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Foreign Exchange

FX research roundup: EUR/USD rally continues to march but JPY is gaining favour

A couple of weeks ago Nick Beecroft told me that he reckoned we might be moving into a period where US economic weakness trumped Eurozone debt concerns. I didn’t pay the idea much attention. EUR/USD had bounced from the lows, failed to break 1.2500, and retraced back to a 1.22 handle. It looked to me that we’d had a shakeout and the move towards parity could resume. But Beecroft was absolutely right; I was daft not to pay a little more attention to the opinion of a man who’d run the FX operations at Deutsche, Citi and Standard Chartered.

The rally in EUR/USD has caught a few commentators on the hop. Simon Derrick at BNY/Mellon writes this morning that “with EUR/USD moving beyond our corrective target of 1.2700, we need to revisit our view of the world”. Derrick has analysed the flow data and finds that foreign investment in the US may have lost its shine: “The first surprise is that we have monitored some active outflows from the USD over the past couple of weeks, matching the noticeable turnaround in the USD index. The second surprise is that our data fail to show any meaningful interest in US paper overall from foreign investors.” Derrick concludes that: “It is only a matter of weeks ago that we found ourselves talking about longer-term problems for the USD. Could it be that they are emerging far, far quicker than we imagined?”

Regardless of the recognition of US difficulties, there should be a limit to the degree that the Euro can benefit: Paul Day at Market Securities has the manically precise target of 1.3284 in mind, while BNP Paribas targets 1.3110. But Morgan Stanley is already increasing the EUR/USD short in its portfolio from 10% to 20% and still keeps faith with the US economy: “Though economic data have recently come in softer than expectations, we still believe US growth will be among the strongest in the developed markets this year.” Morgan Stanley sees the rally as little more than a short squeeze and gives more credence to weak Eurozone data (ZEW and Industrial production) than weak US data.

Picking the least ugly from the currency beauty parade has meant that a lot of the strategy papers are now commenting on JPY strength:

BNY/Mellon sums it up well: “If so then the question of what safe haven assets to hold has just become even more fraught. This may go a long way towards explaining the continued strong performance of the JPY (despite the problems facing Japan [the quintessential deflated economy] and the apparent damage this strength is doing to the Nikkei 225).”

BNP notes that: “...the BoJ has raised its growth forecasts for the FY2010 to 2.6% from 1.8% previously. We expect Japan to be the fastest growing economy among the G3 in 2010.” BNP looks for a retest of 87.00 and a further break down to trend-line support, currently at 85.15, in the medium term.

Derek Halpenny at Bank of Tokyo Mitsubishi notes that the strengthening yen contributes to underperformance in Japanese equities and that “...the Japanese authorities must be somewhat concerned with the idea that Japan’s large liquid [securities] market has enhanced Japan’s safe-haven status” and that this is compounded by “...the news that China is aggressively buying short-term money market instruments in Japan...with the record May total coming in the midst of a collapse of confidence in euro-zone assets. Certainly central bank holdings of yen are extremely low and with yields so low globally, the liquidity on offer in Japan may be proving attractive temporarily.”

But Morgan Stanley, still the USD bull as mentioned above, takes the contrary view: “...long USD/JPY positions remain a core view. The recent strength of JPY is not surprising, as the currency trades with a high correlation with US front-end yields, which have fallen dramatically this year. That being said, as the global economy recovers and interest rates broadly begin to rise, the BoJ will likely continue to keep rates anchored to battle deflation. As a consequence, JPY is likely to weaken as investors seek higher yielding assets abroad.”

As they say, you need differing views to make a market.


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