Australian Dollar Advances A Second Day As China Funding Crisis Eases

Both the Dow Jones FXCM Dollar Index (USDollar) and S&P 500 closed the day higher Tuesday. This counter-fundamental, positive correlation tells us something very important: that the ‘risk aversion’ drive that followed the Federal Reserve’s Taper warning is losing its potency. If risk aversion were truly intensifying, an unwinding of the front-run-the-Fed trades would evolve into a deleveraging of the exposure that was founded on the assumption of boundless support by the central bank. Yet, there is not enough momentum behind this fear to keep US equities – which are arguably the most stubborn benefactor of the ‘more hazard’ – shedding the uncommitted investors as the benchmarks pull back from record highs. This hesitance should not be taken to mean that the danger of a full-scale bear market has been avoided however. Leverage (measured on the NYSE) is at record highs and participation (S&P 500 futures open interest) at 15-year lows.

Australian Dollar Advances a Second Day as China Funding Crisis Eases
Funding pressure in the Chinese markets is a significant threat to financial stability globally, but it is especially troublesome for the Aussie dollar which is exposed through its direct trade exposure as well as its position as the major’s top ‘investment’ currency. The story out of China has developed around a few Chinese banks essentially defaulting on loans due to a severe shortage of short-term funding. This issue has evolved out of regulators cracking down on particular venues for financial institutions to continue to lend out short-term credit at excessive rates in hopes of trying to curb a lending bubble in the economy. The People’s Bank of China (PBoC) voiced confidence that funding risks would be met individually but they wouldn’t lax rules. Shibor lending rates have eased today, and the relief offers further Aussie reprieve.

Japanese Yen: Asia Market Volatility Remains, Stirs Yen Crosses
The Tokyo session is proving to be the more active period for swing traders. While the Nikkei 225 started Wednesday’s session following in the wake of the US equity market’s climb, the Japanese benchmark suffered a severe jolt as trading wore on. The more than 300-point intraday plunge from the stock index may be technically smaller than the near 450-poing tumble the previous session, but it still represents serious volatility issues for the region. And, volatility begets volatility. If the market’s remain this reactive, the proper catalyst to align investors’ concerns can generate a breakout to undermine the past few weeks’ worth of congestion. A bearish break for shares would be a direct spark for yen buying (spark for yen crosses to drop) as it would rouse risk aversion that leads to carry trade deleveraging. Yet, general activity itself – regardless of direction – is also a problem for Asian markets as it volatility is elementally a measure of ‘risk’.

Canadian Dollar the Most Oversold Currency Short Term?
Over the past few months, the Australian dollar may have shed more value than any other major currency; but more immediate comparison performance of the past two weeks shows a different scale. Through that period, the FX market’s worst performer has been the Canadian dollar. While the USDCAD’s 3.2 percent advance is most remarkable, the rest of its pairings have delivered the loonie between 1.7 and 1.3 percent in losses. Through that same period, the Canadian data has held up relatively well. Capital inflations, home sales, retail sales and inflation have improved. Furthermore, we have seen net speculative short interest on the Canadian currency via futures positioning on the COT drop 65 percent from a six year low set two months ago. An eight-day straight advance in USDCAD (the longest since 2005) looks stretched.

Swiss Franc: SNB’s Zurbruegg EURCHF Cap Necessary, Risks Can’t be Hedged
EURCHF hasn’t returned to the Swiss National Bank’s (SNB) imposed 1.2000-floor in nine months. However, that doesn’t seem reason enough for the policy authority to lift its backstop on the critical pairing. Governing Council member Fritz Zurbruegg remarked this past session that the barrier is especially necessary considering the stability of the Euro-region is once again at risk. Speaking to regional bankers’ group, Zurbruegg also made note that the SNB’s reserve levels are a result of FX exposure accumulated through monetary policy. Furthermore, he noted that the central bank couldn’t hedge itself of these risks and volatility via the euro or dollar was felt immediately by the group. This may be obvious, but it breaks from the unflappable confidence we expect from central bankers. Is that recognition of the possibility of failure?

British Pound Traders Take Note of King’s Warning that Carney Limited
When Bank of England Governor Mervyn King testified before the Treasury Committee for the last time as the leader of the central bank, he said something sterling traders consider. In a humorous quip, King suggested that while his replacement may be more persuasive than he is; Marc Carney would not likely gain more traction than his predecessor. Each person has one vote under the current regime at the Monetary Policy Committee (MPC); and King has been outvoted in his call for stimulus in the past three policy meetings 3 to 6. The market would do well to remember that Carney can only accomplish so much in his new position without the support of the Committee. Speculation that the BoE will materially upgrade its stimulus efforts to match that of the BoJ, Fed or even ECB has added material weight to the pound. We will see if this reality clears up slowly or all at once on July 4 when Carney casts his first vote. Meanwhile, we should read through the details on the upcoming BoE Financial Stability report. Last week it was suggested that there is a £26 billion hole in bank financing…

Gold Extends its Plunge to Fresh Multi-Year Lows Overnight
Bulls were making a feigned attempt to keep gold above the $1,275 level following last week’s FOMC route. That line in the sand was crossed this morning as the precious metal dropped another 2-plus percent through Asia session trading. The stability of the US dollar through the past session – despite the firming of the US equity markets and thereby sentiment – was one aspect of erosion for the ‘alternative store of wealth’ asset. Yet the real trigger for fresh lows for the metal seems to be the reduced tension in the Chinese funding markets. Without a material and pressing financial stability threat, the task of reviving the fundamental strength of a last resort and heavily pummeled asset like gold is even further out of reach. Meanwhile, volume behind the gold selling may be backing off, but the CBOE’s gold volatility index is still above 25 percent (before April’s market collapse it averaged around 13 percent) and ETF holdings hit yet another multi-year low. In fact, the 1.1 percent drop in the exposure was the second biggest in 22 months and ushered in a fresh 3-year low 66.46 million ounces.