US Treasury sell-off resumes, but USD loses against high yielding G10 FX
In FX markets, the rise in US yields has persisted while the USD has continued to remain weaker, especially against the high yielding currencies. This should translate into more upside on high yielding JPY-crosses with higher US yields likely to result in JPY weakness. Comments yesterday from Germany’s Merkel that she supports ECB Draghi’s recent message are positive, in our view and continue to pose upside EUR risks especially vs. USD,JPY and GBP in the weeks ahead (more below). Today’s University of Michigan consumer index should come weaker (72.0 from 72.3) with higher petrol prices the likely culprit. USDCAD continues to trade lower especially as oil prices rise, and we remain short USDCAD position targeting 0.9800. Prospects for the CAD look bright, with Moody’s reaffirming its AAA rating due to economic performance and government financial position. In an environment where most ratings of G10 countries are threatened, the CAD surely stands out. It may see an extra boost today from an expected bounce in CPI. In June, both headline and core inflation fell significantly, so we expect both core and headline CPI to increase 0.2%m/m.
* Playing for a short USDJPY rally, followed by a longer decline
While we are confident that US yields will remain lower (given continued anchoring by the Fed with QE3 to follow), timing the move is an issue as US yields have moved higher despite disappointing US manufacturing data- yesterday being a strong case in point. Indeed, recent regional ISMs (Philadelphia Fed and Empire Surveys) suggest the closely watched national ISM manufacturing index for August will remain in contractionary territory. But if the tactical driver for the higher US yields are (a) diminishing euro area tail risks and (b) higher oil prices (both factors present in Feb-March US yield pick up) then weaker US data in itself may not help to reverse current movements. This means such moves in the US treasury market will continue to drag USDJPY higher. However, we remain strategic USDJPY bears and would view the current rally as temporary given our view that Fed QE3 should see US yields lower multi-month. So, while USDJPY can rally into September, we expect it to reverse with likely catalysts being Fed easing and JPY inflows on repatriation ahead of the Japanese FY half year end. Accordingly, we have suggested an option structure to capitalise on USDJPY first rallying before falling. (See FX Weekly for more details).
* Swedish unemployment likely to support SEK
Following a brief run of SEK weakness, the Scandie currency continues to shine. The high-beta currency continues to thrive as risk appetite improves. SEK strength is likely to be uninterrupted if today’s unemployment rate declines slightly as we project. However, we have noted previously that the rise in SNB interventions is strongly correlated to the EURSEK decline. Thus, as eurozone risks abate and sovereign yields decline, the SNB will intervene less in the currency markets, as has been the case recently. With the SEK likely to lose a strong bid and long SEK positions overstretched and at extreme levels, we expect NOKSEK to rally to 1.1700.
* Next week will be key for the Eurozone
EUR gains on Thursday were mostly due to short covering, but the real test for the EUR will be next week. German Chancellor Merkel expressed her support for ECB President Draghi’s strategy and called on her European counterparts to move closer towards integration of fiscal policy. Mrs. Merkel reiterated her stance that she favours stronger EU intervention rights on budgets. This comes ahead of a slew of meetings scheduled for next week with the Greek Prime Minister and French President Hollande. In addition, there is a Spanish Cabinet meeting on 24 August. Any progress on the eurozone front should sustain risk appetite. The promise that the ECB would support the markets in cooperation with the EFSF has bolstered market sentiment since the ECB meeting and suppressed volatility.
BNP Paribas