A look at the major foreign exchange pairs.
But first a quick retrace of where we have come from.
The US$ index has been in a bear market trend since forming a double top price range in the period June to end July 2013. Conversely the Euro has enjoyed a reasonably strong bull market vs the US$ during the last 7 months or so. This recent cyclical bear trend of US$ weakness appears under pressure here and there are some signs this is more serious than prior attempts on trend support. This ties into the eurusd cross as the pair contributing pair to the $ index. The euro has seen a cyclical bear market vs the US$ from its 2007 peak value. This 6 year trend scored a sept2013 breakout for the euro to the upside. This breakout initially got support but has subsequently faded. The 1.35 level area of first trend line support and subsequently the 1.32 area must hold if this 4 month old breakout is to sustain.
Given monetary policy, economic growth divergence and private sector credit creation divergences its hard to envisage a macro scenario whereby the euro bull trend vs the US$ can hold in the coming months. The only macro way the US$ would once again come under immense pressure if the FED step back from their taper and even expand their monetary creation measures. Private sector loan growth in the US is positive but barely so as US consumer mortgage applications slow.
Are there grounds for a continuation or even increase of monetary creation measures?
Today the US released its latest inflation nos. The inflation rate has dropped to 1.5% as the annual rate. European inflation fell to 0.8% and the UK inflation rate fell to 2% or nearly half her 2.9% reading back in June and the lowest reading for four years. Australian unemployment is the highest for four years as the slow down in EM countries countries and therefore demand for Australian commodities continues.
The divergence between developed and emerging markets is going ever wider. Stagflation is threatening many emerging markets whereas inflation threatens many EM states. Many Em currencies are plunging s the US$ now as a scenario of low growth and inflation hits many inc Turkey, Brazil, etc.
Assuming you are a neo keynesian and believe there exists a correlation between money creation and growth then yes there is certainly scope or more not less given the low growth and inflation recent data.
The asset price consequences of such measures are not central bank’s primary concern. Or so they tell us.
If we are to believe the recent speeches by FED central bankers tapering money creation does seem likely to continue in the coming months. US rates are rising and real rates are rising more rapidly still as rates rise and inflation falls. This rise in real rates is likely to be very supportive for the US$ and GBP currencies should recent trends in inflation and bond prices maintain.
With this back drop in mind lets look at the latest reports.
Here Citi to kick us off on their weekly run through the FX major pairs.
And here Barcap with their own weekly
And here the CS team with their ‘FXcompass’ comprehensive doc from last week. (apologies for the delay)
And here the UB team
And here JP with there daily FX technical strategy paper from the 14th:
And here from 15th
And here JP on the all important US$ credit (fixed income) markets.
And note the near term distribution at present, albeit within a higher 2014 rate environment. (Unless inflation jumps quickly and soon, real rates will rise faster).
Note, I want to make a very quick comment here on spreads between corporate paper, sovereign USTs and junk bonds. The spread is narrower than we have seen since the credit crisis. Why? Because the markets are on fire and heavy with the belief that this recovery is widening and that this year as opposed to 2013 earnings will rise for all and therefore the smaller cap, junk bond cos will do well. Either this is the reason or there is price momentum in a liquidity rich market and speculators are buying the chart rather than the fundamental view. I believe its the latter not the former! Otherwise why would the market breadth for smaller cap cos (nyse) be so poor. Why would so many smaller cap cos be missing this rally entirely were it not for the fact that so many are struggling. In this situation it appear the market may be totally mis-pricing the spread of junk bonds to higher grade paper.
Not that i trade cdfs for junk bonds (as mainly over thee counter) but if you are a asymmetric trader bets on junk bond insolvency is very cheap at present. The junk bond markets are booming again on a wave of optimism that the equity markets are not demonstrating. Either sme indexes are a screaming buy or junk bond insolvency protection is a screaming buy. The asymmetric traders may buy both on the basis that the probability of the current ‘status quo’ remaining is next to zero!
Here, the government owned, RBS moving back into the high risk junk market.
Risk taking whether in equities or the art market or here junk bonds is the vogue now again given the central bank’s zero interest rate and monetary creation policies.
Never mind the taper, rising real interest rates and falling inflation. High risk junk $ bonds keep rising and issuance keeps accelerating.
http://www.moneynews.com/InvestingAnalysis/junk-loans-Kroger-Harris-Teeter/2013/12/23/id/543394
I mention these things as the US$ is the funding world wide currency for most credit markets. And especially in junk bond markets! Ie if the US$ strengthened rapidly these excesses of risk taking illustrated by the spread to corporate paper would evaporate over night. High risk junk bond markets are very liquid as are many equity markets even now. Volumes are light even as prices reach record levels and momentum is high. This mix of factors sets the stage perfectly for a higher US$, higher real rate, risk off, crash. I’m not forecasting a crash but the factors that could create one are one by one forming!
Back to Fx pairs
Here CS and their FX strategy released today
And here the Nomura technical trading team with their near term analysis of the eurusd and usdjpy. I agree that the euro is under enormous pressure here technically. She is at her trend line within a trend up vs the US$ that has lacked momentum for most of the move. If she slips beneath her price supports, as above, the sept13 breakout will be failed a breakout. From failed moves come fast moves! We also have very likely news events very close inc the German court ruling on OMT as well as new ECB unconventional measures. If/when the ECB does announce some monetary measures expect technically the euro to collapse vs the GBP and US$. The technical jigsaw is in place to allow this to occur. Macro wise official deflation is very close now and private sector credit creation c0ntinues to slide in most member states Germany aside.
And here on the USDJPY. I left the trade at 1.05 and change and happy to be out. You can always chase trades for more but i prefer to take the “easy money” off the table and come back when the risk reward is more favorable for a long term entry.
My own book is long US$ and long GBPs. I am borrowing euros to fund the few euro long equity positions i still hold. Its a fairly defensive position. I have no asymmetric option positions on FX or bullion at present though i believe a long US$ option call vs the euro and or some em currencies taking a 3 month view could well be a wonderful position especially where 3 month volatility is low.
I do still hold some cad assets fully cad funded. I am reviewing whether this should be funded via borrowed cads, long us$s given the AUD’s recent fall and the general strong US basket scenario as above.
Here finally CS with a view on the cad for 2014.
2014 is shaping up to see increased volatility return to the FX pairs. This is good event for traders and should feed into volatility for all asset markets. Increased volatility implies lower risk taking and leverage which is bad for asset prices generally. Time will tell but these are the omens for now.
All the best
Rich