Reflection time for dollar traders

It’s been pretty slow-going today as economic data has been thin on the ground. Ranges in FX are fairly tight and stock markets are flat to fairly neutral. Currently US futures are pointing to a slightly lower open. But there are some important fundamental events this week that could impact the medium-term direction of markets.

Japan voice concerns over yen decline

Firstly, Japan’s Economy Minister said today that the yen’s decline could have gone far enough, and any further decline could have a negative impact on “peoples’ lives”. The sharp decline in the yen (USDJPY is up nearly 7% in the past month) might be troubling the government in two ways: 1, it threatens to boost inflation and reduce consumption power. This comes at a terrible time for the government as it also plans to introduce an increase in the consumption tax during this parliament. 2, the massive BOJ stimulus has caused Japanese government bond yields to surge, the yield on the 2-year JGB has risen nearly 40 basis points in the past month. Unsurprisingly, the pace of gains in bond yields is concerning for a government with a debt-to-GDP ratio of more than 200%.

The BOJ conclude its latest meeting later this week. No new stimulus is expected and BOJ Governor Kuroda is expected to play down volatility in the JGB market. However, after comments from the Economy Minister it will be interesting to see if Kuroda follows suit and urges caution on future yen declines. Although we think that the probability is low as the BOJ is concentring on trying to achieve an aggressive inflation target, if Kuroda does change his tune expect the yen to fly and yen crosses to drop sharply.

Can the USD and S&P 500 develop a beautiful relationship?

The dollar is also in view. Last week the bulls helped to propel the buck higher by close to 2% on a broad basis, as hawkish Fed commentary and good news on the budget deficit provided a positive fundamental backdrop to the USD. This week the fundamental support could be more muted. Fed governor Ben Bernanke testifies to Congress on Wednesday about the economic outlook. How will he explain the uptick in initial jobless claims last week? How will he react to the drop in core inflation to a 2 year low at 1.7% for April? His answers to these potential questions from Congress could determine the medium-term outlook for the buck. An optimistic tone from Bernanke is dollar positive, and could see USDJPY march back towards 105.00, while a cautious tone from the governor could do the opposite, causing USDJPY to fall back below key support at 101.25, and EURUSD may rebound to 1.2950 – a key resistance level.

Last week the stars seemed to be aligned for USD. The buck was moving higher alongside Treasury yields and stocks, suggesting that it was the next growth currency of choice. However, Bernanke could challenge this market assumption. In the past the dollar has not been able to sustain the mantle of growth currency for long. Likewise, if the dollar is to retain its growth currency status and shrug off the label of safe haven then we need to see it move higher alongside stocks. The dollar and the S&P 500 do not have a historically strong relationship. Over the past year this correlation has been -0.4%, basically a mildly negative correlation. In the past month this has picked up to a mildly positive correlation and in the past week it has surged to 94%, which means that the dollar and the S&P 500 have moved together 94% of the time. This is a dramatic shift in the relationship, and thus we need to see if it can thrive. From a fundamental perspective it is hard to see how the dollar can continue to rally without a continued rise in Treasury yields, yet rising Treasury yields could spook stock investors.

Looking ahead today, the SPX 500 is expected to open lower later, after a strong rally last week saw it reach fresh record highs. There are no notable levels on the upside, a problem with trading at record levels, and support is about 60-80 pips away at this stage. Thus, we will be watching to see if buyers come in even though the index looks overbought. Overall though, we are waiting for Bernanke on Wednesday.

Источник: Forex.com

20.05.2013