AUDUSD and AUDJPY at odds - which one is "right"? University of Michigan Confidence on tap.
MAJOR HEADLINES – PREVIOUS SESSION
* Japan Q2 GDP adjusted down to 0.6% QoQ from 0.9% QoQ
* China Aug. Producer Price Index fell -7.9% YoY vs. -8.2% in Jul.
* China Aug. Purchasing Price Index fell -11.4% YoY vs. -11.7% in Jul.
* China Aug. Consumer Price Index fell -1.2% YoY in Aug. vs. -1.3% expected and -1.8 % in Jul.
* China Aug. Industrial Production rose 12.3% YoY vs. 11.8% expected and 10.8% in Jul.
* China Aug. Retail Sales rose 15.4% YoY vs. 15.3% expected and 15.2% in Jul.
* China Aug. New Yuan Loans rose to 410B vs. 320B expected and 456B in Jul.
* China Aug Trade Balance rose to $15.7B vs. $13.6B expected and $10.6B in Jul.
* Japan Aug. Consumer Confidence rose to 40.4 vs. 40.2 expected and 39.7 in Jul.
* Sweden Q2 GDP out at +0.2% QoQ vs. 0.0% expected and 0.0% in Q1
* UK Aug. PPI Input/Output out at 2.2%/0.2% vs. 1.0%/0.3% expected
* Canada Jul. New Housing Price Index rose 0.3% MoM vs. -0.1% expected
* US Aug. Import Price Index rose 2.0% MoM vs. 1.0% expected and fell -15.0% YoY vs. -15.9% expected
THEMES TO WATCH – UPCOMING SESSION
(All times GMT)
* Upcoming Economic Calendar Highlights
* US Sep. Preliminary University of Michigan Confidence (1400)
* New Zealand Jul. Retail Sales (Sun 2245)
* New Zealand Aug. REINZ House Sales (Mon 0000)
Market Comments:
China still looking strong
China's fresh data overnight looks very impressive, though it doesn't seem the market takes much impetus from these data releases, though the strength in Chinese equities contributed to sustained strength in other world equity markets. The New Yuan Loans figure for August was up from the July figure, but is still a small fraction of the enormous stimulus unleashed on the Chinese economy in previous months, so the pessimists will be out looking at whether the sharp reduction in credit stimulus shows up in months to come. It's tough to draw a bead on the Chinese economy due to the nature of the calculations of its statistics and wildly diverging reports on its prospects. Whether the housing market is a bubble is a vital question: an article from Reuters today notes that affordability is a significant problem in key markets like Shanghai and Berlin, where mortgage cost about 75% of income (though the article questions the calculation of average income and indicates that ).
So far, China seems to be navigating the demand drop from abroad with aplomb - and must continue to do so for the rosy scenario already priced into markets to continue to play out. Auto sales have surge recently and GM says that the country's auto sales could surpass those in the US this year as China becomes the world's largest auto market. Despite the clear evidence of a credit clampdown by banks over the last couple of months, premier Wen Jiabao promised to keep stimulus measures in place, saying "we cannot and will not change the direction of our policies when the conditions aren't appropriate (since the rebound is "unstable, unbalanced and not yet solid"). Our expectations are for weak external demand in China's export markets over at least the coming year (and the one very weak spot in the Chinese data overnight was the export drop of -23.4% YoY for Aug. vs. -19% expected) - so the question is whether China can continue to weather the external demand shock with internal solutions aimed at infrastructure buildout and consumption growth.
JPY strength
JPY certainly wasn't looking for direction from the revision to Japan's GDP overnight (down) nor the strong Chinese data, as it rallied sharply overnight and into the European session. The JPY still seems to get more pull from moves in other markets. This time around it is likely interest rate spreads that are giving the JPY a push, as it finally responded to the very strong signals at the short end of the curve where interest rates spreads have tightened sharply in favor of the JPY in recent days. If we are to pay attention to rate spreads any longer, in fact, then the likes of especially EURJPY (on the last cycle of dovish ECB comments) and other JPY crosses to a lesser extent have further to sell off in the near term to price in the latest tightening. By the 2-yr. interest rate spread measure, USDJPY looks fairly priced. USDJPY is now nearing critical territory at the 90 level - much below here and the pain begins to become ratchet up for the Japanese economy. Let's see how the new administration responds beyond 90, if that comes to pass.
AUDJPY and AUDUSD - out of synch
Just as yesterday we noted the confusing combination of a weak US dollar and very strong US bond auction results - if the market theme is one of "sell the USD due to fiscal profligacy", then why is demand till robust at the longest end of the curve. Another sign of the divergence in the last leg of the market action is the divergence in the behaviour of the USD and the JPY. The JPY has found intermittent support from the still relatively strong fixed income market, while it has been held back at times by the very strong risk appetite in asset markets and traditional carry trade boost that this gives. Meanwhile, the USD has broken strongly to the downside recently. This divergence is very evident in the comparison of the AUDUSD and AUDJPY pairs shown in today's chart - which tracks AUDUSD and AUDJPY on an indexed basis since mid-2007 and shows the two pairs' rolling 40-day correlation. AUDUSD has touched new highs for the cycle recently, while AUDJPY remains well off its highs for the cycle and has been in a back and forth pattern over the last few weeks. There is no consistent pattern as to which pair is the leading indicator, but we have a hard time imagining that this kind of divergence can continue for long. Either JPY must join the USD in the ranks of the weaklings among the G-10, or the USD needs to find strength. (There is a third scenario of course: AUD volatility spikes very strongly relative to USD and JPY volatility and gets the pairs moving in synch again.) We assume in our setup here that the fourth scenario of continued and sustained divergence in the pairs' moves continuing for more than a few more sessions will not happen.
Looking ahead
As long as the Chinese growth story bulls ahead and asset markets remain robust, it is hard to see what is going to stop this USD sell-off in the near term, even if we fear the market is pricing in far too robust a recovery further out. Is 1.5000 in EURUSD the next big psychological target? Looking to play on further USD weakness, we might ought to turn our eyes on USDCAD after yesterday's fairly compelling bearish reversal, though it did take place within the range... The 1.0800 area in USDCAD has not really held here after yesterday's bearish inverted hammer reversal. If the pair can work its way below the 1.0750 level (0.618 Fibo of the recent rally), it could push lower below the lows for the cycle and perhaps to 1.0450 (target calculated with Fibo extension)
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