A Few Notes on FX

The US dollar is trading heavily after yesterday's mini-reversal, with a stronger than expected UK GDP report allowing sterling to lead the charge.  The UK reported a 1% rise in Q3 GDP over Q4.  The consensus was for 0.6%-0.7% expansion after three quarters of contraction.  

The news, coupled with recent comments from BOE's King, have dampened expectations for a continuation of the gilt purchase program when the current operation is complete next month.  The gains in sterling have been sufficient to take out the downtrend line drawn off the year's high on the first day of autumn, Sept 28 and Oct 17.  It comes in near $1.6135 today.  A close above there, especially tomorrow, on a weekly basis, would be a very constructive sign.  The next immediate hurdle is near $1.6175, but the positive technical impulses suggest potential back toward $1.6300. 

That said, fundamentally, we are not convinced that the GDP report heralds the end of the UK economic woes.  There is a statistical fluke related to the number of working days in Q3 compared with Q2.  Also, more austerity is in the pipeline and the UK's biggest export market is in recession. 

Meanwhile the dollar has pushed through the JPY80 level and is trying to establish a foothold, off which it can test the June high near JPY80.60.  News reports from Japan continue to play up the likelihood of another extension to its asset purchase program.   The problem with that narrative that nearly every one and their sisters are talking about is that the BOJ has been engaged in QE for several years, which has generally failed to arrest the yen's gains or deflation's grip on the economy.  

Perhaps the story is more basic.  Contrary to reports that the carry trade is dead, which means that interest rate differentials are not an important consideration in currency movement, the US 10-year premium over Japan is near 106 bp, a level seen once since early May.  The widening spread is a function of the rise in US yields not Japanese.  Over the past month, the US 10-year yield has risen 17 bp, while Japan's 10-year yield is off 1 bp. 

Similarly, the 2-year differential, which even the BOJ has acknowledged, tracks the dollar-yen rate, is moving above 20 bp, which it has done only a couple of times in the past six months. 

Elsewhere, we note that although Sweden's Riksbank did not cut rates, as we had previously thought was likely (before the Governor threw cold water on the idea last week), it did lower the trajectory of rates, suggesting that rates will remain low for longer.   This was enough to send the krona to new 3 month lows against the euro.  

The euro itself bounced smartly off the $1.2920 yesterday and pushed to almost $1.3025 in the European morning.  It has since stalled, but is holding a trend line on the hourly bar charts and provided the $1.2980 area holds, look for the euro to challenge the highs again.  The $1.3070 area is the next important technical hurdle.  

Lastly, in our weekly positioning and technical note, we pointed out that the 50-day moving average crossed above the 200-day moving average for sterling in mid-September.  The same moving averages (called the golden cross or death cross, apparently depending on which side you are on) are on the verge of crossing in the euro--today or tomorrow-.  The same averages look set to cross in the Swiss franc early next week.   We have found this is the most favorable sequence:  sterling leads the euro and the franc confirms it.  However, in our fundamental view, the dollar is carving out a bottom after trending lower for the last several months.