What is FX Market Saying

May 6th, 2014 11:23 am | by John Jansen |

Notwithstanding my previous note moments ago I could not resist sending this excellent piece from Richard Gilhooly of TDSecurities:

The USD is under generalised pressure this morning, a delayed reaction to Friday’s reversal in yields which left the DXY index unchanged on the day even as long-end yields moved to new lows for the year. Monday’s holiday in many markets left liquidity thin yesterday and today’s Euro area data, RBA meeting and UK data, explains why we got the delayed reaction in those crosses. However, the USD is weaker versus practically every cross today and this suggests that the issue is more with USD selling as opposed to individual developments on one cross. $/Yen is also weaker, although not of medium-term significance until we get under 100, reflecting some mild equity concerns as Japan re-opens tonight.

The reversal to lower yields after initially moving higher on strong headline NFP is subject to debate as to the fundamental justification for the move. Dealing with the facts right now, as opposed to whether it is right or wrong in the face of a “potential” 3% GDP rebound in Q2, we would note that the push higher in 30yr yields yesterday appears to reflect near-term supply (Thursday) and some long-end corporate issuance. If anything, the move in the USD is adding support to the bond market reaction on Friday, suggesting that it is not just a “technical” shortage of bonds, but something more fundamental that is undermining the USD and rallying US bonds.

The DXY index is not just weaker today, it is trading at new lows for the year and, in fact, new lows since October 2012. Even with $/Yen strength starting that November, DXY index did not start to rally until the Euro peaked in February 2013 at 1.37. The low in DXY was just under 79 at that time, a level we are testing today with the Euro coiling towards 1.40, a level not seen since late 2011. A break over that level could bring back much wanted volatility and would likely see the market sell Dollars broadly as there is an ongoing reluctance to accept that the Euro is going higher.

The fact the DXY is at near 2 year lows, failing to bounce with better export data this morning, is a reflection either of renewed US economic difficulties ahead or of the need to raise short rates, as foreign/pension fund money continues to pour into the long-end to lock in yields. Real short rates are on the rise in Europe with declining inflation rates, while long-end spreads have widened as Euro area yields continue to fall even with stronger growth data. 5yr Italy is trading flat to the US and Spain continues to trade 10bp through, while 10yr Germany is 115bp through, helping to pull long rates down in the US.

The y/y effect on Japanese inflation temporarily boosted $/Yen as real rates fell on QE, which had already been reflected in $/Yen jumping over 100 before the inflation effect had peaked. Without another round of QE, Japanese inflation will start to move lower again which could see an unwind of foreign and leveraged money that remains short Yen.

View:
We are becoming more bearish on 2yr and 3yr notes as the weaker USD highlights the need to raise short rates.

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