Big Picture : FX theme dispersion
In today's Weekly Report we discuss the implications of the JPY breaking above 160, specific factors currently driving up both the Swedish & Canadian currencies and recent dollar strength in general.
FX Themes
Short dated volatility in Usd/Jpy has begun to pick up with 1 week vols trading close to 9% as spot approaches the key level of 160. Re-assertion of the Fed’s 2% target coupled with policy confusion in Japan threatens to push the cross definitively above 160. Jawboning and sporadic intervention is to be expected now by the BOJ as they look to ensure the advance to 165 happens in an orderly way. Option players are hoarding short dated gamma, as they expect significant market gyrations in the weeks ahead. While the vol curve in Usd/Jpy is currently inverted, the longer spot remains above 160 the more likely it is that long dated vols also begin to rise thereby re-steepening the curve, all else being equal.
I am also noticing that currencies of countries that have a relatively high Household Debt to Income ratio such as Sweden and Canada have also recently been appreciating. The Kroner as benchmarked against the Euro has moved up some 3.5% since the Riksbank started easing monetary policy while the Canadian dollar has moved up a similar amount when measured against the Yuan, the Euro and particularly when measured against the Yen (Cad/jpy is currently trading at 116.60 which were levels last seen prior to the 08 crash). While intuitively it is difficult to digest these moves given the high DTI ratios of these two economies, from a macro-economic perspective the appreciation can be explained.
During a rate hiking cycle, the FX market always prices in a certain amount of risk premium into those currencies where maintenance of mortgage debt can become problematic as a result of a declining real estate market. When central banks in those countries begin easing policy there is some downside pressure on those currencies via the direct interest rate carry channel but it can be more than offset by upside momentum generated by a reduction in the market’s perception of the debt vulnerability risk premium and hopes that as consumers begin to re-lever and growth picks up, house prices may again begin to rise. It is exactly this dynamic that is causing the Canadian Dollar and the Swedish Kroner to outperform against its other G10 peers in the past few weeks.
For the Canadian Dollar specifically, there currently is also an additional tailwind in USD strength which has gradually crept back into the market. An easy ECB and French politics have helped drive the Euro to below 1.07, while Usd/Jpy threatens to break through 160.00 and the Chinese Yuan flirts with the 7.30 level as local assets test key downside supports on the charts. The Canadian Dollar tends to outperform when the broad dollar is doing well but in this particular instance the recent retracement of Usd/Cad back below the 1.3700 level might prove to be short lived if the Dollar Index itself breaks out topside. A clear double top technical formation in Usd/Cad is now evident at 1.3880 and we will be keeping a close eye on both that level and the topside DXY level of 106.20 in order to obtain clues about the future direction of the broader FX market. (See Usd/Cad chart below)
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Disclaimer
The information provided in this post is for general use only and does not constitute a solicitation for investment. It should not be construed as professional financial advice. Seek independent professional consultation before making an investment decision.