FX carry trades extend to further extremes as the yen slumps to all time lows against the euro, new four-and-a-half-year lows against the U.S. dollar, while the high yielding Aussie and Kiwi surge to record highs and 22-year highs against the U.S. dollar. A stuttering improvement in Japanese inflation and sluggish data in consumer demand are further quelling speculation of Bank of Japan summer rate hike, while increased prospects for a summer rate hike from the Bank of England, Bank of Canada, Riksbank (Sweden) and European Central Bank (late summer) are bolstering confidence in further elevating the bids on these currencies against the yen.
Yen weakness nearing unjustifiable levels
The tightening policies of the aforementioned central banks may justify the strengthening of their currencies against the Japanese yen, but it is important to note that speed of the accumulation in yen carry trades is largely founded on the verbal interference of Japanese policymakers, rather than weak Japanese data. Indeed, Japan’s economic growth is not at a level that justifies the deteriorating sell-off its currency. With Q1 gross domestic product (GDP) growth at 3.3% annualized, matching that of Q4, the rate of growth is well above that of the United States, which grew by 0.6%, 2.5%, 2.0% and 2.6% in Q1 07, Q4 06, Q3 06 and Q2 ‘06 respectively. Meanwhile, less than three weeks ago, Japan’s unemployment fell to a nine-year low of 3.8% while household spending increased by over 2.0% in April. This also explains the broad increase along the Japanese yield curve, where 10-year yields hit five-month highs.
Thus, Tokyo’s political realities of delaying a rate hike will only serve to accelerate the yen carry trades to economically unjustifiable levels, whose chances of a violent unwinding could easily materialize from:
a deterioration in U.S. housing
a reduction in risk appetite from CDO-related sell-off
a negative impact on U.S. housing and equities from renewed surge in U.S. bond yields; and
any improvement in Japanese data that points to stronger consumption. Indeed, the most immediate upside risk may emerge come from Japan’s tankan quarterly survey on business sentiment, due July 2, which is expected to tread near two-year highs after a gradual retreat in recent quarters. And with the currency at all time lows and equities at lofty levels, Japanese companies’ capital expenditure plans—a vital element of the survey.
Our medium-term USD/JPY forecast remains for further strengthening towards the 124.80s, which is the 50% retracement of the major decline from the August 1998 high (147.64) to the January 2000 low (101.21). The 125 figure has proven to be an important level of resistance in fall 1998 and spring-summer 2001. The aforementioned fundamentals in Japan as well as political pressure from the United States and the IMF are unlikely to permit prolonged yen weakness beyond these levels. Interim resistance stands at 124.30, followed by 124.55. Support holds at 123.70, backed by 123.40.
Euro joins liquidity wave, targets 1.3470
Despite a retreat in Germany’s sentiment survey, EUR/USD rallies to two-and-a-half-week highs amid absence of factors that could trigger nervousness in U.S. equities, i.e. absence of U.S. data. Germany’s IFO business sentiment survey slowed to a 107 in June from May’s 108.6, undershooting expectations of 108.4. The current assessment index slowed to 111.4 from 112.5, versus expectations of 112.3, while the business expectations slowed to 102.8 from 104.8 versus expectations of 104.5. We regard these figures as an ordinary cooling off levels that were not seen in over 20 years, rather than a sign of a protracted slowdown. Even though this week’s Germany’s IFO and ZEW surveys show that growth to may have reached a plateau, it is farm from a slowdown, thereby, not yet preventing the ECB from halting its tightening monetary policy course. Indeed, IFO economists indicate that Germany’s economy remains robust, and the export outlook still bright, adding that current euro levels are not hurting the economy.
In other data, German industrial orders fell 0.4% in April m/m, bettering expectations of a 0.8% decline, while the year on year rate showed a 12.2% increase following a revised 8.1% rise.
With no risk appetite-threatening data/events due today, prolonged gains in U.S. equities to prop the euro towards the 1.3460s and onto 1.3480 high. Nevertheless, U.S. equities could well retreat later in the session, as has been the case in recent Friday sessions. This is especially the case ahead of next week’s round of key U.S. housing data. Support stands at 1.3440, followed by 1.34.
CAD gains amid absence of threats
One day after selling off on disappointing retail sales, the Canadian dollar amasses fresh gains, dragging the USD towards the 1.07 figure from the yesterday’s three-week highs of 1.0752. Rising risk appetite and positive prospects for the U.S. stock session has consistently proven to be a favorable combination for CAD.
USD/CAD eyes support at 1.0680, followed by 1.0665. Upside capped at 1.0740.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
