A Misconception FX Traders Cant Afford to Believe
The equity markets got a big boost Thursday from reports of a short-term debt-ceiling resolution, but for currency traders, this temporary reprieve is no reason to turn bullish on the US dollar (USD).
Thursday’s price action in the equity markets tells us that investors were cheered by the potential for a temporary increase in the US borrowing limit. However, currency traders don't feel as enthusiastic because they believe the short-term reprieve does not reduce the risk of owning US assets.
The US dollar (USD) gained against the Japanese yen (JPY), but saw virtually no gains against other major currencies. Instead, the improvement in risk appetite encouraged investors to buy high-beta currencies, leading to strong gains in JPY crosses.
As the prospects for a temporary spending agreement nears, we expect a further improvement in risk appetite that could drive USDJPY above 99, but additional dollar gains beyond that level—and in general—should be limited.
See related: Why the Big Budget News Does Little Good
US retail sales were initially scheduled for release on Friday, but will be on hold due to the shutdown, leaving the University of Michigan consumer sentiment index as the only US data on the economic calendar. Understandably, the fiscal debt crisis is expected to have weighed on sentiment in the month of October.
US Budget Fallout Being Felt in Japan, too
The yen traded lower against all major currencies on the back of rising US Treasury yields and strength in the Nikkei. The performance of these instruments reflects the hope for progress in the US fiscal debt debate. Considering that USDJPY is moving in lockstep with equities and Treasuries, this strength helped drive all JPY crosses higher.
Japanese data also continued to improve, with machine orders rising 5.4% in the month of August and consumer confidence rebounding in September. These consistent upside surprises in data have made Japanese investments increasingly attractive to foreign investors.
According to the latest report from the Ministry of Finance, foreigners bought JPY 322.7 billion worth of Japanese bonds last week. Unfortunately, Japanese demand for foreign bonds dropped by more than JPY 2 trillion, the largest net sales ever since the publication began in 2005. These sales can largely be attributed to concerns about the US fiscal position.
Looking ahead, we expect further recovery in the JPY crosses as investors look forward to a formal announcement about a short-term debt resolution.
By Kathy Lien of BK Asset Management
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.