Australian dollar rallies, Korean won bounces back

On the currency front, the best performers so far this year have been an odd combination of JPY, NZD and AUD versus USD. JPY has benefitted from both compressed yield differentials with the US and risk aversion but its gains are likely to reverse over the coming weeks as these factors reverse.

I have been generally more constructive on AUD and NZD than the consensus and remain so. Both AUD and NZD look oversold and will gradually appreciate further, especially as both the RBA and RBNZ have now likely ended their easing cycles, with the latter set to raise policy rates by the end of this quarter. AUD/USD breached 0.90 this morning helped by a strong business confidence reading for January.

Most Asian currencies have rebounded so far this month, with some of the biggest losers over January recording gains. The KRW has been the best performer in February recording gains despite continued outflows of equity capital. Korea has recorded $1.26 billion in equity outflows so far this month, the highest among Asian countries.

In contrast bond inflows into Korea have been relatively solid over January and this continued into February, helping to provide some support to KRW despite equity outflows. Helping the KRW is the fact that is much less sensitive to US bond yields than many other Asian currencies helping it to avoid any fallout from higher US yields in February. USD/KRW is on path for a break below support around 1070.

Awaiting Yellen

There was very little activity of note overnight, with markets taking on the appearance of grounding to a halt ahead of the first semi-annual testimony to Congress by new Fed Chairman Yellen later tonight. A Japanese holiday today will act as another dampener on activity.

Weaker data and/or emerging market tensions are highly unlikely to deter Yellen and the Fed from maintaining a tapering path but of interest to markets will be any indication that the unemployment rate is to be deemphasized given its misleading fall over recent months. With little else of note on tap until the release of US retail sales and Eurozone Q4 2013 GDP later in the week Yellen’s speech will set the tone for markets over coming days.

The biggest market movers over recent days have been the VIX index, natural gas and gold prices. The VIX has fallen sharply reflecting a major turnaround in risk appetite from an elevated level, which has been corroborated by our risk barometer moving back into risk ‘neutral’ territory from risk ‘hating’.

Nonetheless, although emerging market fears have calmed down the path ahead is still likely to be a volatile one. Natural gas prices have also dropped reflecting expectations of milder weather ahead in the US. In contrast gold prices have rallied further extending gains this year to around 6%. Lower US yields and a weaker USD have helped to buoy gold prices over recent days while news of record gold demand and supply from China has also helped.

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