Thoughts about the Euro and Yen Price Action

The euro has spent this week inside last week’s trading ranges.  It is consolidating the break of the $1.28 support, the lower end of the trading range from mid-September through last week.  This former support is now resistance as seen in Thursday’s price action.  That area now also corresponds with the 200-day moving average and the 38.2% retracement of the euro’s slide since the October 31 high near $1.3020.  

A weekly close above the $1.2800-20 area would be a constructive technical development.  Fundamentally nothing was resolved this week, but it does seem that the Eurogroup  is moving toward a deal on Greece that will get it some aid, but leave the 2015-2016 funding unresolved  The fact of the matter is that no matter how imminent it may have looked to some observers, Greece will finish the year still in EMU.  The sooner Greece runs a primary budget surplus the better its negotiating position with its creditors.

That the euro zone economy contracted for the second consecutive quarter merely confirmed what many investors already were fairly confident about.   Perhaps the unexpected “strength” of the French economy (0.2% expansion vs flat expectations), and the magnitude of the Dutch contraction (1.1% q/q), alter the dynamics slightly.  The French government seems emboldened by the first increase in GDP is Q3 last year, which seems more than a little premature, especially given the preliminary signs that the economic headwinds have strengthened here in Q4.  The Dutch government may need to find more savings, which is precisely the challenge that toppled the previous government.  

 

The yen’s movement eclipsed the euro‘s vagaries this week.  There have been weeks (five session periods) in the past six months in which the dollar rallied a little more than 2 yen.  This time it does feel different.  Indeed the different circumstances this time is partly why we did not a break out. 

In our work, we have tended to emphasis two drivers for the yen, the general investment climate (risk-on/risk-off) and interest rate differentials.   US equities, the proxy for risk-on, continue to do poorly and there has been no increase in the US premium over Japan.  

This is an unusual set of circumstances—the yen is being driven by internal considerations.  In particular the market assumes that next month’s election will see the LDP return to power, even if leading a coalition with Hashimoto’s (center?-right) Restoration Party.  That means that Japan’s seventh prime minister in as many years will be Abe.  

Abe wants a dramatically more aggressive monetary policy and it was the markets discounting some part of this that has driven the yen to six month lows against the dollar.  In fact, our contacts in Japan tell us that yesterday may be remembered  as “Abe Mine”.    

We suspect that the break in market psychology has taken place and that dealers will be looking to buy the dollar on pullback against the yen, whereas previously they were more inclined to sell dollar bounces.   We see support for the dollar now just below JPY81.  Note that the dollar has not closed two days beyond two standard deviations from its 20-day moving average (top of the Bollinger band) since last November, after massive (~$100 bln on 31 October 2011) intervention.  It will do so again if it finishes the week above JPY81.00.  

On the upside, the JPY81.50 area is thought to contain option barriers.  There has been talk of JPY83 and JPY84 strikes, though the charts suggest potential toward JPY85.    Lastly, the anticipation of easier monetary policy and a weaker yen is net positive for Japanese stocks.  In fact, in a weak yen environment, foreign fund managers may want to consider switching from JGBs (to which they have been adding this year) and toward Japanese stocks.  Foreign purchases of Japanese shares has fallen by about 2/3 this year to about $2.72 bln.