The unwinding of carry trades that took place right after yesterday’s disappointing U.S. retail sales has intensified in Asia and Europe, as the Japanese yen pummels the higher yielding Aussie, Kiwi, Loonie, sterling and U.S. dollar. The depth of the global market rout is highlighted by the fact that gold prices have fallen $37 off their all $915 high as fund managers unload positions in the precious metal to meet margin calls in their losing positions in equities, oil and currencies. Yesterday’s S&P 500’s 2.5% tumble to 1,380 sent the index 1 point away from its August lows, while the Dow closed at 12,501, the lowest close since April 2007. Losses in Asia included a 5.4% decline in Hong Kong’s Hang Seng index and a 3.4% drop in Japan’s Nikkei-225, the lowest in 26 months.
Unlike in Monday, when the dollar fell across the board due to the possibility of an inter-meeting rate cut of 50 basis points this week, the current currency dynamics see the dollar rally against most currencies while continuing its damage against the yen. Also extending the unwinding of carry traders is the possibility that the Fed will NOT ease rates before Jan. 20, which would prolong market losses. In the event that the Fed waits until its scheduled meeting later this month, a 50 bp cut on Jan. 30 meeting will likely be poorly received by the stock market and further drag the Aussie, kiwi against the U.S. dollar, while damaging the latter against the yen. We would also see further selling in AUD, CAD and NZD against all majors.
If the Federal Reserve cuts rates this week, it will do it in the morning (before the opening bell) in order to stabilize sentiment from Asia and Europe. We do not place much importance in today’s 8:30 am release of the December CPI, which is expected up 0.2% from 0.8%, with core seen up 0.2% from 0.3%. Instead, we expect the 9:15 am release of December industrial production (seen down -0.1% from +0.3%) as a key mover for currency and equity markets. The 1 pm EST release of the Housing Market Index is expected to remain unchanged at 19. The 9 am release of the TICS report is unlikely to have a lasting effect on the market due to the two-month lag of the data. The 2 pm release of the Beige Book is expected to provide the anecdotal evidence of last week’s speech by Chairman Bernanke.
We argued in yesterday’s charts strategy that further declines are seen for the Aussie as long as the global equity sell off extended into Asia and Europe . We mentioned that in the event the Fed does not deliver a rate cut this week, we could Aussie nearing 0.8780 and 0.8730. We now adjust this target towards 0.8680. CAD/JPY risks downside losses are extending towards 103.00 and 102.70. AUD/GBP is set to extend losses towards 0.4440.
We continue to warn against a sharp reversal in these positions in the event of an inter-meeting as well as against holding Aussie shorts into next week when the Australia’s PPI and CPI figures are Sunday and Tuesday evening, which are expected to add to the odds of an RBA rate hike next month, thus reversing most of this week’s losses.
Yen flexes carry trade muscle
The yen broadens its rally and extends USD/JPY losses to fresh two and a half year lows, at 105.97. Yet we expect further upside in the currency against the Canadian dollar and British Pound, rather than the U.S. dollar and Aussie due to relative strength factors underpinning these currencies. Support stands at 105.70, while upside seen extending to 106.30 and 106.80.
Euro foundation shaky amid unwinding
The Euro’s decline found stability at our projected support of 1.4765—the trendline support extending from the Dec. 21 low, a break of which may extend towards 1.47 and 1.4660. The catalyst to such moves may be unexpectedly strong U.S. figures on Industrial production and housing. An inter meeting Fed cut is seen propelling the pair to as high as 1.4860.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
a.laidi@cmcmarkets.com
