We have identified two forces lifting the US dollar: positive developments in the US and negative developments elsewhere. Last week's ECB meeting and next week's FOMC meeting, however, are not the driving forces presently.
Three issues dominate the foreign exchange market. First, the risk of Scotland voting for their independence next week is a major force. It continues to weigh on sterling, were there's a new, albeit marginally lower low, for the move was recorded in the European morning, ostensibly on back of reports (Guardian) suggesting that Rupert Murdoch may be supporting the independence movement and may use his media assets, like the Scottish Sun, to express his views.
Second, disappointing economic data and verbal official encouragement have contributed to the yen's slump. The dollar has risen to new multi-year highs against the yen, near JPY106.80. This is a three yen move since the end of August. The official jawboning appears to have been stepped up recently. Partly, it appears defensive. Clearly, the ECB was not only talking down the euro, but the negative rates may be encouraging as we have been suggesting, with the use of the euro as a funding currency, or short-leg of cross positions.
Partly, with inflation stalling and the economy weakening, more juice is deemed necessary. We have highlighted the likely fiscal response in the form of a supplemental budget, but many others still expect the BOJ to step up its efforts as well. Having expected it by the end of July, many observers now think it will happen by the end of October. We are less sanguine, and instead see the weakening of the yen as likely to renew the upward drift in prices.
Earlier today, Japan reported prices fell 0.2% in August. The consensus was for a flat reading. When excluding the effect of the sales tax, the year-over-year rate slipped to 1.1% from 1.4%. Separately, machine orders rose 3.5%in July, which was a bit below expected. However, the year-over-year rate rose to 1.1%, the first positive reading since April.
Third, the Australian dollar has been crushed. It briefly poked through $0.9400 before last weekend, and slipped briefly through $0.9120 in early European activity today. The usual suspects have been cited: falling iron ore prices, softening of the Chinese economy, RBA jawboning, disappointing confidence data, a smaller than expected rise in new home loans. We suspect that the real precipitating factor was the sell-off in global bond markets.
Hedge funds were reportedly large buyers earlier this year and have turned sellers over the past several sessions. Australia's 10-Year yield has risen nearly 30 bp since the end of August. Kangaroo bonds, (foreign issuers of Australian dollar-denominated debt in Australia) have been quite popular this year, and with the Aussie breaking out of its range, hedging strategies have also been triggered, it appears.
Australia reports August employment figures on Thursday. July saw a small net jobs loss, but that was a 14.5k increase in full-time jobs. The Bloomberg consensus expects a 15k headline increase. The Reserve Bank of New Zealand is widely expected to leave rates on hold at the end of its policy meeting, which corresponds to late in the US afternoon today. Rates have risen at the past four consecutive meetings, and officials have signaled a pause.
U.S. 10-Year yields are pushing above 2.50%, but the sell-off in European bonds continues apace. Some news wires are linking the steep sell-off in Spain (the 10-Year yield is up 10 bp today and 25 bp this week) to the heightened risk of that Catalonia's independence movement will be inspired by Scotland. We are skeptical. Italian 10-Year bond yields are up 23 bp this week. The slightly sharper sell-off in Spain is not worthy of a big fundamental explanation. Spanish bonds outperformed on the upside and are outperforming on the downside. QED.
There is a significant difference between Catalonia and Scotland. The Scottish referendum was authorized and legitimate. It is binding. The Catalonia referendum is not. Tomorrow is the Diada celebration, and this will feature nationalistic demonstrations. The regional parliament is expected to vote on September 19 whether to approve the law calling for a referendum. This could, and would likely be overruled by Spain’s Constitutional Court.