Yen holds ground amid intervention risk

The Week Ahead:

  • Did things just get better or worse?
  • JPY holds its ground as a safe haven but intervention risk remains high
  • Extraordinary CHF strength calls for extraordinary SNB measures
  • Taking a look at intermarket analysis
  • Key data and events to watch next week

Did things just get better or worse?

Regular readers of TWA will know we have been cautioning since early June that risk markets (Stocks, commodities, JPY-crosses, CHF-crosses and commodity currencies) were ripe for a serious setback as incoming data consistently disappointed and optimistic outlooks needed to be tempered. We think the declines of the past two weeks constitute that pullback, though we were somewhat surprised by the speed and degree of some of the declines. At this point, we think markets have broadly adjusted to the more sluggish global recovery we had projected and we’re cautiously optimistic that the worst of the downturn is behind us. We also think markets likely overshot to the downside this past week and we’re leaning toward upside corrective potential in coming weeks. It’s too soon to sound the all-clear, but a number of key developments have occurred that suggest to us that markets should stabilize at the minimum, and possibly rebound further.

The ECB, dragged kicking and screaming as the Eurozone institution of last resort, has been successful in stabilizing Spanish and Italian government debt markets, with 10-year yields for both back below 5%. The ECB will need to maintain its debt buying likely for months to come to ward off fresh speculation, but for now the contagion has been stopped. We think concerns over France are a red-herring and would note the credit rating affirmations and stable outlooks from the major ratings agencies as more important. The Fed has taken the unprecedented step of attaching a timeframe to near zero interest rates (until mid-2013) and this should remove any uncertainty that the Fed will act too soon. But it’s also a reminder of the weakness of the US recovery and the overall state of the global economy. Along those lines, the Fed’s action opens the way for other major central banks to step back from additional tightening, and we think the low interest rate environment will ultimately be more growth supportive. Additionally, central banks from the SNB to the BOE to the BOJ are considering additional easing measures to support the economy or weaken the currency in the case of Switzerland and Japan . We think the actions of major central banks are likely to calm markets further in coming weeks (they finally ‘get it’), and investors are most likely to return to markets to take advantage of recent declines.

In line with our more optimistic interpretation of this past week we would shift our overall bias to buying risk assets on dips, rather than chasing what may prove to be only a short-term rebound. (See more in Intermarket Analysis below.) In particular, we would focus on buying dips in the CHF- and JPY-crosses, especially against the commodity currencies, like NZD/CHF . Commodity currencies (AUD, CAD and NZD) look to us to have further recovery potential higher against the USD, which should stay soft on the Fed’s zero rate pledge, sluggish US growth, and a potential further rebound in risk appetite. We will be closely watching various risk cross pairs to see if they can rise above the daily Ichimoku Kijun lines, a major upside pivot after recent declines. Encouragingly for our ‘risk on’ view, NZD/CHF is finishing the week above its 0.6429 daily Kijun line.

JPY holds its ground as a safe haven but intervention risk remains high

The Japanese yen was the largest gainer against the greenback this week with an advance of over 2% against the buck while the remainder of the G10 currencies softened against the USD. In a week of tremendous uncertainty and volatility, the yen emerged as the only safe have to hold its ground. CHF corrected lower following increasing rhetoric from the SNB and rumors of a potential peg to the euro while gold declined amid increases in margin requirements. The Aug. 4 unilateral intervention which is estimated to be a record amount of nearly 4.5T yen has already seen USD/JPY pare gains to trade back near record lows. The previous single day record amount of intervention was the 2.12T yen sold on Sept. 15. The market reaction has not been proportional to the increasing scale of intervention. Thus, we would expect that the element of timing rather than size alone is likely to be of importance when the BOJ decides to be active in the FX markets again.

Japanese Finance Minister Noda was on the wires Friday noting that ‘yen moves have been one sided’ and he called on the G7 to take action in the coming weeks. Noda mentioned that he will keep watching the markets closely and that more time is needed to evaluate the intervention effect. Economic data of late has been disheartening with a downward revision to CPI that showed deflation in June of -0.2%. The government recalculated previous figures to change the base year for prices from 2005 to 2010. The country faces deflation and is already back in a recession with two consecutive quarters of negative GDP highlighting the fragile economy. The week ahead sees the preliminary 2Q GDP figures which are expected to show continued contraction with the market forecasting a print of -0.6% q/q from the previous -0.9%. Continued economic weakness may prompt the BOJ to take action as a strong yen will limit growth by restraining exports.

Key technical levels in USD/JPY include the all-time lows of around 76.25/30. A break below may see losses extend towards the psychological 75.00 figure. To the upside, the 21-day SMA comes in around 77.90/78.00 which also happens to be where the weekly Kijun line lies. A move above here may see towards the 80.00 figure which is where the base of the daily ichimoku cloud is seen in the middle to later part of the week ahead.

Extraordinary CHF strength calls for extraordinary SNB measures

The SNB has undertaken a number of measures to curb record shattering CHF appreciation over the past two weeks. A number of officials ramped up rhetoric with Governor Hildebrand stating ‘the franc represented a danger to the economy’. Not only did the central bank talk the talk, but they walked the walk – measures taken so far include two increases to Swiss banks’ sight deposits of +CHF50B on August 3rd followed up with another +CHF40B on August 10th totaling CHF90B, narrowing the 3-m Libor target range to 0-0.25%, and conducting foreign exchange swap transactions to accelerate CHF base money supply. The SNB’s intentions have materialized into results as CHF has lost about 7 big figures against the buck to 0.7700 and EUR/CHF reversed from a near test of parity to current levels around the 1.1000 figure. However, some of the sharp CHF declines are attributable to elevated speculation of a potential franc-euro peg and a 1% tax on CHF deposits. Further fueling CHF weakness was the relief rally in risk which extended from Thursday into the weekly close.

Reports on Thursday noted SNB Vice Chairman Jordan indicating that the central bank ‘could take any temporary measures to influence the exchange rate’. This is in direct contrast to Hildebrand’s comments on August 5th that ‘a fixed CHF-EUR exchange rate would be incompatible with the SNB’s job’. We tend to agree with the Governor’s comments and think a franc-euro currency peg would only be considered upon exhaustion of alternative measures mainly due to the multitude of political/implementation risks involved in its undertaking.

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