Profit Taking Hits USD/JPY, Gold

Impact Of Profit Taking On USD/JPY And Gold

The U.S. dollar traded lower against all the major currencies Monday and this weakness drove USD/CHF to its lowest level in 2 years. The odds of December tapering increased after the latest non-farm payrolls report, but the move in the dollar along with the selloff in U.S. stocks and drop in bond yields suggest that there is still significant uncertainty surrounding Fed policy. With the chance of a reduction in bond purchases this month at 50-50, it is no surprise to see profit taking ahead of next week’s meeting especially on a day with no major U.S. data or comments from Federal Reserve officials. The greenback sold off the hardest against the Japanese Yen but not before the currency pair hit a fresh 6-month high overnight. With speculative positions at 5-year high, USD/JPY has been due for a correction. The lack of US data on Wednesday means the currency pair could sell-off for another day but we continue to see declines in the pair as an opportunity to buy at lower levels. The 103.74 year-to-date high is still in reach and the first opportunity for a break would be on Thursday when the U.S. retail sales report is released. A strong rise in consumer spending would revive the rally in USD/JPY.

The pullback in the dollar has also benefitted commodities. Gold and silver prices rose to their strongest level in 3 weeks. This was the third straight day of gains for the yellow metal and also the longest rally in 3 weeks. Tapering by the Fed is bearish for commodities but if the decision is supported by good data, the pain may not be as significant. In many ways, the 26% drop in gold prices suggests that commodity traders have already discounted the move. If investors believe that there is enough demand to offset the impact of tapering, gold could prices could stabilize. Of course, short covering is also playing a role in Monday’s price action because gold and silver short positions have been at record highs. However unless there is a fundamental shift in the outlook for the U.S. economy or Fed policy, the impact of profit taking on gold and USD/JPY should be limited.

EUR Hits Fresh Highs Despite Dispersion In Growth

EUR/USD climbed to a fresh 1-month high just shy of 1.38 Monday despite mixed euro-zone data. According to the latest industrial production reports, manufacturing activity increased in Italy and deteriorated in France. This follows the surprise drop in German industrial production earlier this week. With each piece of incoming data, we are seeing more divergence in euro-zone growth. The disparity in the recoveries of various parts of the region is deepening and the downturn in France in particular should be a concern for the central bank, especially since German data has taken a turn for the worse. But the two-speed growth in Europe has not stalled the EUR/USD rally because the European Central Bank hasn’t expressed any specific concerns. ECB President Draghi did not touch on monetary policy in his speech Monday but according to ECB Governing Council member Coeure, the ECB is ready to act if needed but more LTROS would only be offered when banks can lend and there is no need for large scale asset purchases. Their relatively nonchalant view on the need for easier monetary policy is one of the main reasons for the EUR/USD’s resilience in the face of weakening data. Looking ahead, any revisions to German consumer prices is not expected to have a significant impact on the euro.

NZD: What To Expect From The RBNZ

The Australian and New Zealand dollars traded higher against the greenback Monday ahead of the RBNZ’s monetary policy announcement. Of all the major central banks, the RBNZ is the only one talking about raising interest rates next year. When we last heard from the RBNZ, not only did they say that rates will rise in 2014 but according to central bank Governor Wheeler, rates will increase 200bp or 2% by the end of 2015. Considering that some central banks are still thinking about increasing stimulus and others are only looking to unwind their asset purchases programs, the hawkishness of the RBNZ has and should continue to keep kiwis in demand. Outside of a decline in food prices and drop in building permits, every piece of key New Zealand data showed the economy improving from the last meeting. Thanks to stronger job growth, the people of New Zealand have grown more confident and this sentiment has boosted consumer spending, business and service sector activity. The problem is outside their borders – there are signs of slower growth in China and Australia, New Zealand’s 2 largest trading partners. With Wednesday’s announcement, the main question will be whether the recent appreciation in the currency has delayed the central bank’s plans to raise rates. As an export dependent economy, the level of the currency is extremely important for New Zealand. Currently, the RBNZ is expected to raise interest rates around March 2014 but if they place greater emphasize on concern about the currency over the brighter outlook for the economy, the NZD could weaken as investors interpret this to mean later tightening. It is hard to say where they stand because in late November Assistant RBNZ Governor McDermott said the exchange is overvalued and out of line with that is necessary for New Zealand to achieve its economic goals. He added that the central bank would like to see a lower exchange rate. In the last RBNZ statement however, the central bank noted that the currency remains high but simply said these gains provide flexibility on rate rises. While the value of the NZD/USD hasn’t changed significantly, the New Zealand dollar appreciated significantly against the AUD and this rise is more important for the country’s trade activity. Yet the RBNZ’s pain threshold for the currency could be higher now that China overtook Australia to become New Zealand’s number one trading partner in April and the NZD/CNY rate has not changed much since the last meeting. If the RBNZ sounds more concerned about the high level of the currency, we expect the NZD to fall after the rate decision. If their views on the exchange rate remain unchanged, the NZD should extend higher.

GBP: Mixed Data Solidifies BoE Steady Stance

The British pound climbed to a fresh 1-year high Monday against the U.S. dollar but the move was driven risk appetite and not U.K. data since sterling lost value against the euro. The latest U.K. economic reports were mixed. Industrial production rose 0.4%, which was slightly more than expected but weaker than the 0.9% pace of growth seen in September. The trade deficit on the other narrowed to -9.7B from a downward revised -10B but economists had been looking for a more significant improvement to -9.2B. These reports suggest that while the manufacturing sector is still recovering, weaker activity abroad is hampering the overall progress. The housing market is also continuing to improve with the RICS house price balance rising to its strongest level since 2008. While the increase was less than economists had anticipated, expectations have also been notched higher due to the outperformance of the U.K. economy. The slow improvements seen in Monday’s reports explain why the Bank of England is in no rush to raise interest rates.

Profit Taking Drives Yen Higher

The Japanese Yen traded higher against most of the major currencies Monday but not before hitting fresh 6-month highs against the U.S. dollar, a 5 year high against the euro and British pound and 23 year high against the Swiss Franc. The only piece of noteworthy data from Japan last night was consumer confidence, which increased slightly in the month of November. The Nikkei was flat which suggests that the sell-off in yen crosses can be largely attributed to profit taking. With no U.S. data to support the move higher in USD/JPY and no more comments from FOMC officials before the December meeting, investors are reducing their short yen exposures ahead of Thursday’s U.S. retail sales report. As we wrote on Monday, short yen positions are at their highest level since June 2007 and when positioning reaches such extreme points, profit taking can be expected. However we continue to view pullbacks in USD/JPY as an opportunity to buy at lower levels as long as the sell-off is contained to 101.50. If this support level is broken, it may be smarter to wait for an opportunity to buy below 100. It is also worth noting that Prime Minister’s Abe’s approval ratings have plunged 10% after the diet approved a law that would penalize government officials for leaking confidential information. While this would normally be viewed as a positive development, a number of members of the Your Party announced their plans to resign from their party. Political trouble is never good for a country’s currency – right now it is not a major issue but if Abe’s approval ratings fall further, the Nikkei could slide, dragging the yen crosses down with it. Tuesday night’s Japanese corporate goods price index and machine tool orders are not expected to have a significant impact on the Yen.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.