January forex reserve data revealed on the weekend that China is burning through reserves at an unsustainable pace in order to strengthen the yuan. Yet the common theme remains that China wants to soften their currency. We look at the dilemma officials are facing and how it will end. In the Premium trades, Ashraf closed the USDJPY and GBPJPY shorts at 320 and 335 pip gains respectively. Many clients questioned his decision to short USDJPY 45 mins after the BoJ announced negative interest rates.
It's Chinese New Year Monday and markets there and in other parts of Asia will be closed all week. That may give markets an opportunity to stabilize as one of the factors driving volatility is removed.
It's also a chance to try to make sense of China's strategy. Why not just allow market forces to weaken the yuan?
For Chinese officials, what's as important as the direction of the currency is why it's moving. At the moment, they see capital exiting China on jitters about the economy and stock market. Beijing is obsessed with stability and the appearance of control. That's why they've put much effort into smoothing yuan and stock market moves.
China wants to have open markets, but only on its terms. Unfortunately, even the most well-developed, transparent markets are prone to irrational volatility, as 2016 so far has proven. China won't spend all its reserves to combat the inevitable loss to market forces, so it's a matter of when and how they give in.
Naturally, Beijing wants to give up control on its terms but it's increasingly likely that markets won't cooperate. The opacity of the Chinese economy will always make it vulnerable to capital flight. China's true dilemma is whether to accept it or change course back towards tighter capital controls. The latter is more likely than most market participants believe.
Commitments of TradersSpeculative net futures trader positions as of the close on Tuesday. Net short denoted by - long by +.
EUR -87K vs -127K prior JPY +37K vs +50K prior GBP -45K vs -47K prior AUD -26K vs -33K prior CAD -52K vs -67K prior NZD -8K vs -5K prior
This is the first look at the data since the surprise BOJ decision. The yen long trade wasn't squeezed as much as it appeared, although the numbers could also reflect fresh shorts after the USD/JPY to 121 fizzled. Instead, it was euro shorts that rushed out of the way and that was before the latest break above 1.10.
Middling economic data persisted in the US but markets showed some signs of stabilization ahead of non-farm payrolls. The Swiss franc was the top performer while the pound lagged after the BOE. Australian retail sales are up next. In the Premium Insights, the EURUSD long was closed with a 273-pip gain, while a new GBP trade was added shortly before the BoE announcement. At this point, 5 of 6 existing trades are currently in the green.
The US dollar fell hard in early New York trading and it looked like an extension of yesterday's rout. The Dec factory orders report fell 2.9% vs 2.8% expected and it was compounded by a 0.5 pp downward revision to the prior report. Initial jobless claims were at 285K compared to 278K expected.
The high of the day in EUR/USD was immediately after the data at 1.1238 but then the dollar bleeding stopped. The euro fell back to 1.1160 before finishing at 1.1200.
The Fed's Kaplan underscored the recent tentative tone, saying the Fed wants to normalize but it can't be forced. He also fretted about tightening financial conditions. The dollar barely recovered against the yen throughout the day but it made progress against CAD, climbing 100 pips from the lows. It was aided by a 59-cent drop in oil despite the usual OPEC jawboning and headlines about Syria.
The pound was extremely volatile. It fell hard on the 9-0 vote to hold rates as McCafferty abandoned his hawkish stance. It soon recovered as Carney talked up the prospect of rate hikes (eventually) but then fell back on weaker growth forecasts.
Position squaring ahead of non-farm payrolls might have also helped the dollar, and broader markets, stabilize. The consensus is for 190K new jobs but the momentum is a bit lower with some forecasts revised lower after the weak ISM non-manufacturing report, notably Goldman taking its call to 170K from 190K.
In any case, it's tough to see how the jobs report could be a game-changer for the Fed or the market.
What may end up being a bigger factor for markets is the Australian Dec retail sales report. It's expected to rise 0.4% and will be released at the same time as the RBA Statement on Monetary Policy, which is a more detailed breakdown of the RBA thinking than the monetary policy decision.
Canadian jobs will also be released on Friday.Earlier in the week, we floated the idea that perhaps the developed commodity bloc is a more resilient to the bust than the market believes because of 15 years of savings, ample space for fiscal stimulus and the FX moves. Friday's data will help begin to answer that question.
|Nonfarm Payrolls (JAN)|
|190K||292K||Feb 05 13:30|
|Retail Sales (DEC) (m/m)|
|0.5%||0.4%||Feb 05 0:30|
|RBA Monetary Policy Statement|
|Feb 05 0:30|
Dovish Fed comments and a soft ISM non-manufacturing index contributed to a massive run on the US dollar Wednesday. The dollar suffered 200 pip losses on multiple fronts as commodity currencies surged. Asia-Pacific traders have a relatively quiet calendar to sort through the wreckage. In the Premium trades, GBPUSD was stopped out, while all existing 6 trades are currently in the green.
Heavy US dollar selling began when an interview with the Fed's Dudley appeared on MNI. He warned that a continued financial tightening would weigh on the FOMC in a signal they could delay hikes.
That doesn't stray far from the recent FOMC script and it shouldn't be a big surprise given Dudley's dovish bent. The dollar declines were compounded by the ISM non-manufacturing index. It was at 53.5 compared to 55.1 expected. Tellingly, the employment component slipped to a one-year low of 52.1 compared to 56.3 previously. That could spell trouble for Friday's non-farm payrolls report.
Even with that news, the scope of the US dollar selloff was a surprise. EUR/USD rallied as high as 1.1145 from 1.0900 early in the day even as German 2-year yields hit a record -0.50%.
Two things contributed to the exaggerated move. The first was the overcrowded US dollar position. It became even more one-sided after the BOJ squeezed out yen longs and has been vulnerable to softening data and weakening conditions. It may have just been today's news that was the straw that broke the camel's back.
The second was technicals. EUR/USD faced a series of January highs in the 1.0980 range and a medium-term wedge. As those levels gave way, a squeeze got underway and momentum players jumped in. It was a similar story in other pairs, including AUD/USD, which traced out an impressive outside day.
Oil was a big part of the story as well. Another huge build in US supplies was overshadowed by talk of an OPEC/non-OPEC meeting and crude rallied 9% to wipe out the bulk of the declines in the previous two sessions.
We wrote yesterday about how impressed we were than CAD was hanging tough as oil slumped. It was a signal. The recovery in oil sent USD/CAD to a six-week low of 1.3760 from 1.4100 in a massive rout.
Gold once again proved to be a reliable safe haven in the thrashing sea of 2016 markets. That will add to its allure.
Has the time come to buy gold, or is it another false bounce? Ever since its intermediate high of October 2012, gold descended in a long forming downtrend, interrupted by a series of five upward corrections, each lasting no more than 3 months. The yellow metal had been dragged down by a combination of eroding inflation and a raging US dollar. But as central banks become increasingly stuck at negative interest rates, and/or are unwilling to raise rates, then gold's substitute characteristic could help it higher over time. Or will it?
Despite the fresh bouts of QE from Japan in Q4 2014 and the ECB in Q1 2015, none of those currency debasing policies managed to trigger any meaningful rally in gold. Is it different this time? Will a retreat by the Fed on hiking rates in Q1 or/and Q2 be sufficient in dragging down the USD, to the extent of boosting gold?
What about gold stocks? Are they a preferable investment to bullion, or ETFs? Many strategists have offered confusing analysis about the bullion-goldbugs relationship, not clearly indicating, which leads what?
After issuing a new trade in gold to our Premium subscribers, we back up our idea with a special Premium Video, exploring: i) the lead-lag relationship between bullion and goldbugs; ii) how to use the GoldBugs ratio in assessing bullion's direction; ii) the cycle pattern of net long contracts in the Comex; and 6 other fundamental/technical forces acting on the prevailing trend. Access to the Gold Video & XAUUSD trade.
It was Groundhog Day on Tuesday and the Bill Murray movie of the same name was a perfect description because it was a replay of theme and market moves we saw over and over again in January. The yen led the way as oil, stock markets and commodity currencies dropped. However the New Zealand dollar rebounded on a blockbuster employment report in early Asia-Pacific trading. Yesterday's Premium trade in gold was supported with technical charts and the relationship between bullion and in gold miners. A new JPY trade was added today.
The Fed didn't do the market any favours today as George continued to press for more hikes, although she qualified it by saying the Fed always evaluates the economic outlook. US data on car sales were a healthy sign for the consumer but those small positives could weigh a 6% decline in oil.
More energy market problems resurfaced by a second day of heavy downgrades and warnings in the oil sector from Standard & Poor's. The ratings agency cut Chevron and put the major US producers on credit watch for downgrades. More importantly, that same credit stress is hitting smaller indebted oil producers hard.
It's also hitting oil-exporting sovereigns and there is persistent talk that they will be forced to liquidate sovereign wealth fund holdings.
At the moment, the resilience in CAD remains impressive. Oil has fallen $5 from last week's highs and yen USD/CAD is just 150 pips above its lows.
What offers hope to the USD/CAD bears is something of a pattern developing in the developed-world commodity producers. In January, Poloz was upbeat on the non-commodity sector. Yesterday, Stevens was similarly positive on the outlook for the domestic economy (while expressing worries about emerging markets). Today, New Zealand announced a shocking drop in unemployment to 5.3% from 6.1% in Q4.
There is no doubt that parts of Canada, Australia and New Zealand will be hard hit by the commodity drop but we are keeping an open mind on the idea that other parts of the economy may prove resilient. That may be a factor of the exchange rate, economic flexibility or built-up savings from the 15-year commodity boom. Or it might just be a matter of time before they crack.
The next data on the agenda is Australian trade balance at 0030 GMT. It's expected at a deficit of 2.45m million but we will closely watch the breakdown of imports and exports. If exports rise, it could be a sign that a weak AUD is helping.
At 0145 GMT, the Caixin China services PMI is due for release. The prior reading was 50.2. It's not likely to be a big market mover.
Fifteen minutes later, the Japan PMI for services is out. The prior reading was 51.5.
|Markit PMI Composite (JAN)|
|53.7||Feb 03 14:45|
|Markit Services PMI (JAN)|
|53.7||Feb 03 14:45|
|ISM Non-Manufacturing PMI (JAN)|
|55.1||55.3||Feb 03 15:00|
|50.5||50.2||Feb 03 1:45|