Chinese currency drops sharply

Once again the Chinese currency CNY dropped, this time recording its biggest drop in 2 years. The message is clear China wants to deter hot money inflows ahead of a potential band widening.

Weaker Chinese economic data is also undermining demand for the CNY from exporters while the Chinese authorities want to increase the volatility of the CNY and engineer a degree of two way risk.

Chinese officials have played down the drop in the CNY and CNH but nonetheless, markets are seeing it as a shift in policy following recently weaker economic data. China’s Finance Minister Lou Jiwei noted that that move in the yuan is “within normal range” an indication that officials are not particularly concerned about the currency.

From a technical perspective the move in USD/CNY is significant. The currency pair touched 6.1227, breaching its 200 day moving average around 6.1018. The MACD (moving average convergence/divergence) has turned bullish too although the RSI (relative strength index) suggests that USD/CNY may be overbought.

Overall, expect further CNY weaknes in the short term (next few weeks) but dont expect this it to turn into a long term trend. Eventually CNY will resume an appreciation path assisted by continued strength in the country’s external balance.

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USD/JPY bracing for a rebound

In the post below I look at the arguments for JPY weakness in the weeks and months ahead.

A combination of elevated risk aversion and a narrowing US / Japan yield differential have been the major contributors to the strengthening in the JPY over January resulting in safe haven JPY demand and repatriation flows. The sensitivity of the JPY to both factors has been especially strong and it will require a reversal of one if not both of these to spur another wave of JPY selling.

Improving risk appetite required
If there is not a metamorphosis of the current bout of pressure into a full blown crisis as seems likely, risk appetite will improve and the upward pressure on the JPY will abate. Any improvement in risk appetite will however, be gradual and prone to volatility, especially in an environment of Fed tapering. It may therefore require more than simply improving risk appetite to weaken the JPY anew.

Japanese equity performance will be eyed
Of course associated with any improvement in risk appetite has to be a reversal of the recent negative performance of Japanese equities. Although Japanese equities will continue to be hostage to the fortunes of global risk sentiment, assuming that “Abenomics” continues to deliver results and growth in Japan continues to pick up (our forecast this year is 2% YoY GDP growth) further fallout in the Japanese equity market may be limited.

Flows will need to reverse
Over the past several weeks Japan has registered net inflows of capital in large part due to repatriation by Japanese investors. JPY has faced upward pressure from such inflows over recent weeks. Looking ahead assuming that risk appetite improves and US yields increase net capital outflows are expected to resume, which will put further downward pressure on the JPY.

Yield differentials will be particularly important
The extra dose of JPY pressure and important determinant of renewed weakness will be a re-widening of the US / Japan real yield differential. Eventually US bond yields will resume their ascent, driving the yield differential with Japan wider, and putting upward pressure on USD/JPY. The same argument will apply for EUR/JPY, albeit to a lesser degree.

Speculation positioning more balanced
The recent short covering rally has likely resulted in a market more evenly balanced in terms of positioning, providing a solid footing for the next leg lower in JPY. Indeed, compared to the three month average, JPY positioning has bounced back and is susceptible to a rebuilding of JPY shorts over coming weeks, driving the JPY lower.

Model points to renewed JPY weakness
Combining the factors above (except positioning) and adding in forecasts for US bond yields, risk aversion and conservative estimates for a recovery in Japanese equity markets over coming months, my quantitative model for USD/JPY highlights the prospects of a major rebound in the currency pair.

Untimely end to the Flappy Bird

Flappy_Bird_logo

I have a confession to make. Over the last few days I have become adicted to Flappy Bird. The idea of the game is to tap the screen and fly a bird through sets of pipes. I am clearly no good at it as my high score is a measly 6 but I continue to perservere in order to better my score. Sadly or perhaps fortunately for would be Flappy Bird addicts the game will no longer be available as an app. According to the FT the Vietnamese creater of the mobile game which topped the app charts has said that it “ruins my simple life” and therefore he removed the app from sale. The good news is that those who have already downloaded it won’t lose it so my Flappy Bird adiction can continue unabated.

AUD oversold, to push higher in the short term

Not much is going right for the AUD. Board members of the Reserve Bank of Australia appear to be competing in outdoing themselves in talking the currency down, with latest comments from the RBA’s Ridout indicating a preference for AUD/USD 0.80 to be reached compared to 0.85 stated by Governor Stevens previously.

Concerns about slowing growth in China have added to the pressure on the currency. Indeed, worries about the impact of weaker Chinese growth on Australia’s economy have grown given the strong trading links between the two countries.

Such concerns have resulted in a drop in AUD speculative positioning (CFTC IMM) to its lowest since September 2013 and not far from its all time low. It’s easy to be bearish on the AUD but I suspect that negative sentiment for the currency is looking overdone.

Admittedly in an environment of elevated risk aversion it is difficult for AUD/USD to rebound as indicated by the risk reversal skew but I do not expect the pressure on the currency to be sustained.

AUD/USD near term support seen around 0.8633. Resistannce seen around 0.8825.

Watch me on Financial Times Video – Emerging market jitters rattle investors

To watch me discussing the emerging markets sell off with the Financial Times please click on the link below.

Emerging market jitters rattle investors

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