- The USD bounces back on global weakness, positioning
- Eurozone debt concerns resurface
- JPY-strength may prompt official action
- Key data and events to watch next week
The USD bounces back on global weakness, positioning
Just a week after making new lows for the current decline, the USD has rebounded sharply against all other major currencies, though less so against the JPY. For the last several weeks, we had been suggesting that an eventual turn for the worse in economic data outside of the US would see the USD come back into demand. But where we were looking for a gradual turnaround in the data and most likely later in September, the shift came sooner and over a matter of days. A downgraded Fed assessment on the US outlook and data disappointments from all major economies (China, Japan, Australia, Eurozone) caught the market exceptionally short of USD and long others, triggering a massive rebound in the greenback. Mid-August doldrums and lower liquidity likely contributed to the rapid, one-way move. As of the end of the week, market anecdotes suggest real-money asset managers are still not on board with the USD recovery and are consequently lowering orders/offers to sell EUR/USD, GBP/USD, AUD/USD and other risk currencies. That the move was primarily safe-haven in nature is evident in US data continuing to show signs of weakness (meaning the USD was not being bought on better economic news) and sharp declines in US rates as investors sought safety in US Treasuries. Gold also strengthened alongside the greenback, suggesting gold was resuming its role as a currency alternative.
The reversal this past week was not solely a USD rebound, but also a EUR sell-off, as sovereign debt concerns resurfaced (more below). The Euro finished the week lower against all major currencies as a series of events raised concerns anew over the risks of a sovereign debt default. Early in the past week, the Irish government was forced to pump more funds into troubled Irish banks, already largely under state control. Disappointing June German, French and Eurozone industrial production offset a string of more positive data and highlighted a potential slowing in the months ahead. Even better than expected 2Q GDP in Germany and the broader Eurozone (a backward looking indicator) could not spark a EUR recovery. Weaker Greek and Spanish 2Q GDP readings served to remind that slower growth exacerbates budget deficits and increases debt service burdens. Lastly, the Slovak parliament rejected participating in the Greek EU aid package, drawing a sharp rebuke from Germany and the EU, and again rekindling fears of a currency union dissolution. We think there is more downside potential for the EUR ahead, especially if under the 1.2720/50 zone, and more upside potential for the USD. But while the US slowdown now seems increasingly priced-in to markets, further signs of US weakness should eventually make the traffic more of a two-way street, but that is probably after a move down to the 1.2450/2500 area in EUR/USD.
Eurozone debt concerns resurface
While recent European data has had a somewhat positive tone (EZ 2Q GDP rose to +1.0% from the prior +0.2%) the Eurozone still faces many headwinds with the most significant coming from sovereign debt concerns. Friday’s Italian bond auction attracted bids worth only 1.27 times the amount offered with a yield of 4.36%. This was a very poor number and down from the bid-to-cover ratio of 1.74 (and a yield of 4.42%) the last time comparable bonds were offered in May. While yields were rising in the peripheral EU (Spanish 10-yrs climbed 23 bps this week to 4.27%), yields on German 10-yrs fell to record lows today around 2.37%. Weak economic data from the peripheral countries ( Greece 2Q GDP fell -1.5% from the prior -0.8%, Spanish 2Q GDP at +0.2% QoQ missed expectations of +0.3% gain) raised growth concerns which drove safe haven demand into Germany ’s bonds pushing down yields. A look at the widening spreads between EU periphery debt and German debt ( Europe ’s benchmark) shows increasing worries. The spread between Greek 10-yr yields and German equivalents rose to 810 bps, the most since early May and the yield spread between 10-yr Irish bonds and German bunds widened to 294 bps, the most since late June.
At the same time that yield spreads are widening between the core and periphery nations, sovereign debt credit default swaps (CDS), which are a measure of the risk of default, are reaching elevated levels for the peripheral-EU. Ireland ’s 5-yr CDS reached 17-month highs on Thursday as it rose to 286bps and Greek CDS advanced to 825 basis points up from 782 last week. We believe that the trend in widening yield spreads between the core and periphery nations will continue as investors flee risk. This, coupled with ascending CDS, is likely to weigh on the euro in the coming weeks. The Irish bond auction to be held on Tuesday will be a critical near-term event risk. The Irish central bank may step in and buy bonds in the market, as it has been doing over the last few days, to offset any shortfall in demand. While this would technically avoid a failed auction, markets would not view it kindly and the EUR is likely to suffer further. Some key EUR/USD levels to keep an eye on to the downside are the 1.2750 pivot and retracement level and the 1.2610/20 cloud top and 50% retracement of the June-August rally. 1.2950-1.3000 should be the key pivot to the upside and although we expect this to hold as resistance a break higher could see towards 1.3200.
JPY-strength may prompt official action
Japanese officials from the BOJ Gov. to the Finance Minister, to the Prime Minister himself, spoke out against JPY strength in the past week. The JPY hit multi-year highs against the USD at 84.70/80 amid the safe haven panic mid-week, before pulling back on the intensified rhetoric. The BOJ reportedly 'checked rates' on Thursday in Tokyo , a move that potentially suggests that outright market intervention to weaken the JPY may be imminent. Up until recently, we thought the global politics of the situation would restrain Japan from active intervention, but sharp declines in Japanese shares highlight the risk a strong JPY poses to the Japanese recovery. JPY-strength not only hurts export-sector competitiveness and profitability, but also drives down share prices (the Nikkei hits its lowest level since July 2009 on Thursday), which undermines consumer and corporate sentiment even further, endangering the broader economic recovery. For these reasons, we think the risks of JPY strength have become too great to ignore for the MOF/BOJ, and that a break below 84.50/70 would likely trigger intervention. Market reports are of semi-official USD/JPY buying interest in the 85.10/20 area, and we would note a potential descending wedge pattern, where strength above the 86.50/60 level could trigger a sharp rebound in USD/JPY. We will also closely watch the reaction to a forecast drop in 2Q Japanese GDP (+2.3% annualized vs. prior +5.0%) due to be released Monday morning in Tokyo as a potential catalyst to JPY weakness.
Key data and events to watch next week
US data kicks off with the August Empire Manufacturing Survey and June TIC flows on Monday. Tuesday sees a heavy load of data releases beginning with July PPI followed by July Housing Starts, Building Permits, Industrial Production, and Capacity Utilization. The weekly data comes to a close Thursday with Initial Jobless Claims, August Philly Fed, and July Leading Indicators.
Euro-zone data starts off with July EZ CPI on Monday and the August ZEW Survey of Economic Sentiment on Tuesday. Of particular note considering the recent 17 month highs in credit default swaps on Irish government debt, the Irish government will auction EUR 1.5 bio in bonds on Tuesday; markets will be closely watching demand and price results as an indicator of appetite for beleaguered Eurozone debt. Wednesday closes out the data session with Euro-zone Construction Output for June. A light data session for Germany kicks off with August ZEW Surveys of Economic Sentiment and Current Situation on Tuesday and wraps up with Producer Prices for July on Wednesday.
UK data begins with July CPI, Retail Sales, and RPI on Tuesday. Wednesday sees the Bank of England Minutes and Thursday wraps up the week with July Retail Sales.
Japanese data kicks off with Q2 GDP and June Tertiary Industry Index on Monday morning in Tokyo . Thursday sees the All Industry Activity Index for June and Friday wraps up with July Machine Tool Orders. Although light in the data front, potential event risk exists in the week ahead as recent yen strength combined with aggressive rhetoric from Japanese central bankers increases the potential for BOJ intervention.
Canada sees June Manufacturing Sales on Tuesday followed by July Leading Indicators and June Wholesale Sales on Thursday. The data comes to a close with July CPI on Friday.
Australia sees the RBA’s August Minutes released on Monday. Tuesday sees the June Westpac Leading Index and DEWR Skilled Vacancies for August. In New Zealand, the data kicks off Wednesday with Q2 Producer Prices-Outputs, Inputs and wraps up with July Credit Card Spending on Thursday.
The only significant data out of China sees the Conference Board of China June Leading Economic Index released Monday.
Brian Dolan is chief currency strategist at www.FOREX.com.
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