“The sky is falling onto USD” is a good summary of last week’s developments. That’s what happens when the positioning gets to the extremes and somebody decides to change the music! The previously hard hit ones, like ZAR, stabilized somewhat as hoped. Notably, some Emerging Markets are losing patience and changing the side of the barricades in the currency war – like Brazil, scrapping bond inflows tax last week; or Poland, intervening in the FX market… Expect more of this if the exodus from bond market begins in earnest (Did I tell you about my bad dream several weeks back where South African central bank had to raise rates to 37%? No? Now I did).
The goldilocks US jobs report was good news to USD. But ok, let’s admit, the huge USD fall already by Friday (DXY index at 81.00, 200D moving average) made it very unlikely for USD to fall further, whatever the payrolls. Judging from the recent data, we are still in the “very safe speed” economy globally, in particular manufacturing, which keeps risk sentiment hanging in the air. I am most worried about the US and China (no, not about the EMU, Japan and UK), which everyone has perceived as global growth drivers. Disappointing reports from EM Asia (PMIs) last week, and China over the weekend…almost makes you wish they should rather fake data (white lies?) than show a dismal 1% y/y export growth, and even worse imports. Provided the recent correlation pattern between stocks and USD holds (Figure 1), further fall in stocks would be in line with more USD weakness against majors, and EM FX weakness against well…pretty much everything.
Figure 1. US correlation with S&P 500
OMT – the weapon of mass destruction (of risk premias). That’s me, summarizing Draghi last week. The EURUSD broke out on the upside above 1.3150, as expected, which now serves a support. The ECB retains the prudent German tone, and keeps up the positive spirits. It’s funny that many markets people instead of accepting it, and trading on it, go into denial mode talking what is “fair” and what is “not fair”. But while dogs are barking, the caravan moves on: the passive and smooth ECB exit continues with another 3bn of 3Y LTROs being repaid last Friday, and excess liquidity in the interbank market dropping to levels critically close to 200bn. No surprise, the money market rates are pressured on the upside. Yes, peripheral yields were up too. But before you start to panic, consider this: peripheral yields are trading in line with EURUSD more often recently (which I see as a good sign of normalization/reduced fragmentation I blogged about another day). Also spreads – see Figure 2.
Figure 2. EURUSD correlation with peripheral spreads
Good news from Germany is no big news, and we have heard enough about green shoots in Greece lately…but the “big cat” Spain also shows some positive/ less negative, if you wish, dynamics across a number of releases over the past few weeks, good for EUR. That being said…we are just talking about exiting recession in the EMU. And given the fact that exports are big hope for the economy in H2, it’s obvious that policymakers don’t want a much stronger EUR soon. And yet there is more room for upside before jawboning against EUR may emerge (in a form of negative depo rate warning, for example) – the effective EUR is still at multi-year average (Figure 3). And the EURUSD y/y change is still below the rate when we last got ECB anti-EUR comments back in the Trichet days (Figure 4).
Figure 3. EUR – nominal effective exchange rate
Figure 4. EURUSD change
Neutral positioning from my side, entering this week, expecting some consolidation following last week’s rout. Light calendar as well: only the US retail sales really matter for tapering/non-tapering talk, but even that is not a material market mover unless it misses big time. I took large profits on USDJPY short (from 100.5 to 97.00) and EURUSD long (from 1.2999 to 1.3280) last week, and exited the AUDCAD long for now at a loss (from 1 to 0.9858), but will keep on watching AUD for reversal opportunities. The USD will try to recover a bit here, especially the USDJPY, but I am not buying into it. Still prefer to buy on pullbacks the EURUSD and GBPUSD with several weeks’ horizon, as data moves in line with expectations (thinking 1.3400, 1.5800), and more downside on USDJPY (92 area) if global stocks fail to rebound convincingly here, BoJ does nothing this week, and..
Nordea