FX: Stll Waiting

To say that the foreign exchange market is quiet is to bemoan the obvious.  What is particularly striking is that the euro's range yesterday may have been among the smallest and today is matching it, thus far.   According to Bloomberg data, yesterday's range was 17 ticks.  

Looking at the volatility implied by the options market exaggerates the low actual volatility.  Consider, for example, that the options market implies 4.5% euro-dollar volatility (one-month). The actual volatility is 3.1%.  This is, of course, more than the term structure or the vol smile can justify.  It partly reflects fear that volatility may rise sharply.   It may also partly reflect dealers reluctance to take on the risks and costs without getting compensated.  

A similar pattern is found in sterling.  Implied one-month volatility is just below 4.6%, while actual volatility over the past month is 2.5%, the lowest among the major currencies.  The implied one-month yen vol is 4.9% and actual volatility is 3.5%.   

The US dollar is slightly firmer today, while the 10-year US Treasury yield is a bit softer at 2.47%.  China and Japan stock markets extended yesterday's gains, while the other Asian markets were mixed.   European bourses are mixed, leaving the Dow Jones Stoxx 600 little changed, with earnings reports lifting financials and telecoms, but weighed down by the auto sector after Renault's cash burn rate disappointed investors.   

Bond markets are mostly firmer and German 10-year bund yield hit a record low near 1.12%.  Spain's 10-uear is also at a new record low of 2.46%, edging just below the US.  While the fact that Spanish yields have fallen below US yields has become a talking point, what is often missed in the discussion is what is happening to real rates.  Given the near zero inflation in Spain, the real yield is almost identical with the nominal yield.  In the US, with near 2% inflation, the real yield is almost 50 bp, a fifth of Spain's.  

We recognize, of course, that the decline in Spain's 10-year yield reflects not only the fall of the inflation premium, but the risk premium in general.  This risk premium included  a risk that the euro zone would break up (redenomination risk) and that Spain would default.  The risks have also fallen, though they are more difficult to measure. 

The evidence suggest that Japan's retail sale tax increase pulled the rug under the Japanese economy.   Unemployment unexpectedly jumped to 3.7% from 3.5%.   Retail sales rose a miserly 0.4% in June and in Q2 fell an average of 2.9% a month compared with an increase of roughly the same magnitude in Q1.  Overall household spending fell 3.0% (year-over-year) after an 8.0% collapse in May.  

We suspect that Japanese officials had been prepared for a poor Q2.  That the government and the central bank cut growth forecasts recently indicates a weaker than expected performance.  However, the key to a policy response is the economy's performance in Q3.   Meanwhile, Abe's support is waning.  Many households did not experience the benefits of the first two arrows in terms of wages and returns on fixed income investments.  This leaves Abe in a weaker position to pursue controversial plans like the reinterpretation of the constitution and restarting nuclear plants. 

Even without new support from the US Treasury market, the dollar is testing a three-week high around JPY102, where both the 100- and 200-day moving averages converge (JPY102.05 and JPY102.10 respectively).  There is market talk large sell-orders are there, which is also the middle of the JPY101-JPY103 range that has confined the pair for more than three months.  

The UK is much in the news as well today.  The IMF's report got the ball rolling, but it was the strong mortgage data that set the chins wagging.   The IMF said three things of note.  Sterling was 5-10% over-valued (OECD say 15%).   After being critical of it last year, the IMF now supports the government efforts to cut spending.  And finally, the Bank of England should consider an interest rate response if the macro prudential efforts do not curb the housing market.  

As if cued up by the IMF report, the UK reported a surge in mortgage approvals for June.   The 67.2k  approvals compares with the 62.6k expected by the Reuters survey and 62.0k in May.  It is the largest since February, before the UK raised its affordability criteria and the BOE tightened the loan-to-income ratio.  

For its part, the correction in sterling continues.  Over the past four sessions, it has established a little base ahead of support we pegged at $1.6950.  The technical tone still feels fragile and  the risk is still to the downside.    The next technical objectives are in the $1.6885-$1.6900 band.  

The New Zealand dollar is the worst performing of the major currencies, with a 0.4% loss.  The main catalyst was the sharp drop in Fonterra's payout for milk (NZ$6 down from NZ$7).  The milk coop that accounts for about seventh of the New Zealand economy noted falling demand from emerging markets and rising inventories in China. 

The Australian dollar, which is little changed against the US dollar, is trading at new highs for the year against the New Zealand dollar.  This cross has rallied 3.8% in the past two weeks and appears to have drawn interest from trend followers and momentum traders. 

The North American session features the US CaseShiller house price index.  A slowing in price increases is evident and the risk is that May is the first single-digit print since the February 2013.  There may be some headline risk when new sanctions on Russia are announced.