Rates and Currencies Act like They are From Different Planets

The 10-year yield slipped four basis points on the week to 1.32%. The yield has risen in three of the past 15 weeks. It is tough to argue that it is a fluke. While it is holding above the 200-day moving average (~1.25%), the 30-year yield has spent the last two sessions below its 200-day moving average (~1.975). The implied yield of the December Eurodollar futures fell five basis points last week and is off near 15 bp over the past five weeks.

The dollar rose against all the major currencies but the Japanese yen, which eked out a negligible gain. The combination of economic data and central bank statement (and an end to asset purchases) spurred the market to price in an RBNZ rate hike as early as next month (August 17). Still, the Kiwi finished slightly lower on the week. Still, it joined the yen and Swiss franc, whose central banks are widely expected to be among the laggards in adjusting monetary policy, to be the only currencies that have risen here in July against the US dollar.

Perversely, the other two high-income countries in the front of the queue to adjust policy, Norway and Canada, have the poorest performing currencies this month (~-2.80% and -1.70%, respectively).

Dollar Index

The Dollar Index rose by about 0.6% last week. Still, it is up less than 0.30% in July after rising 2.9% in June. In recent days, it has held below the three-month high set on July 7, near 92.85. The MACD is slowly declining, while the Slow Stochastic has pulled back from overbought territory but is threatening to cross higher. The year’s high was set at the end of March near 93.45. A break of that March high would have bullish implications and it least signal at test on the 94.40-94.50 area. On the other hand, a move below 91.55 would suggest a high may be in place.

Euro

The euro fell to new three-month lows last week, slightly above $1.1770. The single currency has spent the last three sessions within the range set on July 13 (~$1.1770-$1.1875). Immediate resistance is seen in the $1.1840-$1.1850 area. Ahead of the ECB meeting on July 22, the risk is on the downside as the market prepares for a dovish forward guidance adjustment in light of its new symmetrical 2% inflation target. The MACD has not confirmed last week’s lows. The Slow Stochastic edged out of oversold territory but has moved sideways in the second half of last week. A convincing low does not appear to place, and the next important support area is seen closer to $1.17.

Japanese Yen

After matching a five-day high on July 14 (~JPY110.70), the dollar reversed lower, arguably with the drag of falling yields, and finished below the previous session’s low. The outside down day saw follow-through dollar selling the following day, but good bids were seen around JPY109.70. The greenback recovered a bit ahead of the week, as yields edged higher and settled slightly above JPY110.05.

Although the MACD and Slow Stochastic appear to be poised to turn higher, they haven’t yet. The correlation between US 10-year yield and oil prices over the past 30-day is near the highest since March 2019 (~0.52, rolling 30-day correlation of differences). A move above JPY110.85 could see the dollar rested the month and year high around JPY111.65. Below the JPY109.50 area, support is seen ahead of JPY109.00.

British Pound

Strong inflation and consumption figures spurred hawkish rhetoric from a couple of BOE officials and firmer short-term UK rates, but sterling still fell around 0.95% against the US dollar and lost about 0.35% against the euro. Indeed it posted a weekly close below $1.38 for the first time since April. Sterling closed poorly, and although it held above the recent lows in the $1.3730-$1.3740 area, it looks weak.

The cap near $1.39 looks stronger than support, and the 200-day moving average may beckon (~$1.3695). The Slow Stochastic has cycled to the middle of the range without a strong recovery in prices, and it looks to be poised to level out. The MACD moved gently off its lows but could turn down again.

Canadian Dollar

What a miserable two-week stretch for the Canadian dollar. It has fallen in eight of the ten sessions and has fallen by 2% over this run. The data has been firm, and the Bank of Canada did take another step toward slowing its bond purchases. The greenback covered the week’s range in two days. There were buyers for it on the pullback after the Bank of Canada’s announcement near CAD1.2425, and the following day it was flirting with the upper Bollinger Band (~CAD1.2610) and the 200-day moving average around (~CAD1.2625).

Above there, the CAD1.2700 marks the halfway point of the US dollar’s sell-off since last November’s election, but there appears to be little chart resistance ahead of the CAD1.2740-CAD1.2750 area. The MACD is stretched but continues to move higher. The Slow Stochastic has flatlined below last month’s high.

Australian Dollar

With a little more than a quarter of the population having received a single vaccine and a longer and tighter lockdown in parts of the country, the economic prospects have dimmed. They offer a stark contrast with New Zealand. The Australian dollar was sold to new lows for the year ahead of the weekend, as it slipped below $0.7400. We have recognized the risk of a move to $0.7380, which would complete the retracement (61.8%) of the rally since the US election last year. Below there may not be much support for another half of a cent. The MACD has is nearly a horizontal line in the trough, while the Slow Stochastic is moving sideways a little above the low set earlier this month.

Mexican Peso

The US dollar set the week’s range on July 13 (~MXN19.8150-MXN20.0820). It finished the week near the lower end of the range, but this represented only a small loss for the greenback (<0.15%). Still, it is the third decline in the past four weeks. The JP Morgan Emerging Market currency index eked out a minor gain last week (0.1%) to end a two-week decline. Although the peso is the only LATAM currency to rise so far here in July (0.4%), it was a poor performer last week in the region.

The Brazilian real came back into favor rising 2.8%, the Peruvian sol rose 1.6%, and the Colombian peso rose slightly more than 0.6%. The Chilean peso lost the most in the region (~1.25%) despite the central bank hiking rates and suggesting it may be the first of several. The momentum indicators are mixed. Broad sideways trading seems like the most likely near-term scenario. The MXN19.75 area offers support below MXN19.80.

Chinese Yuan

The yuan was virtually unchanged against the dollar last week, finishing slightly below CNY6.48. It leaves it off by about 0.33% here in July and up by nearly 0.75% year-to-date. Three-month implied volatility settled June a little above 5%. It began last week above 5% and finished at its lowest level since March 2020 (~3.93%).

The lower end of the near-term dollar range appears around CNY6.45, but it looks poised to test the upper-end that comes in around CNY6.49. The greenback has not traded above CNY6.50 for about three months. Although the firmness of June economic data shows the quarter ending on an upbeat, the PBOC does not appear to be in a hurry to ease policy further. The 10-year onshore yield fell to fell to 2.92% on July 13, its lowest in a year.

The low currency volatility and the non-correlation of the bond market to other major bond markets attract foreign asset managers. Year-to-date, the US 10-year yield has risen 40 bp, the German Bund by 22 bp, the British Gilt 43 bp, and the Chinese bond yield is off almost 20 bp.

This article was written by Marc Chandler, MarctoMarket.

Brazil Cenbank Minutes Raise Possibility of 100 bps Hike at Next Meeting

By Jamie McGeever

The minutes of the June 15-16 meeting, where the bank’s rate-setting committee known as Copom raised rates to 4.25%, showed policymakers believe a full normalization of policy is now appropriate, shifting up a gear from a more cautious “partial” approach in recent meetings.

With inflationary pressures “more intense than expected”, a faster pace of policy tightening at the next meeting may be required, the minutes said. This would lift the Selic closer to the “neutral” level of interest, when the economy runs at full employment and potential growth without fueling inflation.

“In our view, the minutes go a step further (in relation to the statement) in giving Copom the flexibility to increase the rate of interest rate hikes, and/or go beyond neutral,” said Caio Megale, economist at XP Investimentos.

The 75-basis point increase in the central bank’s benchmark Selic rate last week was the third consecutive hike of that magnitude, as Copom seeks to prevent current inflation from lifting 2022 expectations beyond target.

The central bank’s 2022 inflation target is 3.50%. Copom last week said its baseline scenario currently points to 12-month inflation of 3.50% by the end of next year, but many economists reckon inflation next year will be closer to 4.00%.

Annual inflation is currently running at more than 8%. Copom’s own estimates point to it ending this year 5.8%, well above its goal of 3.75% and even the 5.25% upper limit of its target range.

“The Committee evaluated a quicker reduction of monetary stimulus already on this meeting,” the minutes read.

“The Committee decided that the best strategy would be to maintain the current pace of stimulus reduction but highlighting the possibility of a quicker adjustment in the next meeting.”

Economists reckon the neutral rate of interest would be a Selic of around 6.00%-6.50%. If inflationary pressures do not cool, Copom may be forced to go beyond 6.50%.

The minutes show Copom maintained “transparency” in its communications that more flexibility to adjust policy at a potentially faster rate was required, and that a return to the neutral rate “has become appropriate”.

Despite the recent exchange rate appreciation that has seen the dollar fall to around 5.00 reais, short-term inflation pressures remain strong, the minutes said.

(Reporting by Jamie McGeever; Editing by Andrew Heavens and Raissa Kasolowsky)

Without Yield Support, the Dollar Wilts

The JP Morgan Emerging Market Currency Index is edging higher for the fourth consecutive session. The lower yields are not doing equities much good today. Outside of China, the large equity markets in the region fell, and the MSCI Asia Pacific Index is posting back-to-back losses. The three-day rally in Europe’s Dow Jones Stoxx 600 is at risk as most sectors, but health care and real estate, are losing ground. Financials are the largest drag.

US future indices are a little changed to slightly firmer. Oil and other industrial commodities are firmer, and the CRB Index closed yesterday at new six-year highs. Gold is unable to benefit from the weaker dollar and lower interest rates. The upside momentum that had carried it briefly above $1900 fizzled.

Asia Pacific

China reported a smaller than expected rise in last month’s consumer prices but a larger rise in producer prices. Falling food prices helped temper the rise in consumer prices to 1.3% rather than 1.6% that the median in Bloomberg’s survey projected. The decline in pork prices helped keep food prices in check, while non-food prices rose by 0.9%. Producer price inflation accelerated to 9.0% from 6.8%. The median forecast was 8.5%. Oil, metals, and chemicals were the drivers. Beijing is trying to finesse lower producer prices by cracking down on unauthorized activity, but it does not appear sufficient.

Reports suggest it is considering some sort of cap on thermal coal prices before peak summer demand. One proposal would cap the price to the miners, while another proposal was to limit the price at the port. Still, the discussion shows that Chinese officials are still reluctant to allow supply/demand to adjust prices. If thermal coal prices or other commodities are not allowed to move freely, is Beijing really prepared to allow the yuan to be convertible as some are suggesting could take place with the introduction of a digital yuan?

The Reserve Bank of Australia did not adjust policy last week, but comments today suggest it may join the queue of central banks adjusting their stance as the inoculations are gradually allowing some return to normalcy. Former RBA member Edwards said that the RBA would likely scale back its QE next month, which others, including ourselves, had suggested was possible.

The RBA’s Assistant Governor Kent admitted he has been surprised by the strength of the rebound and is optimistic about growth fueling wage increases and inflation. Currently, the RBA targets the April 2024 bond at 10 bp. It is to decide next month whether to switch it to the November 2024 maturity. Targeting the 3-year yield at the cash rate is a way to underscore the lack of intent to raise rates in the interim.

The dollar is trapped in almost a 20-pip range against the yen today in the upper end of this week’s range. It has not been above JPY109.65 so far this week nor below about JPY109.20. There are about $1.2 bln in options in the JPY109.00-JPY109.10 area that roll-off today. The benchmark three-month implied volatility reached almost 5.53% yesterday, its lowest level since February 2020. The Australian dollar is steady, trading inside yesterday’s range, which was inside Monday’s range (~$0.7725-$0.7765). Like the dollar-yen, the Aussie is also in a 20-tick range so far today.

The Chinese yuan rose today, recouping the losses seen in the past two sessions. The dollar reached CNY6.4120 at the end of last week but has consistently recorded lower highs and lower lows this week. The PBOC’s reference rate for the dollar was set at CNY6.3956, spot on expectations. It is beginning to look as if official intent is more about breaking the one-way market that had appeared to develop and stabilize the yuan rather than reverse it. Whether defending a set line, which some have suggested at CNY6.35 or not, still has to be seen.

Europe

The ink G7 finance minister agreement on the minimum corporate tax is hardly even dry, and the first exception is being sought. The UK (and apparently the EU) want to exclude financial services from the new global tax regime. Separately, the US and the EU will have a rapprochement that will resolve the two outstanding disputes: The goal is to resolve the Boeing/Airbus subsidy issue by July 11 and end the steel and aluminum tariffs imposed by the Trump administration on national security grounds by the end of the year. The US has protested but will not escalate the sanctions for the Nord Stream 2 pipeline, and the tax reform would see European countries drop their digital tax initiatives.

Meanwhile, Europe is gradually taking a harder line against China. The EU Parliament is not proceeding with the ratification of the EU-China trade agreement struck at the end of last year. Italy, which was the only G7 country to sign on to the Belt Road Initiative, has blocked Chinese acquisitions under Prime Minister Draghi. Europe has endorsed the US call for new efforts to find the origins of Covid-19, even though the origins are unnecessary to combat virus and protocols to tighten security as labs during such work are necessary regardless of the precise origin.

Germany reported a 15.5 bln euro trade surplus in April, down from 20.2 bln in March. Exports growth slowed to 0.3% after a 1.3% gain previously. Imports fell by 1.7%, more than expected after the March series was revised to show a 7.1% gain (initially 6.5%). The smaller trade surplus translates into a smaller current account surplus (21.3 bln euros vs. 30.0 bln in March).

Unlike what we saw yesterday with the Japanese trade and current account figures, the German current account is driven by the trade balance. In Japan, the current account surplus is driven by foreign earnings, interest, royalties, and licensing fees, not trade in goods and services.

The euro is firm, but it too is trading inside yesterday’s range, which is inside Monday’s range (~$1.2145-$1.2200). There is an option for about 1.14 bln euros at $1.22 that expires today. The market is also circumspect ahead of tomorrow’s ECB meeting, for which a consensus has emerged that it will not return its bond-buying to that which prevailed before March.

We caution that knowing the ECB’s bond-buying plans does not help trade the euro or European rates, both of which have risen since the ECB accelerated its buying. Sterling, too is range-bound with last Friday’s range (~$1.4085-$1.4200). The general consolidative tone looks set to continue.

America

The Bank of Canada meeting is the highlight of the North American session today. At its last meeting in April, it announced it would slow its bond purchases and brought forward the closing of the output gap into H2 22. Since then, Canada has reported back-to-back job losses. The Canadian dollar has appreciated by almost 3.4% since that April meeting. It is the strongest of the major currencies. A decision on whether to proceed with tapering is expected at next month’s meeting, not today.

Yesterday, Canada reported an unexpected trade surplus for April. Exports and imports fell, with motor vehicle trade disrupted by the line shutdowns due to the shortage of semiconductors. Canada’s energy trade balance was in surplus by about C$6.8 bln, while the non-energy balance was in deficit by about C$6.2 bln. Canada had a C$6.4 bln surplus with the US and a C$2.2 bln deficit with China.

The US reports wholesale inventory data today ahead of tomorrow’s May CPI. The focus, however, is shifting to next week’s FOMC meeting. Yesterday, the US sold $58 bln 3-year notes. Although the high yield slipped fractionally, the bid cover ticked up, as did indirect bids. Today, the Treasury sells $38 bln 10-year notes and tomorrow $24 bln 30-year bonds.

Tomorrow’s four and eight-week bill auctions may draw more attention than usual as the earlier bill auctions showed a little uptick as the market anticipates that the Fed may have to tweak the interest it pays on reserves or the zero rate on the reverse repos (demand reached a new record of almost $500 bln yesterday). Separately, the US Senate passed (68-22) the bill to boost US competitiveness, which has some elements that were in the infrastructure bill. The bill now gets taken up by the House.

Mexico reports May CPI figures today. The year-over-year pace is expected to pull back from the 6.08% pace seen in April but not sufficiently to change anything. Moreover, the core rate is expected to quicken a little. Through April, Mexico’s core rate has risen by almost 5% at an annualized rate. The market appears to lean toward a rate hike by the end of the year and as much as four hikes by the middle of 2022. Brazil reports its IPCA inflation today as well.

The year-over-year pace is expected to have accelerated to nearly 8% from about 6.75% in April. The central bank has already indicated it will raise rates next week by 75 bp, the third such move of the year. It would lift the Selic rate above Mexico’s cash target rate after having begun the year at half of it.

A little position squaring yesterday lifted the US dollar to almost CAD1.2120, but it has come back offered today and traded CAD1.2085 in the European morning. This week’s low so far is about CAD1.2055. Key technical support is seen at CAD1.20, while CAD1.2145 marks the upper end of the recent range.

The Mexican peso is rising for the fourth consecutive session, the longest rally in two months. The greenback finished last week near MXN19.96 and is testing MXN19.62 now, its lowest level in five months. The next area of chart support is seen near MXN19.50. The US dollar is also on its 2021 lows against the Brazilian real. It has not been below BRL5.0 since last June.

This article was written by Marc Chandler, MarctoMarket.

Brazil’s 2021, 2022 Interest Rate Outlooks Shoot Higher after Cenbank Move: Survey

The central bank’s benchmark Selic rate is now expected to end this year at 5.50% and end next year at 6.00%, according to the average forecast of over 100 economists in the bank’s weekly ‘FOCUS’ survey.

The central bank’s rate-setting committee known as ‘Copom’ last week hiked the Selic rate by 75 basis points to 2.75%, the first increase in six years. It was more than economists had expected, and the biggest rise since 2010.

The new ‘FOCUS’ survey forecasts for this year and next are 100 basis points higher than they were only four weeks ago, but do not signal an increase in the terminal interest rate. That remains 6.00%, the average 2023 forecast economists have held for around five months.

The average 2021 inflation forecast rose for an 11th week in a row, to 4.7% from 4.6%, the survey showed, further above the central bank’s official goal of 3.75% with a margin of error of 1.5 percentage point on either side.

Annual consumer inflation is currently running at 5.2% and expected to rise to around 7% in the middle of this year before easing back.

A persistently weak exchange rate, strong global commodity prices and growing concerns over the government’s fiscal position are all pushing inflation expectations higher.

(Reporting by Jamie McGeever; Editing by Chizu Nomiyama)

Even When She Speaks Softly, She’s Yellen

After posting the first back-to-back decline this year, the MSCI Asia Pacific Index bounced back today, led by a 2.7% gain in Hong Kong (20-month high) and a 2.6% rise in South Korea’s Kospi. The Nikkei and Taiwan’s Stock Exchange rose by more than 1%. Europe’s Dow Jones Stoxx 600 eked out a small gain yesterday and is a little higher today. The S&P 500 fell in the last two sessions for a loss of a little more than 1% and is trading about 0.6% better now.

The US 10-year is firm at 1.11%, while European bonds are little changed, and the periphery is doing better than the core. Of note, France’s 50-year bond sale was greeted with a record reception. The dollar is lower against all the major currencies, but the yen. Most emerging market currencies are firmer as well. We see the dollar’s pullback as part of the larger correction that began almost two weeks ago.. Gold recovered smartly from yesterday’s test on $1800 to return to the 200-day moving average (~$1845). February WTI reversed lower ahead of the long holiday weekend and made a marginal new low today (~$51.75) before recovering nearly a dollar.

Asia Pacific

According to the recent government data, China’s rare earth exports fell by more than a quarter to what Reuters estimates are the lowest in five years. China attributed it to weaker global demand, but there is something else going on. Yesterday, China indicated that a new mechanism will be created to decide, coordinate, and regulate the rare earth supply chain (including mining, processes, and exporting).

Rather than exporting rare earths, China’s industrial policy aims to export products containing rare earths. Move up the value-added chain. The big push now apparently is for batteries for electric vehicles. The PRC has become a net importer of rare earths that it processes. Its imports often come from mines it owns outright or has an important stake. For example, the Democratic Republic of Congo is responsible for 60% of the world’s cobalt.

There are 12 mines, and reports suggest China has a stake in each, and more than 85% of the cobalt exports are headed to China. In 2018, China provided around 80% of US rare earths, and at least one mine in the US sends the material to China to be processed.

For the past several sessions, the dollar has forged a base in the JPY103.50-JPY103.60 area and is probing the JPY104.00 level. The high from January 14 was about JPY104.20, and there is an option for roughly $360 mln at JPY104.35 that expires later today, just shy of last week’s high near JPY104.40. The Australian dollar closed below its 20-day moving average yesterday (~$0.7100) for the first time in a little more than two months.

It rebounded earlier today to $0.7725. The session high may not be in place, and we suspect there is potential toward $0.7740. The dollar’s reference rate was set at CNY6.4883, practically spot-on median expectations in the Bloomberg survey of bank models. The dollar’s four-day advance was snapped today. It has risen from almost CNY6.45 and stalled in front of CNY6.50. Faced with an increase in interbank borrowing costs for the ninth consecutive session, the PBOC injected CNY75 bln in seven-day cash via repo agreements.

It is the first injection after draining for the past six sessions, and it was the largest supply of funds this month. Some liquidity appears to be going into equities, and Chinese traders reportedly bought a record $3.4 bln of HK shares today.

Europe

Despite Germany’s social restrictions, which may be tightened and extended, business sentiment held in better than feared. The ZEW survey assessment of current conditions did not deteriorate as economists expected, though it did not really improve, either. The -66.4 reading compares with -66.5 in December. However, the expectations component rose to 61.8 from 55.0. This is the highest since September and more than anticipated.

The UK Prime Minister, who holds the rotating G7 presidency, has invited South Korea, India, and Australia to the summit in June. Moreover, reports suggest Johnson intends on getting them involved right away, which seems aggressive. It appears to be causing some consternation among other members. Germany, Japan, France, and Italy are opposed.

Italy’s Prime Minister Conte survived the vote of confidence in the Chamber of Deputies yesterday, and today’s challenge is in the Senate. The government support is thinner. However, the ability to secure a majority is somewhat easier given that Renzi’s party will abstain, though it will still be close. A defeat could see Italian bonds sell-off, but Conte will seek to broaden the coalition in the existing parliament before elections are required. This could include independents or members of center-right parties.

Two central bank intervention announcements last week caught our attention. First, Sweden’s Riksbank announced a three-year plan to purchase SEK5 bln a month. The purpose is to fund reserve purchases in SEK and pay down the SEK178 bln fx loans from the National Debt Office, which is thought to be about 70% in US dollars.

The krona was trending lower this year against both the dollar and euro, which follows the krona’s appreciation in the last few months of 2020. The impact is minor in terms of average daily turnover, estimated to be around SEK300-SEK320 bln almost equally divided between euros and dollars.

Second, the Israeli shekel soared in recent months and reached levels not seen since Q1 1996. The Bank of Israel intervened and bought $21 bln in all of 2020, with almost $4.5 bln in December alone, and still the shekel appreciated by 7.5% and nearly 3%, respectively. Businesses and investors were crying for relief. The central bank announced it would buy $30 bln this year, which triggered a powerful short-covering rally that carried the dollar from nearly ILS3.11 to almost ILS3.29 by the end of last week.

Dollar sellers emerged yesterday. It is steadier today, but in wider ranges than typically seen before. Its preannounced intervention war chest may ultimately prove insufficient to prevent shekel appreciation. The $30 bln is roughly twice its current account surplus, but foreign direct investment inflows are nearly the same size as the current account surplus. And yet, net portfolio inflows should be expected, but most importantly, how Israeli offshore investment is managed can be impactful.

Profit-taking on foreign investments or hedging the currency risk, even on a small fraction of the roughly $470 bln of foreign stocks and bonds owned by Israelis, can be a significant force rivaling the current account and direct investment-related flows.

The euro was sold a little below $1.2060 yesterday, its lowest level since December 1st. It reached $1.2130 in the European morning, and the $1.2140 area is the halfway point of last week’s decline. The bounce has left the euro’s intraday momentum indicator stretched.

We expect North American dealers will take advantage of the upticks for a better selling opportunity. Also, note there are around 4.1 bln euros of $1.2190-$1.2200 options that roll-off today. Sterling recovered a little more than a cent from yesterday’s lows (~$1.3520) to today’s high. It faces resistance near $1.3635. Tomorrow the UK reports December CPI figures, and a small uptick is expected.

America

The Senate holds the confirmation hearing for Yellen. She was the first woman to head the Federal Reserve, and she will be the first woman to lead the US Treasury, and the first person to have held both posts. It is a reflection of our age. Like the current Federal Reserve, the former Chair can be expected to recognize the need for fiscal support, while at the same time acknowledging that deficits will decline on the other side of the emergency.

The stock of debt is elevated, but it not extreme in relative or absolute terms. Despite higher debt in 2020, the servicing costs appear to have fallen. Moreover, as the economy grows faster than the level of interest rates, debt will decline as a percentage of GDP. Her remarks on the dollar will be scrutinized. To demonstrate the Biden Administration’s multilateral thrust, at this juncture, it is sufficient for Yellen to acknowledge the G7/G20 position that exchange rates are best set by the market.

At the end of last year, the US Treasury cited Switzerland and Vietnam as currency manipulators. She may be asked about those, and of course, the yuan. The new US Treasury model had the yuan a few percentage points undervalued. However, it is interesting to note that when adjusted for GDP per capita, The Economist Big Mac index of purchasing power parity has the yuan slightly (~2.5%) overvalued.

The economic calendars for North America are light today. The Treasury’s International Capital (TIC) for November will be reported today at the end of equity trading. Capital flows were volatile at the onset of the pandemic, but long-term inflows averaged $23.56 bln in the first ten months of 2020 compared with an average of $27.21 bln in the same period in 2019 and $54.32 bln in the Jan-Oct period in 2018.

The week’s highlight includes the January Philadelphia Fed survey Thursday and weekly jobless claims, as well as Friday’s preliminary PMI. Canada reports the December CPI tomorrow, shortly before the outcome of the Bank of Canada meeting is announced. Although the consensus is for a standpat outcome, a “mini-cut” cannot be ruled out given the official rhetoric. The current overnight target rate is 25 bp. The main feature for Mexico is the December unemployment figures on Thursday. Brazil’s central bank meets tomorrow, and the is little chance of a change in the 2% Selic rate.

Last Thursday, the US dollar recorded its lowest level against the Canadian dollar since April 2018 (~CAD1.2625). Between the modest greenback strength seen yesterday and expectations that Biden cancels the XL pipeline, the US dollar tested CAD1.28. It has come back offered today and is testing the CAD1.2720 area in the European morning.

It can fall a bit further in the North American session, but we look for support in the CAD1.2690 area to hold. That said, a break could signal a move toward CAD1.2640. The greenback held below MXN20.00 yesterday and reversed lower, closing a little under MXN19.69. It has taken out yesterday’s low (~MXN19.66) but struggles to maintain the downside momentum. A move above MXN19.75 would suggest a return to MXN20.00 is likely.

The dollar fell from BRL5.5160 last week, its highest level since mid-Movember, to BRL5.20. The low from earlier this month was around BRL5.12, and there is scope for a re-test.

This article was written by Marc Chandler, MarctoMarket.

For a look at all of today’s economic events, check out our economic calendar.

Yuan Slumps as US-Chinese Tensions Rise

India was an outlier, suffering a 2.4% loss, and Taiwan’s semiconductor sector was hit, and the Taiex fell 0.6%. European markets are off to a strong start with a 2% gain in the Dow Jones Stoxx 600 to cut last week’s loss in half. The benchmark is approaching a two-week downtrend line near 399. US shares are higher, and this could lift the S&P 500 to test the key 2945-2955 area.

The US 10-year yield is little changed near 64 bp, but European bonds are lit with peripheral yields off 4-8 basis points. The dollar is mixed. The dollar-bloc currencies and Scandis are firm, while the European complex and yen are heavier. Risk appetites are also evident among emerging market currencies, where the South African rand, Mexican peso, Turkish lira, and Hungarian forint are higher.

The JP Morgan Emerging Market Currency Index is in a sawtooth pattern of alternating gains and losses for more than a week. It fell before the weekend and is higher now. The Russian rouble has been helped by the continued recovery in oil prices, where the July WTI traded above $31. Gold racing higher after pushing to new multi-year highs at the end of last week. The yellow metal is extending is advance for a fifth session and tested the $1765 area in Europe.

Asia Pacific

Japan reported its GDP contracted by 0.9% in Q1 or 3.4% at an annualized rate. It was a little better than expected though the Q4 19 loss was revised slightly to show a 1.9% quarterly contraction (earthquake and sales tax increase). This quarter understood to be considerably worse with expectations of a quarterly decrease of around 5.0-5.5%. Separately, even if not totally unrelated, the latest Asahi poll shows support for Prime Minister Abe is off about eight percentage points to 33%, the lowest in two years. The two big knocks include the handling of the virus and efforts to secure the power to appoint senior prosecutors.

At the same time that the US was announced a tighter ban on the sales of chips to Huawei, China took steps to dramatically increase its output of 14-nanometer wafers. Taiwan Semiconductor Manufacturing Corporation (TSMC) plans to build a wafer fabrication plant in Arizona needs to also be understood in this context too. The US prohibited without a license the sales of chips to Huawei if designed or made by US-produced technology and hardware. That would apply to TSMC, whose biggest customer is Huawei.

The US export controls were circumvented by servicing Huawei out of foreign fabrication facilities. The new actions seek to close the loophole, and it seems that China had been preparing for this be stockpiling in semiconductor chips.

The dollar is confined to less than a third of a yen range above JPY107.00 and is within the pre-weekend range. So far, it is the first session in four that the dollar held above JPY107.00, though this could be challenged in the North American session today. On the top side, a $2.2 bln option at JPY107.50 expires today. After settling on its lows before the weekend, the Australian dollar bounced back to test the $0.6455 area. Resistance is around the pre-weekend high near $0.6475.

The option for roughly A$635 mln at $0.6495 that expires today looks safe. A closed blow $0.6440 would likely signal that the corrective forces remain in control. Given the heightened tension between the US and China and the greenback’s strength seen late last week, today’s PBOC fix was closely watched. The dollar’s reference rate was set at CNY7.1030, which was a bit stronger than the bank models suggested. The dollar reached its highest level since it peaked on April 2 near CNY7.1280. The highest close was on March 25 near CNY7.1150 and is under threat today.

Europe

Bank of England Governor Bailey reportedly denied that zero interest rates were under consideration last week. And the BOE’s chief economist Haldane seemed to suggest that negative interest rates were among the unconventional measures that were being considered. We suspect that the contradictory signals are more apparent than real.

With the base rate at 10 bp, unconventional policy options are being discussed. Haldane was making this more academic point. Bailey was signaling the policy thrust, which is to say that expanding its asset purchase program holds more promise. The UK 2-year yield, which fell below zero last week, is now near minus five basis points.

The economic data highlight of the week is the preliminary PMI reports. The aggregate composite is expected to rise from the record low of 13.6 in April to 27.0 in May, according to the median forecast in the Bloomberg survey, as both the manufacturing and service sectors are forecast to improve. Ahead of the report, the European Commission is slated to announce its policy recommendations for a recovery package for next month’s meetings.

The euro is trading heavily but within the pre-weekend range. It has found a bid at $1.08, where a nearly 530 mln option will expire today. On the topside, the pre-weekend high was near $1.0850, and the 20-day moving average is just below there, likely keeping the $1.0875, expiring option for about 565 mln euros out of play. Sterling gapped lower (below $1.21) on the back of the talk of negative rates, but recovered to $1.2125 in the European morning.

It is struggling to maintain the downside momentum that has seen it fall for five consecutive sessions coming into today. Note that the lower Bollinger Band is found near $1.2115 today. The Turkish lira‘s short-squeeze is extending for its eighth consecutive session. News that Clearstream and Euroclear will not settle lira trades appears to have encouraged further buying back of previously sold lira positions. The US dollar found support near TRY6.81, as domestic demand (for debt servicing?) emerged.

America

The US calendar is light today. The highlight of the week includes the Philadelphia Fed survey (the Empire State manufacturing survey rose to -48.5 from -78.2) and the preliminary PMI (which is also expected to improve). April housing starts, and existing home sales will also be reported, and no fewer than eight Fed officials speak, including Powell (and Treasury Secretary Mnuchin) before the Senate Banking Committee tomorrow. Canada reports April CPI and retail sales figures this week. Mexico’s data highlight is the April retail sales report.

Conventional wisdom sees the negative yields in the US fed funds futures and concludes that investors are betting that the Fed cuts the target rate again. Some suggest that investors may be trying to push the Fed hand, deliver it a fait accompli, force it to cut, perhaps against its wishes. It is hard to argue against this. It seems to intuitively true.

Yet, the markets are not only about betting and taking on risk, but they are also for hedgers and people trying to layoff risk. The negative yields can be explained, even if no one thought the Fed would adopt negative rates. Imagine businesses that need to protect themselves against the chance.

They buy “insurance” from the seller, who then goes to the market to layoff the risk. Financial intermediaries may also choose to hedge the risk of sub-zero rates. Negative rates in the US appear to be more about swapping from floating to fixed rates and the related hedging then actually reflecting expectations of negative Fed policy rates.

Brazil is being punished. The currency and equity market are among the hardest hit, losing a third of their value. It is not simply a function of macroeconomics. Policy matters. The self-inflicted political crisis adds to the challenge posed by the crippling pandemic. President Bolsonaro has lost the confidence of investors who had been prepared to like him after several tumultuous years. The loss of the second health minister in a month during a pandemic that appears to give Brazil the fourth most cases in the world.

The US dollar is consolidating within the pre-weekend range against the Canadian dollar (~CAD1.4020-CAD1.4120). A six-week downtrend line is found today near CAD1.4160. With stronger risk appetites today, initial support near CAD1.4060 would be pressured in North America. The greenback is also consolidating against the Mexican peso with a heavier bias. Lows from the end of last week around found near MXN23.75. Below there, support is seen around MXN23.50, which also corresponds to the lower Bollinger Band. The dollar posted a key downside reversal on May 14 against the Brazilian real. Still, the follow-through dollar selling ahead of the weekend was reversed in late turnover, and the greenback finished on session highs (~BRL5.8560). The dollar’s record high was set near BRL5.9715.

This article was written by Marc Chandler, MarctoMarket.

Equities Rally and the Dollar Eases to Start the Week

All the industry groups are participating and financials and consumer discretionary leading the way.  The Dow Jones Stoxx 600 has been in a 320-340 range for the better part of three weeks and is approaching the upper end. The S&P 500 looks poised to gap higher at the opening.  The April high just below 2880 is coming into view.

Core benchmark yields are a little higher, but the peripheral European bonds are rallying with risk assets.  Yields in Italy, Spain, and Portugal are 5-10 bp lower, while Greece’s benchmark yield is off 12 bp.  The dollar is softer against all the major and most emerging market currencies.  The dollar bloc is the strongest, while the euro and Swiss franc are laggards. JP Morgan’s Emerging Market Currency Index is snapping a five-day slide. Gold is off almost 0.5% as it consolidates above $1700.  Crude oil is snapping a three-day advance, and the June WTI contract is near $14 a barrel.

Asia Pacific

The Bank of Japan made modest adjustments to its policy earlier today.  Three steps were taken. First, it removed the JPY80 trillion cap on government bond purchases. This is largely symbolic as the yield curve control policy has seen its bond purchases fall well shy of the cap (~JPY14 trillion over the past 12 months).

It did make a minor tweak to the different buckets (maturities) that it will buy.  Second, it doubled the amount of corporate bonds, and commercial paper it will purchase (to JPY20 trillion). This was as expected.  Third, it expanded access to its emergency loan facility to a wider range of banks.  Its forecasts were sobering.  Growth, it suggested, could contract by up to 5% (IMF -5.2%), and inflation could be -0.7% this fiscal year.

India’s central bank opened a new credit facility for mutual funds after Franklin Templeton shut six funds last week, citing a lack of liquidity.  The new facility is for INR500 bln (~$6.6 bln) as of today that can be lent to the mutual fund industry or buy investment-grade debt held by the funds.  Corporate borrowing costs soared after the funds were closed.

The dollar slipped toward the lower end of its two-week trading range against the yen (~JPY106.90-JPY108.10). There is an option for $1.2 bln struck at JPY107.00 that expires today.  There are also options for $1.1 bln placed in the JPY107.55-JPY107.60 range that also expire today.  The options may mark the range in the North American morning.

The Australian dollar was bid to new highs for the month today near $0.6470.  Note that $0.6450 corresponded to the (61.8%) retracement of this year’s decline.  The next immediate target is near $0.6500, though a close below $0.6445 would be seen as a failure.  The Chinese yuan was sidelined and little changed with the dollar near CNY7.08030.

Europe

S&P maintained its BBB rating of Italy and its negative outlook.  It noted the ECB’s backstop, and that in nominal terms, assuming no further deterioration in borrowing costs, Italy may pay less to service its sovereign debt the next few years than it did in 2019.

It seemed to suggest that it needed so see improvement in the debt trajectory over the medium-term (three years).  It suggested the same thing about the UK’s debt trajectory as the rating agency maintained its AA rating.  S&P cut the outlook of Greece’s BB- rating to negative.

The Swiss National Bank appears to have stepped up its intervention.  Sight deposits jumped by CHF13.4 bln (~$14 bln) in the week ending April 24.  They can be influenced by other activities but are believed to reflect ongoing attempts to limit additional strength against the euro.

The euro had been hovering just above CHF1.05 over the last couple of weeks, which is its lowest level in about five years.  Today, the euro traded near CHF1.0560, its highest in a couple of weeks.  A move above CHF1.06 is needed to signal anything important from a technical perspective.

The euro had fallen to its lowest level in a month (~$1.0725) at the end of last week before recovering to settle on the session highs, almost a cent higher.  Follow-through buying today lifted it to about $1.0860 in late Asian turnover.  It has consolidated in the European morning.   The $1.0800-$1.0820 area holds expiring options worth about 1.7 bln euros.

Last week’s high was near $1.09, and this needs to be convincingly taken out to lift the tone.  Sterling reached a five-day high today near $1.2455.  Last week’s top was just above $1.2500.  A gain above there is needed to undermine a potential head and shoulders topping pattern some see.  Initial support is seen near $1.2420.

America

The busy week in North America begins slowly.  The US and Canada have a light schedule today, with Mexico reporting March unemployment statistics.  The first look at US Q1 GDP and the FOMC meeting are the highlights.  Canada reports February monthly GDP later this week.  Mexico also reports Q1 GDP, which is expected to have fallen for the fifth consecutive quarter.

US oil inventory data will draw attention.  Despite cuts in output, and the shuttering of more oil rigs (-60 last week, leaving 378, a four-year low), US storage space is quickly becoming exhausted, and there is concern that the problem will persist through the expiration of the June WTI contract.

Over the weekend, Treasury Secretary Mnuuchin reiterated that the US was looking at how to help the oil sector.  It is not clear if it would be another facility that Fed supported or whether it would be the Treasury or Energy Department taking a leading role.  Last week, President Trump again threatened tariffs on oil imports.

Trump has also spoken about boosting the Strategic Petroleum Reserves and giving some private producers access to some of its storage capacity.  Several of the largest oil companies, including Exxon, Mobil, British Petroleum, and Royal Dutch report earnings this week. Many still insist the lower oil prices are a function of a dispute between Saudi Arabia and Russia. Yet, since 2008, the US has doubled its output, which reached 13 mln barrels per day by the end of last year.

The US is not the low-cost producer, though access to cheap capital helped.  The industry was set for consolidation even before the latest drop.  Failures and acquisitions are rationalizing the fragmented shale industry and the larger players finding opportunities.  Diamond Offshore Drilling became the latest casualty over, filing bankruptcy after missing a debt servicing payment a week and a half ago. Last year, its losses doubled to almost $360 mln as revenues fell by about $100 mln to $980 mln.

We suspect that most of the US assistance would not go to the small fledgling producers, many of whom are not investment grade.  If this is true, it may accelerate the re-shaping of the industry, while at the same time, putting down a marker that claims the US will not bear the burden of the global adjustment: Saudi Arabia and Russia need to accommodate it.

The Brazilian real slumped to record lows before the weekend following the resignation of the Justice Minister Moro, who was held in high regard as the driving force behind the anti-corruption Car Wash investigation that ultimately jailed former President Lula. It followed the dismissal of the head of the Federal Police.  President Bolsonaro has been widely criticized for the handling of the health crisis and last week dismissed the Health Minister that favored social isolation.  The Bovespa lost roughly 5.5% at the end of last week.

The US dollar traded between CAD1.40 and CAD1.42 last Thursday.  This range is still key for the near-term outlook. After finishing last week near CAD1.4100, the US dollar slipped to about CAD1.4040 before finding support.  We continue to see the Canadian dollar more sensitive to the risk appetite (S&P 500 proxy) than oil prices per se.

A convincing break of the CAD1.40 area would target the month’s low near CAD1.3860. The greenback closed firmly against the Mexican peso at the end of last week after poking above MXN25.00 for the first time since April 6, when the record high was set (~MXN25.7850). It is trading within the pre-weekend range and found support near MXN24.75, just above the five-day moving average.

This article was written by Marc Chandler, MarctoMarket.

The EUR Looking Vulnerable to Further Downside

They did give their blessing for a short-term plan of $540b, although we have no idea how it will be funded and this is not the panacea to stop an impending 15% contraction in GDP – 15% being the number ECB president Lagarde made mention of overnight.

EURUSD has seen whippy price action, trading a range of 1.0846 to 1.0756 through European and US trade, and is currently sitting towards the low-end of the range here in Asia. The technical set-up on the daily has become just that bit more damaged and the prospects of a re-test of the 23 March low (1.0634) has increased a touch, but the bears will want to see the 6 April low give way.

I looked at EURAUD shorts in yesterdays ‘Daily Fix’ trader thoughts and I’ve added to that position through 1.7014, as its working well – as in life, if something is working you do more of it. The 100-day MA at 1.6771 beckons. EURJPY (see chart below) also gets attention as we’ve seen a break down through the September lows of 115.87 and a convincing break here opens up a test of the 115-figure, where there’s not as huge amount of support through here.

There has been no move in EUR vols, with EURUSD 1-month implied volatility holding below 8%, but one factor that some traders are talking about is the Euribor-OIS spread. We see this pushing up sharply, suggesting growing stress in the EU banking sector. Granted, we’re some way from the levels seen in the GFC or even the European debt crisis (2011), but there are a few stresses in the system that are getting attention and if they start to really move higher the EUR will find sellers easy enough.

Staying on the JPY, there has been a focus on the idea that the BoJ will announce a plan to remove its ¥80t bond-buying limit. The central bank is due to meet on Monday and we may hear plans then, but we haven’t seen much of a broad sell-off in the JPY as a result.

We can focus on the JPN225 (Nikkei 225) as this could be a beneficiary if the BoJ do step up its liquidity drive. On the daily, which is good for oversight here, I see both the 5-day EMA and 20-day MA headed sideways, with the RSI mid-range – it’s a range traders paradise right now, but my view is to let the market come to me. For that, I would buy a closing breakthrough 19,886. That would give me some belief the market is benefiting from changes to BoJ asset purchases and ready to trend.

USDBRL has seen some flow too, with the pair hitting a new record high of 5.5554, largely thanks to Justice Minister Moro resigning. NZDUSD has printed an outside day (on the daily) and could make a tilt at the 50-day MA at 0.6095 – watch for follow on here, and if this prints a higher high today it could take us to the average and 14 April high.

More positive times have been seen in the NOK, with better flows seen in crude. As I type front-month Brent sits up 7.2% and WTI 23%. I am not sure much has fundamentally changed, but price has shifted. Interestingly we haven’t seen any real relief in inflation expectations, with 5-year breakevens unchanged, with the HYG ETF closing -0.05%.

The S&P500 also closed -0.05%, again on light volumes, with futures finding sellers after the close. One to keep an eye on as there was no interest in participants supporting the index above 2800. Asia has seen broadly mixed trade, with the ASX200 higher but sellers are seen in China and Japan. S&P500 and DAX futures are lower and indicating a weaker open for European trade. Although, as said, it’s the EUR that is more heavily on the radar.

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Chris Weston, Head of Global Research at Pepperstone.

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What are Commodity Currency Pairs?

The currencies of countries around the world are fiat instruments, meaning that they have no backing by anything other than the full faith and credit of the nations that issue the legal tender.In the past, many currencies used gold and silver to provide support for the foreign exchange instruments, but the metals prevented countries from making significant changes in the money supply to address sudden changes in economic conditions.

Meanwhile, some countries with substantial natural resources that account for revenue and tax receipts have an implicit backing for their legal tender. The ability to extract commodities from the crust of the earth within a nation’s borders or grow crops that feed the world allows for exports and revenue flows. While those countries have fiat currencies in the international financial system, the implied backstop of commodity production makes them commodity currencies.

Commodities provide support for some foreign exchange instruments

The fundamental equation in the world of commodities often dictates the path of least resistance for prices. While demand is ubiquitous as all people around the globe are consumers of raw materials, production tends to be a local affair.

Commodity output depends on geology when it comes to energy, metals, and minerals. Soil, access to water, and climate make some areas of the world best-suited for growing agricultural products. Chile is the world’s leading producer of copper. The vast majority of cocoa beans, the primary ingredient in chocolate, come from the Ivory Coast and Ghana, two countries in West Africa.

In Chile and the African nations, the production of the raw materials accounts for a significant amount of revenues and employs many people, making them a critical factor when it comes to economic growth. Meanwhile, the Australian and Canadian currencies are highly sensitive to commodity prices as both nations are significant producers and exporters of the raw materials to consumers around the globe.

Australia and Canada have commodity currencies

Australia and Canada produce a wide range of agricultural and energy products, as well as metals and minerals. Australia’s geographical proximity to China, the world’s most populous nation with the second-leading economy, makes it a supermarket for the Asian country. Canada borders on the US, the wealthiest consuming nation on the earth. Therefore, Australia and Canada are both commodity supermarkets for a substantial addressable market of consumers.

In 2011, commodity prices reached highs, and the price action in the Australian and Canadian currencies versus the US dollar shows their sensitivity to raw material prices.

Source: CQG

The quarterly chart of the Australian versus the US dollar currency pair highlights that highs in commodity prices in 2011 took the foreign exchange relationship to its all-time high of $1.1005. The price spike to the downside during the first quarter of 2020 that took the A$ to $0.5510 came on the back of a deflationary spiral caused by the global Coronavirus pandemic that sent many raw material prices to multiyear lows.

Canada is a significant oil-producing nation. In 2008, the price of nearby oil futures rose to an all-time peak of over $147 per barrel.

Source: CQG

The quarterly chart of the Canadian versus the US dollar currency pair shows that the record high came in late 2007 at $1.1043 as the price of oil was on its way to the record peak. The highs in raw material prices in 2011 took the C$ to a lower high of $1.0618. The deflationary spiral in March 2020 pushed the C$ to a low of $0.6820 against the US dollar.

Both the Australian and Canadian dollars are commodity currencies that move higher and lower with raw material prices over time.

Brazil’s real also tracks the prices of some commodities

Brazil is an emerging market, but the most populous nation in South America with the leading GDP in the region is a significant producer of commodities. The price relationship between the Brazilian real and the US dollar is another example of how the multiyear highs in commodity prices in 2011 sent the value of a commodity-sensitive currency to a high.

Source: CQG

The quarterly chart of the Brazilian real versus the US dollar currency pair shows that the real reached a record high of $0.65095 against the US dollar in 2011 when commodity prices reached a peak.

While the Australian and Canadian dollar and Brazilian real are fiat currencies, they each reflect the price action in the raw material markets, making them commodity currencies. The foreign exchange instruments may not have express backing of the nation’s raw material production; there is an implied backing as higher commodity prices lift the local economies and government tax revenues. Commodity currencies can serve as proxies for the asset class as they move higher and lower with raw material prices.

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Let’s find out what has been moving the market today.

After the unexpected victory for conservative Prime Minister Scott Morrison the Australian dollar was supported. However, the trade war risks keep circulating and any fresh negative news may hurt the aussie. Take a look at AUD/USD.

After the People’s bank of China’s comments on keeping the yuan stable, the Chinese currency gained. Its strength now depends on the path of trade talks. ​- Also, pay attention to the USD/BRL pair. The trade war uncertainties, national protests against the freeze of educational budget and cuts of the growth forecasts weakened the Brazilian currency heavily. The release of the level of business confidence today at 17:00 MT may support the BRL, however, the risks of the further weakness remain.

How to Trade Using the Carry Trade Strategy

Carry trade is the borrowing or selling of a financial instrument with a low-interest rate, then using it to buy another instrument with a higher interest rate. The trades will either be going short on the lower interest rate currency or going long on the higher interest rate currency, with the carry trades needed to be held for a prolonged period of time using leverage for enhanced returns and take advantage of interest rates spread between the two currencies.

The use of leverage with a broker to increase earnings multiples through interest rate arbitrage is considered to be a ‘risk on’ strategy, where investors will either consider the current economic environment to be positive for their position or, more importantly, for the economic outlook to be positive, supporting an interest rate diverging environment that enhances carry trade returns. The strategy is based on the evaluation of the economic situation of each country or financial zone.

Risk Aversion – How to Trade the Carry Trade?

The carry trade has been a particularly popular medium to long-term strategy within the FX world, with shifts in interest rates tending to be few and the opportunity to take long-term positions to appeal to investors and hedge funds. 

Basically, carry trade is all about the interest rates differentials, and, more importantly, interest rates prediction.

Yet, for the retail investors, cautions must be taken into the account. While in an ideal world, where political stability persists and macroeconomic conditions have been supportive of carry trades, it is not always as simple as moving from a low yielding to a high yielding environment.

Economic shocks will be reflected within the FX world, sometimes far more quickly than in other asset classes.

Additionally, while central banks have a tendency to provide guidance for the financial markets, supposedly giving ample time to respond and position in anticipation of a shift in policy, some central banks are less interested in forwarding guidance than other. A surprise shift in policy by a central bank capable of eroding any returns made through a carry trade on a given day and even lead to heavy losses.

Risk aversion can also come about from natural disasters or war and not just from a shift in the policy outlook.

In summary, key risks to carry trade positions include:

  • Geo-Political Risk – A political event that will influence sentiment towards monetary policy and economic outlook for a given country, such as Brexit, sanctions, trade war and more.
  • FX risk – returns from interest rate differentials offset by exchange rate movements in the carry trade, leading to losses in spite of interest rate differentials favoring the carry trade.
  • Gearing risk – Losses resulting from unexpected movements that are exasperated by leveraged positions that could result in margin calls or even positions being stopped out by an exchange.
  • Interest Rate Risk – More of an issue when including compounding interest. Movements in interest rate differentials can have a positive or negative impact on returns, with a narrowing in differentials leaving returns lower than expected until the next interest compounding period.

And yet, although risk aversion can be a risk for carry trades positions, carry trades can come as a smart decision for a long-term investment or a trigger to buy/sell any instrument.

The most traditional carry trades have been the USD/JPY, the NZD/USD, NZD/JPY, AUD/USD and the AUD/JPY, with the EUR/USD coming into its own since the global financial crisis. There are others, including the Brazilian real and the Turkish Lira, with some more volatile exotics also on offer, but risk appetite will need to be particularly high and with some economies less transparent than others, carry trades into such exotic currencies come with significant risk. Although these pairs are at the highest level of popularity when it comes to carry trades, any currency or currency pair can be considered a carry trade transaction.

Interest rates spread between two countries can be the main catalyst for a strength of one currency over another currency.

Looking at today’s interest rate environment, the EUR and the Japanese Yen are amongst the preferred funding currencies, with interest rates sitting at or below 0%.

When looking at the recent moves in yields for 10-year U.S Treasuries, the material shift in sentiment towards the U.S economy and monetary policy outlook has seen the Dollar rally of late, with year-to-date losses having been all but wiped out in just a matter of weeks.

For those looking to take on carry trades, finding the right trading platform that offers the appropriate trading tools is key. HQBroker is one such platform that offers the trading of FX and CFDs, giving the trader the option to scalp, swing or take on longer-term positions that includes carry trades, with the use of leverage to enhance returns.

Every trader must research and understand the significance of carry trades prior to entering a transaction and at the exit of the transaction. Carry trades and interest rates differentials provide the volatility in the FX market and more importantly, provide the opportunity for a trader to execute a carry trade, with high odds of a positive return.

Not only the Turkish Lira – The Indian Rupee Hits All Time Low

This week the Indian Rupee crossed 70 for the first time in its history. India’s currency crossed the psychological level on Monday and traded as high as 70.80 on Wednesday. The Rupee is just one of several emerging market currencies to come under pressure in the wake of the Turkish Lira’s collapse. However, the Rupee may be vulnerable to further weakness regardless of the weakness of the Lira.

The Turkish Lira is now down about 35% since the beginning of the year. The Argentinian Peso has lost close to 37% of its value in 2018 after the country was forced to turn to the IMF in May. Other emerging market currencies losing ground are the Indonesian Rupee, the Philippine Peso, the Brazilian Real and the South African Rand.

However, not all emerging market currencies are losing ground. The Mexican Peso has gained ground in 2018, and most South East Asian and East Asian currencies are holding their value.

Almost all the countries that have seen their currencies come under pressure are those with wide, or widening, current account deficits. In India’s case, analysts have been worried about the deficit for some time, and these fears were confirmed when the commerce ministry announced on Tuesday that it had hit a five year high of $18 billion in July.

The current account deficit is growing due to rising oil prices and a surging USD, and FDI and foreign institutional investment flows are not high enough to offset the widening deficit. The rising oil price alone could see India’s oil import bill growing by $26 billion in 2018 and 2019, and is unfortunately likely to offset any export gains due to the weaker currency.

The central bank has also raised rates twice, in June and August, the first rate hikes in four years. It may hike rates further if the currency continues to weaken, though it will be cautious about doing so if economic growth slows.

India ratings and research have also just lowered its growth forecast for the year to 7.2%, from 7.4% sighting rising inflation due to oil import costs.

USD/INR Weekly Chart (Source: Tradingview.com)
USD/INR Weekly Chart (Source: Tradingview.com)

Going forward, the most important factors to watch will be the oil price and the strength of the USD. While developments in the domestic economy will play a part, they are likely to be outweighed by these external factors. Some analysts are forecasting the Rupee to reach between 72 and 73.55 by year-end, based on current fundamentals – but these can change rapidly.

If current fears over emerging market currencies ease, the Rupee will probably retrace to an extent. Short term support may come into play at 69.70, and if that doesn’t hold, the breakout level at 69 could be retested. It seems very unlikely that the currency would strengthen below that level without a substantial change in the economic environment. A likely trading range for the remainder of 2018 may be 69.70 to 72.

While the selloff of the Turkish Lira has played its part in the weakness we are seeing in the Rupee, fundamentals are equally to blame. The Rupee is not one of the currencies that is most influenced by emerging market sentiment and domestic factors rather than speculation play more of a role in the price.

Traders should, therefore, pay as much attention to oil prices and domestic developments as they do to sentiment or technical levels.

10-Year U.S Treasury Yields are Nearly 3%, US Futures Point Higher on Strong Earnings Reports

Wall Street has been inconsistent the past few trading sessions but set to open higher. Asian equities were strong this morning. Gold has lost more value.

Inconsistent Results from Wall Street, Shanghai Shenzhen Market Powers Up

Asian equities have proven positive today, this as Wall Street has misfired three days in a row with inconsistent results. The Shanghai Shenzhen composite gained more than 2% today, and the Hang Seng and Nikkei Indexes also provided solid climbs. Japanese inflation via Core Consumer Price Index numbers met their expectations. And the U.S saw good economic numbers via Existing Homes Sales and its Manufacturing sector yesterday, but the three major equity Indexes have struggled to add value since the middle of last week. While corporate earnings may be weighing on sentiment, the fly in the ointment for U.S equities is the strong bond market which is producing good results.

Euro Appears Vulnerable as U.S Dollar Gains, U.S Bond Market Influence

The U.S Dollar has been ultra-strong the past few trading sessions and it is putting the Yen, Euro, and Pound near important technical junctures. 10-Year U.S Treasury Bonds are now yielding nearly 3 percent, which has been a definite catalyst for the Dollar trend. The European Central Bank will make their monthly monetary pronouncement on Thursday, but no changes of consequence are expected. The Euro is hovering near the 1.22 level versus the U.S Dollar and still appears vulnerable.

Gold on a Slippery Slope Short Term, April Support Levels May Not Hold

Gold has found itself on a slippery slope the past few days. The precious metal remains under selling pressure and is near the 1325.00 U.S Dollar ounce level. Support proved to be strong around these junctures early in April, but speculative forces may be targeting lower values near term.

Home Price Index from the States, U.S Consumer Data Awaits Today

An important Consumer Confidence reading will be issued for the U.S at 14:00 GMT and get the interest of traders.

  • 13:00 PM GMT, U.S, S&P/CS Composite-20 Home Price Index
  • 14:00 PM GMT, U.S, CB Consumer Confidence

Yaron Mazor is a senior analyst at SuperTraderTV.

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Brazilian Real Higher After Interest Rate Cut

The Brazilian real rallied against the US dollar yesterday after the Federal Reserve released a dovish policy statement and Brazil’s central bank cut its key interest rate.

The Central Bank of Brazil cut the Selic rate by one percentage point to 9.25%, in line with expectations. It was the first time since November 2013 when the interest rate was set below 10%. Moreover, the central bank signaled that it may continue monetary easing at the same pace at the next policy meeting.

USD/BRL sank 1.07% to 3.1384 as of 11:30 GMT today.

This post was originally published by EarnForex