- FX markets lacking direction, correlation between yields USD looser than many supposed
FX markets continue to trade with a lack of clear direction, characterised by quick reversals and a range of mostly unconvincing explanations being wheeled out for the moves. A slow grind higher in equities in the US session, after sharp opening losses suggested that the positive risk/dollar relationship of late is still holding, though there was no real assist from bond yields, 2-year Treasury yields adding 2bp but longer dated yields actually lower on the day. Looking over the first half of the week, the trends are a little clearer: despite US yields being higher across the curve, the EUR has outperformed, while the yen and commodity currencies have slipped against the USD. Clearly, while FX markets have become fixated with Treasury yields/yield spreads of late, the correlation between rising UST yields and a strengthening USD has been looser than many supposed.
- JPY remains linked to US yields while risk is supported; but EUR looks like the better short from here
The tightest relationship has been between USDJPY and 2-year USTs, and if risks assets remain reasonably well supported and Treasury yields further ‘overshoot’ to the upside we expect further support for USDJPY into Japanese fiscal year-end. However the EUR and JPY both now look to be competing with the USD for preferred funding currency status; and with USDJPY lying some way above our BNP STEER (Short Term Equilibrium Exchange Rate) level while EURUSD lies above it (and by even more so when examined purely with reference to benchmark swap yield spreads – see chart), short EURUSD is our favourite tactical trade at present. We look for a re-test of 1.30 on a 1-2 week basis. Yesterday’s AUDUSD losses were triggered by a warning from BHP that it saw demand growth for iron ore from China dropping to single digits – if it has not already. But the lack of reaction in the iron ore markets at the heart of the discussion suggests that a market long the AUD was simply looking for an excuse to trim exposure. Falling volatility in currencies and equities should boost the attraction of the AUD carry trade and see these longs re-established. Meanwhile, the lower NOK in recent days is consistent with a sharp drop in oil price – linked to assurances from Saudi Arabia about supply prospects. We stay short NOK via our long EURNOK/long oil trade established on Feb 23rd and, though it has already come a long way, look for further downside progress on NOKSEK. Riksbank Deputy Governor Svensson participates in a Fed conference on Wednesday at 23:00GMT. If the message is the same as that from his fellow Deputy Governor Jansson last Friday, namely that SEK gains are ‘no drama’, this could well be the catalyst for a fresh move higher in all things SEK.
- UK budget and Bernanke are today’s highlights
Wednesday’s highlight should be testimony by Fed chairman Bernanke along with Treasury secretary Geithner, scheduled to testify on Europe’s Debt Crisis commencing at 13:30GMT. Geithner has rejected suggestions of additional US commitments to the IMF in order to increase the size of the Eurozone’s protective firewall; we suspect this is in the knowledge that Congress is unlikely to approve increased funding in an election year. Data is confined to existing home sales; little change is expected for January. Ahead of that, Chancellor Osborne is to deliver the annual UK Budget, where the focus will be on whether the commitment to current austerity plans (necessary at a minimum to preserve the UK’s AAA credit standing) is unwavering. Sterling has already been knocked this morning by worse-than-expected PSNB data for Feb and an indication from this morning’s MPC minutes that the debate for further QE could continue. Surprises from the budget are unlikely, but we expect that any punitive increases in property taxes may remove some recent support for sterling given that they are seen deterring further inflows into the London property market.
BNP Paribas