News Stream and Price Action Illustrates Themes

Today’s developments and price action illustrate several of the important themes in the foreign exchange market. The news stream from the euro zone has improved from the dark days in Q2. Spain, for example, easily raised the 3.5 bln euros it was looking for at a yield around 100 basis points lower than it paid that the previous auction in June (2013 maturity 2.28% vs 3.32%) and the bid-cover did not suffer much (1.9x vs 2.1x). The IMF has indicated that Greece’s reforms are on track and that it will receive the second tranche of its aid.

It did warn that more difficult reforms are still ahead of it. While the IMF sticks to its forecasts that the economy contracts 4% this year, it has substantially raised its inflation forecast (4.75% from 1.9%) and accurate, makes its ability to boost its competitiveness, which the ECB indicated it needs to do, more difficult. Today’s data also underscores the robustness of the German economy. June manufacturing orders rose 3.2%, more than twice what the market was expecting and the May decline was largely revised away (-0.1% form the -0.5% initially reported). Of note, orders from the euro zone surged 11.3% on the month, while non-EMU orders rose a more modest 1.8%. Domestic orders themselves were uninspiring, though, rising 0.3%. Germany reports June industrial production figures tomorrow and there is upside risk to the consensus forecast of 0.7%.

The price action also illustrates another force in the market. Sentiment is such that pullbacks in the foreign currencies are still seen as a buying opportunity. These pullbacks continue to relatively shallow and brief and this seems to suggest that the risk is that further gains are likely.

While yesterday’s US ADP and non-manufacturing ISM were better than expected, short-term market participants remain wary ahead of tomorrow’s jobs data and next week’s FOMC meeting, where some are still speculating on the resumption of asset purchases. Many currency forecasts in the market assume that the dollar’s setback in recent weeks is largely corrective of the Nov 09-May10 dollar rally and look for the underlying uptrend to resume later in Q3 if not Q4. On the other side, there are a number of perma-bears that have come out of hibernation and are arguing that the Nov-May move was the correction and now the dollar’s longer-term downtrend has resumed. However, a new pick up in US economic activity and the passing of the FOMC meeting with out new QE measures may help produce a better two-way market.

Weekly MOF flows show Japanese accounts significantly stepped up their foreign asset (mostly bonds) purchases. The data out today covered the last week in July. Japanese investors bought JPY1.25 trillion (~$14.5 bln) of foreign assets. This brings the total for the month to an impressive JPY5.7 trillion (~$66 bln). This follows June (was a sum of the weekly time series) purchases of JPY3.4 trillion and brings purchases of the last three months to JPY11 trillion (~$127 bln). Foreign investors returned to the buy side in July (JPY981 bln) after have been net sellers of a combined JPY2.7 trillion in the May-June period.

Clearly these portfolio flows have been insufficient to weaken the yen. Over the last three months, the yen has been easily the strongest of the G10 currencies, appreciating 8.5% against the dollar, more than twice the 3.5% rise of the Swiss franc, the second strongest G10 currency. The DPJ government, including Prime Minister Kan himself, had previously seemed to be more verbally aggressive about desiring a weaker yen. If intervention is best thought of as an escalation ladder, ranging from mild verbal signals to coordinated material intervention, Japanese officials still seem to be on the low rungs, but the tone of the verbal comments have increased as the JPY85 area has been neared. Many players are a bit cautious but appear to be drawn to it. A weak US employment report tomorrow that sees a further decline in US interest rates could provide the necessary cover.

As widely anticipated the BOE left rates on hold. The minutes from the meeting will be released in a couple of weeks. Like a number of other central banks, including the Fed, there has been a hawkish dissenter on the MPC,, but the majority, led by the Governor (and Bernanke in the US) retain a more dovish stance. Next week (Aug 11) the BOE issues its quarterly inflation report, that may shed greater light into the BOE’s thinking.