Australian Dollar

Sterling is has eclipsed the yen as the main focus in the foreign exchange market. The surprising news that has kicked it to fresh multi-month low was that the BOE is closer to easing policy than has been suspected. While it was a unanimous decision to leave rates on hold as expected, it was a tighter 6-3 vote on new asset purchases.

The market had expected a 8-1 vote. Of particular interest, it is the fourth time Governor King has been outvoted.

With the end of Asia's lunar new year celebration and the return of the US and Canadian markets after yesterday's holiday, there is full liquidity in the global capital markets for the first time in over a week. The currencies are mixed, with the yen, sterling and the Australian dollar posting modest gains, while the euro, Swiss franc and Canadian dollar have heavier tones.

The Chinese yuan has weakened for the second day after returning from the extended holiday and is near 2-month lows. After reversing lower yesterday, the Shanghai Composite led the regional bourses lower with a 1.9% decline. The Composite is approaching its 20-day moving average (~2365) which it has not traded below since early December. European equity markets are higher and the Dow Jones Stoxx 600 is up a little more than 0.5% led by consumer goods and basic materials. Of the main industrial sectors, only telecom is lower. European bond markets, core as well as periphery are lower.

Broadly speaking, we identify five factors that will shape foreign exchange rates in coming days.

An overivew of the price action in the foreign exchange market and what it might mean in the week ahead.  

The price action in the foreign exchange market is choppy as short-term participants seem nervous after being whipsawed yesterday. Sterling fell nearly a cent to new multi-month lows following the BOE's inflation report that confirmed official expectations that price pressures will remain above target and King welcomed the recent depreciation of the point. Also of note the Australian dollar, which staged a sharp recovery off the year's lows yesterday and has seen follow through buying today, helped perhaps by gains in a consumer confidence measure.

The was nothing in the rogue G7 sourced comment yesterday that that Japanese Finance Minister Aso did not say prior to the G7 statement and before the weekend. The pace of the yen's depreciation was too fast. The market reacted to it at the time.

As debate about currency wars heats up, there's been little talk about which currencies will prove safe havens. We think the Singapore dollar tops the list.

In what has been a quiet start to week dominated by the G-20 meeting whose only purpose is to put Japan and its upstart currency destruction in its place, many are expecting a formal G-7 statement on currencies and what is and isn't allowed in currency warfare according to the "New Normal" non-Geneva convention. Because while there may not have been much overnight news, both the EURUSD and USDJPY just waited for Europe to open, to surge right out of the gates, and while the former has been somewhat subdued in the aftermath of the ECB's surprising entry into currency wars last week, it was the latter that was helped by statements from Haruhiko Kuroda (not to be confused with a Yankee's pitcher) who many believe will be the next head of the BOJ, who said that additional BOJ easing can be justified for 2013. He didn't add if that would happen only if he is elected. Expect much more volatility in various FX pairs as the topic of global thermonuclear currency war dominates the airwaves in the coming days.

The markets generate noise and a signal.  Reasonable people can and do differ on which is which.  This brief note address the signals for the yen and euro.  Secondarily it looks at sterling and the Australian dollar. 

Here is a review of the technical condition of the major currencies.  In my professional experience, I know few purist fundamental traders in the foreign exchange market.  Even for those, like myself, who study the macro economic and political fundamentals, technical analysis allows us to quantify the risk. Those who make money in the markets, do not do so because they are right more often, but rather they are disciplined risk managers.  Technical analysis provides a way to manage the risk by helping to identify where we are wrong.    It is offered here not as a substitute for fundamental analysis, but as a complement.  

Here is an oveview of the forces that are driving the foreign exchange market and price targets for the euro and yen.  We identify the ECB meeting as a potential challenge to the existing price trends, but expect it to see the tightening of financial conditions in the euro area as partially a reflection of positive forces, especially that banks have reduced, on the margins, the reliance on ECB for funding.  Draghi will likely attempt to calm the market down with words not a rate cut.  Also we see the "currency wars" as being exaggerated, not just because the foreign exchange market has alsways been an arena of nation-state competition, but that it is primarily in the realm of rhetoric among the G7 countries.  Few, including Germany, who have expressed concern about what Japan is doing, have objected to the Swiss currency cap.  There is not a bleeding over into a trade war.  The push back against the Japan (among the G7) appears to have slakcened a bit.  Officials prefer Japan not provide price targets for bilateral exchange rates (like dollar-yen), but if stimulative monetary and fiscal policy weakens the yen, that is ok.  

The divergence of a stronger euro and weaker yen has continued and the latest news stream has pushed it further. There are several sub-themes at work as well and they also have been underscored today. These include: 1) German recovery from Q4 contraction, 2) the divergence between German and French economic performance (suggesting a divergence of national interest too?), 3) the decoupling of sterling from the euro orbit, but we suggest here that while the UK economy is without a growth impulse, the market may be exaggerating the weakness, 4) the ECB is less likely to push against the passive tightening of financial conditions when it meets next week, and 5) the Chinese economic data is sufficiently mixed as not to lend the heavy Australian dollar much support. Following the FOMC, the US economic data needs to be well off the consensus to resist the current forces.

There has been a tightening of European financial conditions. Two more pieces of evidence were reported today. This issue may very well overshadow other issues at Draghi's press conference next week. German 2-year rates are moving above the US-- a 30 bp swing since early Dec. Meanwhile, US rates are rising relative to Japan. The dollar-bloc (and sterling) continue to under-perform. We also look at the US economic calendar for the day that features the ADP employment estimate, the first look at Q4 GDP and the conclusion of the FOMC meeting.

Here is a weekly over view of the currency market from a technical perspective.  The divergence between the performance of the dollar against the euro-bloc, with the exception of sterling, and the other major currencies is noteworthy.  In the analysis, I suggest a few opportnities for near-term contrarians.  I fully appreciate that some readers eschew technical analysis and regulate it to the same space as numerology and witchcraft.  Yet, even still, it is useful to recall Keynes' view that the markets are like a beauty contest and the trick is not to pick who one thinks is the most beautiful, but to pick who others will think most beautiful.  Moreover, technicals allow one to quantify how much one is willing to lose in a way that fundamental macro-economic analysis doesn't.  It is a tool then for risk management.  

The US dollar is trading firmly. The official verbal commentary this week by Europe's Juncker and Japan's Amari were more disruptive noise a true signal. These mis-directional cues whipsawed short-term participants and served to obscure what was really happening. One of the most important take aways, it seems, from this week's action is the narrowing of the breadth of the dollar's decline. It is really limited to only the euro...

There have been some large moves in the foreign exchange market in recent days.  The euro posted its largest rally in four months last week.  The yen has fallen to its lowest level against the dollar since June 2010 and extended the declining streak to nine consecutive weeks, something not seen since 1989.  The Canadian and Australian dollar rose to multi-moth highs, as did the Mexican peso.  

In last week's technical note, we suggested the key question whether the sharp drop in the major foreign currencies following the avoidance of the full fiscal cliff in the US was trend reversal or overdue correction.  We favored the latter and looked for the underlying trends to continue.   They did.  

Now market participants face a different question.  Given the out-sized moves, have the trends become stretched?  The answer, we propose, is more nuanced than last week.  There is not one answer for all the major currencies we review here.

The main macro event today will be the interest rate announcement by the ECB due out at 7:45 am (with the Bank of England reporting earlier on its rate and QE plan, both of which remained unchanged as expected, which will remain the case until Carney comes on board) which is expected to be a continuation of the policy, with no rate cut despite some clamoring by pundits that Draghi should cut rates even more. Overnight, we got Chinese December trade (better than expected) and loan (slightly worse than expected) data, coming in precisely as a country which has a new communist politburo leadership implied they would. Of particular note was that the US has now replaced the EU as the largest Chinese export market: what happens when the euro weakens even further? But at least the net benefit to European GDP as a result of declining imports will, paradoxically, help. Elsewhere, Spain auctioned off more than than the expected €4-5 billion in its first 2013 auctions of 2015, 2018 and 2026 bonds, sending the 10 year SPGB yield to under 5%, or the lowest since 2010, a process driven by expectations of a Spanish bailout. Thus the incredible odyssey of Schrodinger Spain continues, whose interest rates are improving on hopes it is insolvent. Fundamentally, things got better nowhere, with Greek unemployment rising to 26.8% in October from 26.0% previously, while bad loans in Italy soared by 16.7% Y/Y to €121.8 billion, while loans to businesses dropped at the fastest pace ever. And so the scramble to offset the trade and economic collapse of Europe using central bank tools continues.