype. It's real and nothing would make China happier than Japan economic misery. The PBOC has also made clear its intentions to diversify its foreign reserves, which is another reason to sell the USD. Call me a conspiracy theorist if you will, but I would be very surprised to be proven wrong on thsi one and I welcome any indication one might have that China is indeed out there selling USD. After all given Congress's preoccupation with the Yuan, it's not like it would be completely uncalled for.
This great battle will ultimately decide the future of all other asset prices as they are mainly driven by global liquidity expressed in USD, which in turn is greatly affected by USD weakness. As a short-term trade I must admit I like the set-up to sell AUDUSD here, and I also am going to take a closer look at USDCAD which is testing the bottom of its range.
Good luck trading,