Major Overnight Headlines
• UK mortgage approvals highest since March 2008 in July; Nationwide house prices up 3.5% YoY in August
• Berlin rules out any military engagement in Syria, Bloomberg
• Japanese core CPI falls 0.1% YoY in July; slowest decline since February 2009
It’s month-end and to keep thing simple we continue to look to fade rallies in the JPY and the CHF intraday if equities find some support and end the session higher (or vice-versa).
It’s probably tough for many to imagine the EUR doing well when things are [also] pretty bad elsewhere, particularly because of the EUR’s positive correlation with “risk” over the 2.5-year stretch from 2010 to mid-2012. But let’s put things into context. During the heyday of “classic risk-on/risk-off”, the only leg the USD bulls really had to stand on was that the USD was the place to be when everything else outside of the US fell to pieces. Being a USD bull meant being a bit masochistic, and the USD’s biggest weakness was actually its biggest strength. Most trades were funded in USD, and this left the USD with room for appreciation when those trades were unwound. Since late 2011 however, through a combination of interest rate cuts and more LTROs, ECB policy has moderately caught up with that of the Fed’s. This has left the EUR with room to adopt some of the typical “funding” attributes of the USD. At the same time, the USD’s fundamentals have improved across a number of metrics (higher real rates, rising expectations monetary tightening over the medium-term, and a further strengthening of the balance of payments).
From a flows and funding basis, the most important difference between the EUR and the USD is that the latter is a “QE currency” whilst the former is not. This means that the USD’s transformation phase to being positively correlated with “risk” will be gradual. Indeed, the Fed’s July/August “dovishness” has already held things up. If the Fed extends the deadline for ending asset purchases under QE3, the correlation between the DXY and equities should become more negative. If the Fed tapers, then jawbones, then tapers some more and then jawbones again, the correlation will fluctuate around neutral, or shift into and out of positive and negative territory. If the economic data are just so darn good and growth is so broadly positive that an increasing rate of Fed tapering fails to knock asset prices or developing market currencies severely lower, then the correlation will stay firmly within positive ranges.
Read the full report: FX Daily
BMO