The Bank of Japan has raised interest rates by 25 basis points to 0.50%, only the second rate hike in nearly seven years, after raising rates from 0% in July. The 8-1 vote was less contentious than many had expected, especially considering the 50% market split about the outcome. Despite the fact that the decision was also less contentious than the 6-3 vote to keep rates on hold last month, the yen’s gains were short-lived, dragging the dollar from 120.30 to 119.73, before jumping nearly 50 pips to 120.25 in less than five minutes. The speed of the up move is partially explained by emerging rationale that it will take at least four months for the Bank of Japan to follow up with a subsequent tightening, thus, offering ample opportunity for traders to place fresh carry trades with a medium term horizon. USD/JPY is now trading at a one week high of 120.90.
Aside from higher interest rates in Japan, renewed signs of U.S. economic weakness will also serve as a key factor in limiting the build up of fresh carry trades. Despite the 4.75% differential between U.S. and Japanese overnight rates, the recession in U.S. manufacturing, rebound in oil prices and weakness in U.S. housing present a stark picture for the U.S. economy; increasing the chance of a Fed rate cut as early as the third quarter. The drop in U.S. 10-year yields to five-week lows of 4.65% certainly reflects the recent weakness in U.S. data. Much has been written on the correlation between the unwinding of yen carry trades and market sell-offs of U.S. and emerging markets in May. Those developments were partially caused by the reverberations in emerging markets (Iceland, Hungary and Mexico), but were also triggered by continued weakness in U.S. housing and the onset of higher Japanese rates. The potential of further retreat in U.S. home sales and renewed tightening in Japan in the third quarter remains inevitable.
Today’s U.S. data start off with the January CPI (8:30 a.m. EST) expected up 0.1% from 0.4% while the more important core CPI seen up 0.2% from 0.1%. Considering the improved short term sentiment for the USD this session, 0.2% core would be sufficient in extending these dollar gains, albeit within limited parameters as discussed below.
The 10 a.m. EST release of the January leading indicators seen up 0.2% last month following 0.3% in December, 0.0% in November and -0.1% in October.
This week's release of the U.S. inventory data will be released Thursday, a day later than usual due to the Presidents' Day holiday Monday.
The 2 p.m. EST release of the FOMC minutes from the January meeting may not provide much scrutiny after Fed Chairman Bernanke’s dovish testimony last week. The testimony touched upon lower growth forecast, relaxed inflation rhetoric and a cautious assessment for housing.
USD/JPY has recovered towards the 120.95 resistance –61.8% retracement of the decline from the 122.07 high to the 119.01 low, while chances for a breach of the 121 figure appear increasingly potent according to the daily MACD. A breach of 121 should encounter strong resistance at 121.30-35, a break of which would only be made possible by a reading of at least 0.2% in U.S. core CPI (8:30 a.m. EST) and leading indicators index (10 a.m. EST). Selling potential seen viable at 121.30s towards 121 preliminary target. A negative surprise in core CPI could drag the pair back towards the 120.70 support, followed by 120.20.
EURUSD eyes 1.31 The bearish engulfing pattern in the 4-hour EURUSD candle, suggests further declines from the current 1.3135 to initial support of 1.3095—38% retracement of the 1.2943-1.3192. These euro losses could be especially driven by strong US data and a hawkish market interpretation of the FOMC minutes at 2:00 pm. Key support stands at 1.3065, just above the resistance of the previous consolidation. Upside capped at 1.3160 and 1.3190.
Ashraf Laidi Chief FX Analyst CMC Markets US 140 Broadway, 30th Floor New York, NY 10005 (212) 644-4220 (212) 644-4222
a.laidi@cmcmarkets.com
