Behind The Swan Dive In USD/JPY

Behind the Swan Dive in USD/JPY

EUR: Crushed by Italian Election Mess
Will Big Ben Add to the Pain?
GBP: Holds Steady in Europe and North America
CAD: Hit by Cautionary Comments from Carney
AUD: RBA Debelle Still Open to Rate Cuts
NZD: Chinese Manufacturing Activity Slows

Behind the Swan Dive in USD/JPY
Saying that it has been an extremely active day in the foreign exchange market is an understatement. The biggest mover was USD/JPY, which fell more than 1.6% on zero news. While this was the largest one-day decline for the currency pair in 2.5 years, it was a move that was not caused by changes in Japanese fundamentals. Instead, the euro was under pressure for most of the day because of the Italian elections and that led to selling in all euro crosses including EUR/JPY. EUR/JPY fell as much as 600 pips or 5% intraday and this dragged USD/JPY down with it. When 92 in USD/JPY was broken stops were triggered, taking the currency pair below 91 in a matter of minutes. In other words, if you blinked, you missed the move in USD/JPY. EUR/JPY and USD/JPY were not the only Yen crosses affected – AUD/JPY, NZD/JPY and CAD/JPY fell more than 2% while GBP/JPY and CHF/JPY dropped more than 1.6%. However the speed of the swan dive in the Yen crosses suggests that a major hedge fund could have been unwinding its short Yen position. Its no secret that many big players are short Yen. Less than 2 weeks ago, the Wall Street Journal published an article talking about how major hedge fund players like George Soros and David Einhorn have made hundreds of millions to as much as a billion dollars shorting the Yen. It wouldn’t be a complete surprise if some funds decided to liquidate.

Have the fundamentals in Japan changed? No. Prime Minister Abe still hasn’t announced his candidate for Bank of Japan Governor. It is widely believed that Asia Development Bank head Haruhiko Kuroda will be chosen and he is a well known dove whose policies won’t be kind to the Yen. When the nomination occurs, we expect Kuroda to publicly affirm his commitment to easing monetary policy aggressively and reaching the BoJ’s 2% inflation target within 2 years. We expect the rally in USD/JPY to be renewed by Kuroda’s official post nomination comments. It is important to remember that the Bank of Japan has not changed monetary policy this year. Shirakawa’s plan is to increase asset purchases in 2014, leaving the door open for the new BoJ Governor to make changes this year. When then new central bank head takes office in April, he is widely expected to act aggressively and that is when we expect USD/JPY to trade above 95. Of course, this could happen sooner if the market starts to price it in. We believe that investors should look at the decline in USD/JPY as an opportunity to buy at lower levels.

EUR: Crushed by Italian Election Mess
While USD/JPY was the biggest mover, the primary focus today was the Italian elections. The results are a complete mess. While Bersani appears to have won the lower chamber, Berlusconi may have won enough votes in the Senate to block his win. Even these results are changing by the minute because at the time of publication, there are some headlines that say the comedian Grillo may be leading Bersani in the lower house. This would be the worse case scenario for the euro and Italian finances because it means that we could have a Berlusconi-Grillo led government. If Bersani wins the lower house and Berlusconi wins the Senate, new elections may be needed because the current results could make the country ungovernable and therefore prolonging the uncertainty for the euro. What is clear however is that the Italians have voted against Monti and his austerity measures which the market have applauded. We’re not experts in Italian politics, so we quote the Wall Street Journal here that says “The result is that Italy may, over the next few weeks, try to form a temporary government backed by a grand coalition of left and right-wing forces with the sole aim of changing Italy’s electoral law and then going to a vote again as early as summer. It isn’t clear who would run such a short-lived government.” What we do know is that none of this is good for the euro. Italian bond yields have only increased slightly, but if Bersani loses completely, we expect the EUR/USD to fall to 1.30. Even if he wins, it is hard to imagine that the market will cheer his slim victory. We don’t expect the Italian election results to drive the EUR/USD to 1.25 but it could have a bit more impact on the euro before the focus shifts and investors move on to growth and ECB monetary policies.

Will Big Ben Add to the Pain?
The U.S. dollar traded higher against all of the major currencies today except for the British pound and Japanese Yen. No U.S. economic reports were released but the desire for safety spurred demand for the greenback. EUR/USD and USD/JPY sold off aggressively today and the question tomorrow is whether Fed Chairman Ben Bernanke will ease or add to the pain. Unfortunately we can’t see both currency pairs benefitting from Bernanke’s semi-annual testimony. Thanks to the FOMC minutes last week, the U.S. dollar soared against most of the major currencies. The mere possibility that the U.S. central bank could start to taper off its monthly asset purchase program as quickly as next month sent investors rushing to adjust their positions. While the unevenness of U.S. data makes it hard to believe that the economy is strong enough to withstand less stimulus, Fed President and FOMC voter Dudley made it clear that small adjustments could be made to ease the pain of stimulus withdrawal. The question now is where Bernanke, our mild mannered inflation dove agrees. The head of the U.S. central bank will be delivering his semi-annual testimony on the economy to Congress tomorrow. It is always an interesting session to watch because of the colorful question and answer session but if Bernanke confirms that changes to the monthly asset purchase could be made as quickly as next month, the dollar could extend its gains against the euro and other major currencies. However if he chooses to vigorously defend the central bank’s ultra easy monetary policy and downplays the need to slow or stop their asset purchases, it could help the EUR/USD find bottom but could lead to additional losses in USD/JPY. House prices are due for release tomorrow along with consumer confidence. Based on the improvement seen in the University of Michigan consumer confidence report, we expect an increase in consumer sentiment. However any improvement or deterioration will still take a back seat to Bernanke’s testimony.

GBP: Holds Steady in Europe and North America
The British pound held up incredibly well in light of the sell-off in the other major currencies and the downgrade by Moody’s. The EUR/USD and USD/JPY have plunged and yet the GBP ended the day unchanged against the U.S. dollar. Moody’s dropped a bomb on the British pound half an hour before U.S. markets closed for trading on Friday. For the first time ever, a rating agency stripped the U.K. of its prized AAA rating. When it comes to downgrades, what the market is most worried about is the impact on borrowing costs and therefore the decline in U.K. bonds reassures investors that the U.K. will not have to pay up for having a lower rating. We still believe that sterling is headed lower in the near term because the downgrade increases the need for more stimulus to promote growth and fix fiscal finances. The main driver of Moody’s decision “to downgrade the UK’s government bond rating to AA1 is the increasing clarity that, despite considerable structural economic strengths, the UK’s economic growth will remain sluggish over the next few years due to the anticipated slow growth of the global economy and the drag on the UK economy.” Recent U.K. economic reports confirm that the recovery is losing momentum. Retail sales fell in January, showing a weak start to the year for consumer spending. In fact, consumption failed to increase for the past 4 months and conditions are so worrisome that Bank of England Governor King voted with the minority this month in favor of more Quantitative Easing. Therefore Moody’s concerns about economic growth are well placed and if the U.K. government wants to reverse this trend, one way would be to encourage the BoE to provide greater cushion for the U.K. economy by increasing monetary stimulus. As a last resort the U.K. could also print more money to finance its debt, which would be negative for the GBP. So while the GBP/USD held steady during the European and North American sessions, we are still looking for further losses in the pair.

CAD: Hit by Cautionary Comments from Carney
Weaker Chinese economic data and the turnaround in U.S. stocks drove commodity currencies lower against the greenback. The losses were the most severe in the Canadian dollar, which fell to a 7 month low against the greenback on the comments from Bank of Canada Governor Carney. “Economic data has been breaking to the downside” and “Q4 growth may be weaker than the bank forecasted.” While he still believes there’s a need for withdrawal of stimulus, it is “less imminent.” The shift in the Bank of Canada’s tone has driven the loonie sharply lower against the U.S. dollar since the beginning of the year and unless economic data starts to improve, there’s nothing standing in the way of further losses in the CAD. Meanwhile, weaker than expected Chinese PMI numbers drove the Australian and New Zealand dollars lower. HSBC’s Flash manufacturing PMI index dropped to 50.4 from 52.3 in the month of January, which was the first decline in 5 months. While the data may have been distorted by the Lunar New Year holiday, most of the components are still in expansionary mode which should limit the damage to the AUD. RBA Deputy Governor Debelle spoke I Adelaide today and he did not sound nearly as neutral on monetary as RBA Governor Stevens. Debelle says the central bank retains scope to lower interest rates if needed and with the A$ “somewhat on the high side, the RBA can cut rates to counterbalance A$ pressure.” The AUD fell on the headlines but recovered quickly thereafter. No major economic reports are expected from the commodity countries tomorrow.