Dead Wrong With Timing And Paid the Price; Apologies to All
Well, today is hard day for us. We had made an aggressively strong case in favor of the US Dollar on Friday, and much to our dismay, things did not play out this way and instead went in the complete opposite direction. Unfortunately, in reaction to the sharp intraday drop in USD/JPY on Friday, we opted to play the market to the long side at 82.15, near the lower end of a multi-week range, and were stopped out earlier today on a violent post-earthquake-tsunami move. While we had anticipated that there would be the risk for some repatriation flows in response to the event (which would initially benefit the Yen), we did not foresee that the initial Yen reaction on Monday would be so violent. Although the market is currently trading back where our entry was, the whipsaw move proved too much for our wide stop-loss, with the market just taking out our position before reversing higher by some 2%.
This is definitely frustrating and painful, but this is also how markets are and we must learn to take the good with the bad. Not only were we wrong with the Yen, but we were off with our overall view and call that the buck would broadly extend gains on Friday. The major driver for the reversal came from the Euro, which was given a massive prop on Friday after news broke that the EU leaders would agree to the German-France proposal that spelled out demands to guarantee greater economic and fiscal policy coordination. This resulted in the enactment of budget rules into law over the weekend to boost the EFSF fund to EUR 440B from the previous level of EUR 250B.
Despite these efforts on behalf of the EU, and despite the devastation from the Japanese earthquake, we still do hold onto our core USD bullish view and concede that our call on Friday was only wrong in its timing. While the progress made by the EU is certainly Euro positive on the surface, we would bring attention to the fact that Greek, Irish and Portuguese debt levels have remained elevated throughout the year, despite talk and assurances of some for of a deal. It seems that even with borrowing needs being met in these countries, market participants are still pricing in the risks for default. As such, we still feel that there are bigger issues at hand and there continues to be risks to the downside. We will continue to watch these peripheral bond spreads for a better indication of just how much confidence the markets really have with the latest developments.
Meanwhile in Japan, while trillions of Yen have been pumped back into the economy, there are still a number of questions that have yet to be answered and could ultimately weigh heavily on the Yen going forward. Our colleague, a well know currency strategist at a major bank outlines these points quite succinctly:
“ JPY buying is likely to be the immediate market reaction to the devastating earthquake. Unlike New Zealand, Japan has external assets which it can repatriate to finance rebuilding. The rebuilding means that there will be a period of extremely rapid Japanese growth which would be yen supportive. [However] the further out you look the bigger the question marks.As businesses decide to rebuild, they may decide to rebuild elsewhere. Yen strength already was inducing them to relocate. Now that there is additional capacity to replace, the foreign FDI expansion may accelerate. The uncertainty about the Japanese nuclear program and how any retrenchment would affect energy supplies may also on the margin encourage capital exports.
[Additionally], however necessary, the Japanese authorities are hardly starting from a position of fiscal strength in their rebuilding program. FX investors may expect the government to put enormous ongoing pressure on the BoJ to keep rates low for an extended period. Especially if the private investors are favoring FDI over domestic investment, the burden of recovery may fall on an already extended government.
If the net outcome is a lower business capital stock, more government spending and accommodative BoJ policy, a weaker yen would seem needed to crowd exports in. What is less clear is the timing in moving from the short term of capital inflows and repatriation to the longer term risks discussed above, and what guideposts will be in place to tell us that the transition is happening.”
Again, I was clearly off on the timing of my call on Friday, and apologize for the call. I am deeply committed to the markets and just as equally committed to making responsible and compelling calls for clients. It has not been a good day, but we take comfort in the fact that this is a part of it and will only help to make us stronger as we move forward. We are still profitable on the year and this is a testament to our solid strategy and decision making to this point. We are always advocating the use of limited leverage, and it is being wrong with this type of leverage t(or lack there of) that allows us to easily dust off and move on to the next trade. A loss of nearly 2% of our total equity on the Yen trade is no picnic, but it is also something that can just as easily be overcome with one trade. We have only one other open position at the time of print, and that is a long position in USD/CAD from 0.9712. We have gone ahead and moved our stop-loss on the position to 0.9714 to ensure that we do not take a loss of any kind on this trade.
Looking ahead, the calendar for the remainder of the day is extremely light, and perhaps this is a good thing with so much needing to be sorted out in light of the latest natural disaster and EU agreement. Eurozone industrial production is up at 10:00GMT, with Canada capacity utilization later on at 12:30GMT. Canada data has been quite soft of late and any additional weakness today could put more pressure on the Loonie. US equity futures are tracking lower in Europe, while oil is also weighed down and trades back below $100. Gold is trading moderately higher.
EUR/USD: Despite the latest recovery back above 1.3900, we would not get overly bullish at current levels, with the market stalling out by the 78.6% fib retrace off of the latest 1.4035-1.3750 move just ahead of 1.4000. We would recommend looking to see how the market settles on Monday for a clearer directional bias. Inability to close back above 1.4000 would once again open the door for a potential pullback towards and eventually below 1.3750, while a close back above 1.4000 would most likely open the door for a full retracement back to the November 2010 highs by 1.4280.
USD/JPY: Overall, nothing has changed as of yet, with the market still locked within a well defined multi-week range between the 80.00-85.00 area. The latest sharp setbacks have once again been well supported ahead of 80.00, to leave the range very much intact for now. The record lows come in by 79.75 from 1995, and we continue to see the more medium and longer-term risks to the upside, with the market trading just off these record lows. Still, we are now on the sidelines and will wait for a break back above 84.50 or below 80.00 for a clearer directional bias.
GBP/USD: The 1.6300 handle continues to be a difficult obstacle for bulls, with the market unable to hold above the figure for any meaningful period of time. This has resulted in the latest sharp pullback below 1.6000, and from here, we see risks for additional declines towards next key support in the 1.5700 area over the coming days. Any intraday rallies are expected to be well capped below 1.6200 on a close basis.
USD/CHF: The latest break to fresh record lows by 0.9200 is certainly concerning and threatens our longer-term recovery outlook. Still, we do not see setbacks extending much further and continue to favor the formation of some form of a material base over the coming weeks for an eventual break back above parity. Look for a break and close back above 0.9370 to confirm outlook and accelerate gains. Back below 0.9200 delays.
Written by Joel Kruger, Technical Currency Strategist
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