[MKT] FX Strategy - JPY strength creates opportunities
A firmer USD has resulted from the Fed rate rise, but it's hard to get too excited about the prospect of further USD gains when the data isn't coming in particularly strong. Thursday saw weakness in the Philly Fed index, which dropped back to its lows, and a worse than expected current account, following weakness in industrial production and manufacturing PMI earlier in the week. There has also been no significant widening in the T-note/Bund spread which has been a good guide to the fortunes of EUR/USD this year. At this stage, this spread doesn't suggest that the key EUR/USD support at 1.08 will break, and a big options expiry at 1.08 may help to support it as well, but we would not put too much trust on any level as conditions thin towards year end. So we would not look to oppose the stronger USD at this stage, but if we do see a break below 1.08 in EUR/USD we would not expect it to be sustained for long unless we also see some improved data and higher US yields.
Thursday saw volatile trading in GBP, which appeared to gain on a rumour (or leak) of strong retail sales data ahead of the actual release. The November UK sales data was indeed a lot stronger than expected, but GBP gains were extremely short lived, and GBP/USD fell after the data and through the day to make new post April lows. GBP may now be the most vulnerable currency against the USD as a UK rate hike is not expected until after the next Fed move, and the market is also concerned about the UK EU referendum that is expected in June or September 2016, as well as the well established UK current account problems. While the EUR has a big current account surplus to support it in thin conditions, GBP has no such luxury. While concerns about the UK EU referendum may be overdone, they are unlikely to dissipate soon, and further GBP weakness looks likely.
The CAD and other commodity currencies were the other big losers on Thursday, responding to further weakness in the oil price and other commodities. CAD weakness is, however, starting to look a little overdone, with USD/CAD hitting its highest level since May 2004 even though the oil price didn't make new lows on Thursday. However, the rise in USD/CAD is broadly consistent with the widening in yield spreads with the USD. Nevertheless, we would be wary of assuming further significant CAD weakness from here given that there is no reason to price in a more aggressive tightening in US policy at this stage.
JPY strength overnight came after an initial sell off after the BoJ altered the details of its QE program, but the market initially misunderstood this as an easing in monetary policy, which Kuroda was at pains to indicate it was not. A lot of the subsequent JPY strength looks technical as stops were triggered on the JPY recovery, and a lot of the weakness seen early in Europe also looks JPY cross related. GBP/JPY may have made the most significant break below the weekly trendline at 184, and September and October lows at 180.40-60 are now under threat. However, we would expect EUR/JPY to find support around 130.80, which may prove a good medium term buying opportunity.