USD and JPY Succumb to Rebound in Risk Appetite

Summary

The USD rally came to a violent end today, as concern over the European sovereign debt crisis waned and renewed risk appetite sent global equities higher. While some suggest that this is merely a dead-cat bounce for the EUR, the selloff in the JPY and gains in both commodities and commodity linked currencies suggest that this may reflect a change in risk appetite as much as a technical correction in the EUR.

Headlines

UK: BOE Chief Economist Spencer Dale said that the central bank remains determined to tackle inflation. "The Monetary Policy Committee remains as hard-nosed as ever in its determination to hit the inflation target (of 2.0%)," Dale said. "The onus is on us to explain why, in the face of persistently above-target inflation, we are not tightening policy." His "central view" is that the direct impact of the fiscal squeeze is "unlikely to derail the recovery." The "cuts will certainly dampen growth," he said. "But the substantial stimulus from monetary policy and the lower level of sterling should ensure that the recovery continues."

US: White House economic advisor Paul Volcker said the USD is in danger of losing its role as a global benchmark currency. "The growing question is whether the exceptional role of the USD can be maintained." Volcker added that "this is a troubling time for America, a troubling time for the world" and "the time is gone when the US could lay claim as the putative superpower with both unchallenged economic and military might." "The growing sense around much of the world is that we have lost bother relative economic strength and more important, we have lost a coherent successful governing model to be emulated by the rest of the world," Volcker said. "Instead, we're faced with broken financial markets, underperformance of our economy and a fractious political climate."

US: Richmond Fed President Jeffrey Lacker said he is leaning against continuing QE II through mid-2011. "I personally am not well disposed to going on with it, but we will see how the data breaks," Lacker said. He added that "I was one at the last meeting who thought the risks exceeded the benefits. The benefits are kind of small. Risks, while small, would have made me tilt against doing it." "I take really seriously the references in the statement to us re-examining as we go along," Lacker said. "We are going to look at it every meeting."

Lacker said that the US economy will grow about 2.75% to 3.0% in 2011, with "even odds" that the unemployment rate will drop to about 9.0%. "Unemployment is going to fall slowly," he said. "Growth is kind of sluggish right now and inflation pressures are pretty darn quiet." "I don't put high odds on us needing to tighten next year." "Anytime you put in monetary stimulus one of the effects will be to weaken the value of the currency" and help growth "through the trade channel." Lacker said policy makers have stopped intervening in currency markets and he is opposed any move to change that. "We have stopped doing them pretty much for good I hope."

US: St. Louis Fed President James Bullard said that it is "okay with me" to change the central bank's dual mandate for preserving price stability and maintaining full employment. "Our best contribution to the dual mandate is to provide a stable price backdrop," Bullard said today. Some lawmakers in Congress are looking to modified the Fed's dual mandate, and direct it to focus solely on maintaining price stability.

US: Dallas Fed President Richard Fisher said "we are in a gradual state of repair." Fisher is among the Fed officials who have criticized the FOMC's decision to go forward with QE II, saying last month that it may be "the wrong medicine" for the economy's ailments.

US: The ADP employment report for November reflected a gain of 93K jobs from a revised 82K in October, on consensus expectation of 70K. Upward Historical revisions contributed to the reports positive surprise, with October revised to 82K from 43K and September revised to 29K from a prior -2K and an initial 39K. Historical revisions totaled a new +70K jobs in addition to the+23K over expectations for the November number, nearly identical to the prior month's positive surprise.

US: The ISM manufacturing index eased to 56.6 in November from 56.9 in October on consensus expectations of 56.5. This was the 16th consecutive month of expansion in the manufacturing sector. Eight of the ten components in the headline index remain above the 50 boom/bust line, with order backlogs and customer inventories the only areas reflecting contraction. Notably, the employment component was 57.5 in November from 57.7 in October and a cycle low of 25.9 in February 2009.

US: Chicago PMI rose to 62.5 in November from 60.6 in October, on consensus expectations of 53.0. Elsewhere, the Milwaukee NAPM rose to 59.0 in November from 56.0, on consensus expectations of 57.5.

US: The Fed's Beige Book said the US economy gained strength across much of the U.S. as hiring improved, manufacturing expanded and retailers anticipated a stronger holiday shopping season. Five Fed banks, including Boston and San Francisco, said the economy grew "at a slight to modest" rate, while five others, including New York and Chicago, reported a "somewhat stronger pace of economic activity." Conditions were reported as "mixed" in the Philadelphia and St. Louis regions. The positive outlook from 10 banks contrasts with the October report in which eight Fed banks, including San Francisco and Chicago, reported growth. The beige Book report released today reflects information collected on or before Nov. 19 and summarized by the Cleveland Fed.

Dow 11,255.78, +2.3%; NYMEX Crude Oil $86.81, +3.2%

The USD rally came to a violent end today, as concern over the European sovereign debt crisis waned and renewed risk appetite sent global equities higher. While some suggest that this is merely a dead-cat bounce for the EUR, the selloff in the JPY and gains in both commodities and commodity linked currencies suggest that this may reflect a change in risk appetite as much as a technical correction in the EUR. The EUR/USD rose as high as 1.3182 by 11:53am EST from an overnight low of 1.2971, before trading back to 1.3140 by the close. Separately, GBP/USD rose as high as 1.5648 by 5:19am from an overnight low of 1.5548, before trading back to 1.5625 by the close. The JPY joined the USD in the selloff, with USD/JPY rallying to a high of 84.40 by 9:55am from an overnight low of 83.38, before trading back to 84.20 by the close.

Once again it was the JPY crosses that showed the largest moves within the majors. AUD/JPY surged 2.4% to a session high of 81.66 at 3:29pm from an overnight low of 79.76, showing little sign of correcting. At the same time, EUR/JPY surged 2.2% to a high of 110.77 by 1:01pm from at overnight low of 108.42, while GBP/JPY rallied 1.3% to a high of 131.63 from an overnight low of 129.93. While the USD and JPY sold off at the expense of the EUR and GBP, the commodity-bloc also rallied. AUD/USD rose as high as 0.9699 from an overnight low of 0.9537, while USD/CAD fell as low as 1.0142 from an overnight high of 1.0272. Renewed risk appetite sent global bourses up across the board, with the Japanese Nikkei up 0.5%, the Hang Seng up 1.0%, the UK FTSE up 2.1%, the German DAX up 2.7% and the French CAC up 1.6%. For its part, the Dow gained 250 points on the day to post a 2.3% gain. USD weakness bolstered gains in commodity markets, with energy and gains the clear favorites. Wheat gained 7.2%, corn gained 4.1%, while NYMEX crude oil prices gained 3.2% on the day to close at $86.81/bbl.

Positive news from the ADP report was largely ignored as a respite in the European sovereign debt crisis overnight prompted a rebound in the EUR and a rally in global equities. The EUR/USD surged to a session high of 1.3137 by 8:40am from 1.3100 following the report and an overnight low of 1.2971. The EUR crosses also showed sizable gains, as EUR/GBP rallied to a session high of 0.8415 from an overnight low of 0.8335 and EUR/CHF rallied to a session high of 1.3185 from an overnight low of 1.3012. However, there was ample evidence that this was more than simply a relief rally in the EUR. The dollar-bloc all traded higher overnight. USD/CAD fell as low as 1.0180 by 8:40am from 1.0195 following the report and an overnight high of 1.0272. Likewise, AUD/USD rallied as high as 0.9662 from an overnight low of 0.9537. The AUD/JPY cross surged to a high of 81.26 by 9am from 81.05 following the ADP report and an overnight low of 79.76, reflecting an improvement in risk appetite. Equities were also higher, led by a noteworthy 4.7% surge in the Spanish IBEX, a 2.0% rise in the UK FTSE, a 2.3% rise in the German DAX and a 1.5% rise in the French CAC. Dow futures were up +148 points ahead of the market open.
(michael.woolfolk@bnymellon.com)

Flow Analysis:

Our iFlow FX indicators show a slight pullback in risk aversion with the net buying of the US dollar decelerating sharply compared to earlier this week. Amongst other G-10 currencies, we are also seeing renewed buying of the Canadian dollar and Swedish krona. Investor sentiment appears to have been buoyed by the above consensus November reading on Chinese manufacturing that grew at the fastest pace in seven months, while this morning's US numbers showed higher than expected November readings on ADP employment and ISM manufacturing data. Earlier today, market sentiment in the Eurozone also calmed a bit on speculation that the European Central Bank's meeting on Thursday may yield some supportive comments or measures from policy-makers that may help rein in the sovereign debt crisis in the region.

Even so, our iFlow FX indicators show the Euro remains the strongest net sold currency for now, while the Japanese yen continues to attract buying interest. Our iFlow bond indicators show ongoing net selling of Italian, Spanish, Greek and Portuguese exposure remains in place – a note released by Standard & Poor's late Tuesday expressed concerns Portugal may have to seek a bailout and its credit rating may be cut as a result. On the flip side, we are seeing renewed strong net buying of US Treasuries and also German bunds as investors seek relative safety and liquidity. Interestingly, with the storm having passed Ireland amid the approval of the 85B EUR bailout package over the weekend, we are seeing some fresh buying of Irish paper. There are also other selective forays being made into recently oversold markets such as in Hungary and South Korea as investors avail of attractive re-entry levels. Amongst global stock markets, our iFlow equity indicators show renewed buying interest in select Asian markets such as in Indonesia, India, Singapore and Hong Kong.
(samarjit.shankar@bnymellon.com)