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USD/JPY: How Far Will Flying On One Engine Get You? USD/JPY dropped sharply in response to the BoJ’s policy inaction in April. The outcome eroded the market’s belief that the BoJ will be easing anytime soon, if at all, and may argue for further JPY appreciation.
We still think that policy divergence could remain a USD/JPY driver even if it has to rely on only one engine for now – the Fed tightening policy from here.
Below we assess the impact on USD/JPY of the persistent widening of the USD-JPY rate spreads expected by us and the (more dovish) market consensus. Our results point at sustained USD/JPY strength ranging from 3% to 6% by year-end 2016 and 10% to 12% by the end of 2017.
The results suggest that the policy divergence implied from our rates forecasts could push USD/JPY at 116 by end-2016 and 121 by end-2017. When using the consensus expectations, the result is a very gradual appreciation to 111 by end- 2016 and 119 by end-2017.
If we were to relax the above assumption and add some stock market outperformance, presumably on the back of more government stimulus and/or further BoJ easing, this changes the results to a degree. Assuming that Nikkei revisits its recent highs around 18000 – a fairly conservative assumption – it could lift our projections for USD/JPY to 118 by end- 2016 and 123 by end-2017. When using the consensus rates forecasts, we arrive at 113 by end-2016 and 121 by end-2017.
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Tech Targets: EUR/USD, GBP/USD, NZD/USD, USD/JPY
EUR/USD: Bullish: Increasing risk of a short-term top.
While the 1.1600 target indicated yesterday was exceeded with a high of 1.1614, the sharp and rapid drop from the top suggests increasing risk of a short-term top. That said, confirmation of a top is only upon a move below 1.1400. In the meanwhile, EUR is expected to trade sideways but it has to move and stay above 1.1550 within these few days as prolonged consolidation would lead to a rapid loss in momentum.
GBP/USD: Shift from bullish to neutral.
Corrective pull-back has scope to extend lower to 1.4400. GBP touched a high of 1.4770 before reversing abruptly and sharply to take out the stop-loss at 1.4540. A short-term is likely in place at 1.4770 and the current corrective pull-back appears to have scope to extend lower to 1.4400. At this stage, a sustained move below this level appears unlikely. Resistance at 1.4690 is likely strong enough to contain any short-term rebound.
NZD/USD: Shift from bullish to neutral: In a broad 0.6800/0.7000 range.
The shift to a bullish stance yesterday was ill-timed as NZD failed to break above the year’s peak at 0.7055 (high of 0.7054) and plunged from the top. The wild swing recently has resulted in a mixed outlook and we hold a neutral view now and expect this pair to trade in a broad 0.6800/0.7000 range.
USD/JPY: Bearish: High chance that a short-term low is in place.
The call for partial profit-taking at 106.20 yesterday was timely as USD staged a remarkable rally from a low of 105.52. There is a high chance that a short-term low in place but confirmation is only upon a breach of 107.40.
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Tech Targets: EUR/USD, GBP/USD, AUD/USD, USD/JPY
EUR/USD: Neutral: Pull-back has room to extend lower to 1.1300.
We just shifted to a neutral stance last Friday and there is no change to the view. The current movement is viewed as corrective pull-back which has scope to extend lower to 1.1300 but at this stage, a sustained move below this level is not expected. Overall, this pair is expected to remain under pressure unless it can reclaim 1.1495.
GBP/USD: Neutral: Daily close below 1.4400 could lead to a sustained down-move to 1.4300.
As highlighted yesterday, a daily closing below 1.4400 would indicate the start of a sustained down-move with an immediate target of 1.4300. This appears to be a likely scenario unless GBP can reclaim 1.4500/05 within this couple of days.
AUD/USD: Bearish: Expect slow grind lower, below 0.7300 targets 0.7240.
While a move below 0.7300 would not be surprising, we are still of the view that the current AUD weakness is overextended and a sharp drop from here is unlikely. In other words, this pair could continue to grind lower and a breach of 0.7300 would target 0.7240 next. Stop-loss is adjusted lower to 0.7440 from 0.7480.
USD/JPY: Shift from neutral to bullish: Rebound to extend higher to 109.70.
The unexpected break above 108.00 is a good indication that the current rebound has scope to extend higher to 109.70. Support is at 107.60 but only a move below 107.20 would indicate that our bullish expectation is wrong.
sourceGBP Steadies Ahead Of BoE, But Watch Out
In the next 24 hours, FX traders will turn their focus to the British pound because Thursday’s Bank of England monetary policy meeting and Quarterly Inflation Report are two of the most important event risks this week. With the U.K. referendum right around the corner, the BoE has a lot to consider this month and there are 3 specific issues that investors will be focusing on – growth, inflation and Brexit. In recent weeks, some major central banks have eased monetary policy while a slowdown in the U.S. economy caused the Fed to retreat from its hawkish stance. Recent U.K. economic reports show similar weakness in the U.K. economy and according to the table below, we’ve seen nothing but deterioration in U.K. data since the April meeting. With manufacturing- and service-sector activity slowing, wage growth has been pressured causing consumers to cut back and confidence to fall. Based on these measures alone, the BoE’s February growth forecasts look too optimistic.
Inflation, however, is on the rise with oil prices up more than 45% since the February inflation report and sterling trading lower. The latest consumer- and producer-price reports won’t be released until after the central-bank meeting but rising inflation expectations along with price pressures will prevent the central bank from talking about easing. If the central bank lowers its growth forecasts and leaves the inflation forecasts unchanged, sterling will fall. But if they revise down one and up the other, the net impact should be positive for sterling because the upgraded inflation forecasts leave the BoE slightly more hawkish than most of its peers.
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Where To Sell USD/JPY?
USDJPY remains capped beneath resistance from the 61.8% retracement at 109.47, notes Credit Suisse Techs.
"We would allow for a consolidation phase here with a break higher needed to see the recovery extend for 109.90 at first, through which can target price and falling 55-day average resistance at 110.67/81 where fresh selling is expected to show.
Immediate support moves to 108.22, with a break below 107.77 needed to see scope for 107.04. Beneath the latter can then retest 106.43, ahead of a retest of a stronger support at 105.53/19," CS adds.
In line with this view, CS runs a limit order* to sell USD/JPY at 109.90, with a stop at 110.95, and a target at 105.90.
Tech Targets: EUR/USD, GBP/USD, AUD/USD, NZD/USD, USD/JPY
EUR/USD: Bearish: Next key level at 1.1140/45.
As highlighted yesterday, extension lower to 1.1140/45 would not be surprising but a clear and sharp drop below this level is not expected (momentum indicators are lackluster at best). Overall, the bearish phase that started earlier this week is intact unless there is a break above 1.1320 (1.1295 is already a strong short-term level).
GBP/USD: Bullish: Target test of 1.4770.
The outlook for GBP just turned bullish yesterday and there is no change the view wherein we expect the current rally to extend to test the 1.4770 high seen earlier this month
AUD/USD: Neutral: In a 0.7200/0.7400 range.
AUD dipped below 0.7200 yesterday but rebounded quickly from a low of 0.7175. The bias is tilted to the downside but as mentioned yesterday, a sustained down-move is likely only upon a clear break below 0.7200 (say a daily closing below this level). In the meanwhile, this pair is expected be on the defensive unless it can reclaim 0.7300.
NZD/USD: Neutral: In a 0.6690/0.6845 range.NZD touched a low of 0.6710 but rebounded quickly. There is no change to the current neutral view and we continue to expect broad sideway trading within a 0.6690/0.6845 range.
USD/JPY: Bullish: To take partial profit at 110.45.
The bullish USD phase that started last week is still clearly intact and the first target of 109.70 has been exceeded. However, shorter-term indicators are clearly overbought and those who are long from last week should look to take partial profit as the rally approaches the next major resistance near the middle of the trading envelope (currently at 110.45). This is a strong level and a clear break would open up the way for further USD strength towards the next key resistance at 111.90. Overall, the outlook for USD is deemed as bullish unless 109.00 is breached.
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AUDNZD LONG WITH THE BREAKOUT
AUDNZD seems like it is ready to complete a short term cycle on the H4 chart. There is also a down trend line coming from the highs, bullish divergence forming already as well. Wait for the price to reach the 1.06 zone and start looking for buy opportunities on the lower time frames.
AUDNZD LONG ENTRY:
Wait for the price to reach 1.06 first of all to complete the H4 cycle and then start looking for entry setup on the intra-day time frames such as H1 and M15. Conservative entry will be to wait for a breakout above the down trend line.
Traders Wary, Uncertain About FX 'Code Of Conduct'
Currency traders were wary, uncertain, but at the same time not yet overly troubled by the pending release of a formal "Global Code of Conduct" designed to apply new rules to the already beleaguered foreign exchange market.
On Thursday, the Foreign Exchange Working Group (FXWG) is scheduled to unveil the first phase of the Global Code of Conduct.
A teleconference at 9:00 a.m. ET, in connection with the release, is expected to include Guy DeBelle, RBA assistant governor and head of the Bank for International Settlement's Markets Committee, David Puth, chief executive officer of CLS, Simon Potter of the New York Federal Reserve Bank and Chris Salmon, from the Bank of England.
The FXWG was created by Bank of International Settlement (BIS) Governors in May 2015 in order to "strengthen code of conduct standards and principles" in currency markets, with its main objective to "facilitate the establishment of a single global code of conduct standards and principles and to promote greater adherence to these standards and principle," according to the BIS website.
The FXWG's initial findings will be released Thursday, with May 2017 the "target date for finalization of the Code as well as of the proposals to ensure greater adherence."
Most in the FX industry expected common sense measures to be announced this week, but a few traders fretted that the Code might lead to a further shrinkage in the currency industry that already seen large scale job cuts in recent years.
Those still standing have complained repeatedly to MNI that heightened regulation has made their lives miserable.
"There is more paperwork today than 15 years ago," one trader said, "It is much more expensive to do something," in terms executing an FX deal for a client.
Another trader quipped that while in prior years, there used to be one legal staff member for every 40 traders, now there were 40 lawyers for a single trader.
Heightened regulation comes as five of the world's largest banks laid out $9 billion in bank fines and penalties in 2015 to address wrong doings in the FX market.
Traders lamented that the entire industry is paying the price of a few bad apples, but observed that change was inevitable in light of the FX scandal, that came hand in hand with the LIBOR, subprime mortgage and other financial market scandals.
"It seems obvious that if banks were training their traders properly and not hiring folks with low ethics in the first place, there would be no need for external guidelines," observed one FX analyst.
On the Code of Conduct, "Think the general take is a pretty constrained set of rules for sell side," i.e. about what "can be shared with customers," noted another analyst.
"I guess it all depends on what exactly the code of conduct contains and whether or not the BIS tries to move towards insider trading type rules and regs on FX and perhaps more than that, if they try to then push for 'best execution' type rules, as we currently have in equities and other instruments, where a customer order is taken by any means other than direct and electronically," one trader said.
The sense is that "rules on top of rules" will not make life in the currency market easier or more profitable.
"My view is that the common sense practices will be phase 1 of a multi-step process which will likely be more complicated and more time consuming," a trader said.
As for the FX industry, "I believe the animal is already wounded. This just pushes the arrow in deeper. How much deeper we know over the next 1-2 years," he said.
For those who did not want to wait for the BIS Triennial Central Bank survey of FX and OTC Derivatives Markets for 2016, with preliminary results on turnover published only in September 2016, and final survey in December 2016, Aite Group released its Global FX Market Overview for 2016 Tuesday.
Aite estimated that overall OTC FX average daily volume during April 2016 hit $5.5 trillion, which compared to the $5.3 trillion per day mentioned in the BIS 2013 Triennial survey.
But, in 2015, the OTC FX industry saw a decline (vs 2014 levels) of between 9% and 11%, "due in large part to regulations that forced banks to restructure how they do business, including cutting prime broker (PB) credit, passing higher costs on to the buy-side, and resetting business terms in regulation-compliant ways," the Aite report said.
FX regulation remained a key concern for the currency market, the report stressed.
"Some firms are busy complying with European Market Infrastructure Regulation (EMIR), the Dodd-Frank Act, and Basel III, and are becoming MiFID II and Volcker rule compliant, while others are reluctantly expecting changes to come from a new global initiative (i.e., the FX code of conduct)," the report said.
Aite observed, that "The new code of conduct will unify six legacy conduct codes, bring jurisdictional harmony to the topic, and introduce new, specific sanctions that help regulators prosecute overt rule infractions.
"The extent to which wrongdoing will be punished will fall on specifics outlined within each jurisdiction," the report said.
In the meantime, major global banks continued to lose market share in currency trading.
Euromoney's FX survey 2016, released this week, noted while Citi retained its top ranking (12.91% share) and JPM (8.77%) and UBS (8.76%) rose to second and third place, Deutsche Bank (7.86%) slipped from second place to fourth place, and BOA Merrill Lynch (6.40%) was in the number five spot.
The biggest ranking change is that the combined market share of the top five banks accounts for only 44.7% of the total in 2016.
This compared to a peak of 61.5%, seen in 2009, and a 60%-plus ranking as recently as 2014. The market share of the top 10 FX houses has also declined, to 66% this year from 75% in 2015, with the decline driven by the performance of the top 5 banks.
The banks rankings decline comes as non-bank liquidity providers gain a greater foothold on market share.
XTX Markets has become the leader in this camp, in ninth place in terms of overall rankings, with a market share of 3.87%, the Euromoney survey said.
Other non-bank firms making the top 50 overall market share ranking were Tower Research Capital, Jump Trading, Virtu Financial, Lucid Markets and Citadel Securities.
Euromoney noted that total volumes for the FX survey, polling around 3,500 clients, came in at roughly $95 trillion, a 23% volume decline from last year, which was in line with expectations.
What Drives The USD?
We believe the next catalyst for the USD appreciation will be an increase in real yields, which in our view have become the dominant driver of the currency, rather than nominal yields.
Evidence that the US output gap is narrowing should prompt higher US real yields and a stronger USD.
Given weak growth and low inflation expectations, real yields in Europe and Japan could do with staying low; however, with nominal yields already in negative territory there will in fact be a tendency for real yields to rise in Europe and Japan as inflation expectations fall. This should keep EUR and JPY strong.
For many EMs, especially those with weak fundamentals and external vulnerabilities, the relationship is inverse.
As real yields increase in the US, we'd expect EM currency weakness and an increase in EM real yields. The exceptions are the DM-like EMs, such as Korea, where we'd expect an eventual drop in real yields to drive KRW weakness.
Risk events on the horizon.
Rising US rate expectations support our bullish USD call, however not just in the context of higher nominal yields. In an environment of slowing global earnings, trade and growth, the manufacturing drag could again come into focus with Korea trade data and China's PMI due next week. Any resulting equity market weakness should support the short GBP and KRW trades in particular.
FX investors will also be waiting for Yellen's speech on June 6, with a hawkish tone adding to USD strength. EUR should be stable from an ECB unlikely to change course.
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US Shopper Mood Gallops From 7-Mth Low to 1-Yr Top in May: UoM
Confidence among America's shoppers markedly improved in May and reached a fresh one-year high, a private survey confirmed on Friday, pointing to strong household confidence in economy.
The Thomson Reuters/University of Michigan final Consumer Confidence Index rose to 94.7 points during the fifth month of the year, but was more than a point below the preliminary reading. Still, the gauge was up from the final 89.0 seen in April, when it had dipped to a fresh seven-month low.
A preliminary print had shown the index soaring to 95.8 in May, outpacing original estimates that had penciled in an improved reading of 89.5.