Is The Equity Rally Helping Currencies?

FX: Is The Rally In Equities Helping Currencies?

In the last hour of trading Tuesday, the S&P 500 climbed to fresh five-year highs and the last time we saw the index at these levels was in December 2007. Traditionally a rally in equities is accompanied by a rise in currencies because when investors are optimistic, all risky assets benefit. While that was not exactly what we saw Tuesday, on an intraday basis, all major currencies did benefit from the rise in equities -- some more than others. The biggest beneficiary was USD/JPY, which rose to a new 2.5-year high at the end of the U.S. session. The EUR/USD held onto its gains after rallying into the European close and while the GBP/USD and AUD/USD ended the day with losses, they also rebounded off earlier lows. Country specific factors such as dovish comments from the RBA and reversal of safe haven funds parked in the U.K. continue to overshadow risk appetite but losses in these pairs would have probably been steeper if not for the rise in equities. In many ways, it can be said that demand for AUD/JPY and GBP/JPY, which also rose to multi-year highs is helping the AUD and GBP avoid additional losses. Therefore the rally in equities is helping currencies, but some more than others. With volatility declining according to the VIX, investors are slowly dipping their toes back into the financial markets thanks to stronger economic data in the U.S., euro zone and China.Non-manufacturing sector ISM and the IBD/TIPP Economic Optimism index were the only pieces of U.S. data released Tuesday and according to the ISM report, service sector activity expanded at a slower pace in the month of January. The index dropped to 55.7 from 55.2. The details of the report showed weaker business activity, new orders and backlog. However investors shouldn’t be terribly concerned because of strength beneath the headlines. Supplier deliveries increased along with employment and new export orders. The ISM report is consistent with a gradual recovery in the U.S. economy. Consumer confidence also ticked up slightly in February with the IBD index rising to 47.3 from 46.5. No U.S. economic reports are due for release Wednesday, which leads us to believe that the uptrend in currencies in equities will remain intact.

Behind The EUR Rebound

A variety of factors contributed to the euro’s recovery against the U.S. dollar Tuesday. First and foremost, better than expected service sector activity eased concerns about European growth. The euro zone PMI index was revised up to 48.6 from 48.3 for the month of January. While service sector activity remains in contractionary territory, Germany continues to carry the region on her shoulders with the upward revision largely coming from Germany. The slide in European bond yields and rallies in U.S. and European equities also helped to lift the currency. However what really pushed the EUR/USD into positive territory were reports that the “EUR still not strong enough to prompt action out of the ECB.” As we have previously mentioned, critical comments from central bank could kill the rally in the EUR/USD. With only two days to go before the ECB meeting, traders don’t believe that the current level of the euro causes any angst for the central bank and the ECB is the one that matters because they are the ones that decide whether intervention is necessary. Therefore its no surprise that French President Hollande’s calls for a medium term targeted exchange rate fell of deaf ears. A focus on the value of the currency makes this week’s ECB meeting and press conference by Mario Draghi extremely important for the euro’s near term outlook. In the meantime the EUR/USD appears poised for another move above 1.36. German factory orders are due for release Wednesday and based on the rise in PMI manufacturing and more specifically the increase in new orders and new export orders, we believe that factory orders will rebound, providing additional support for the EUR/USD.

GBP: Hits Five-Month Low vs. USD

The worst-performing currency was the British pound which dropped to a fresh five-month low against the U.S. dollar and gave back its gains against the euro. What was ironic about the move in sterling is the fact that it comes on the heels of stronger economic data. Service sector activity expanded in the month of January after contracting at the end of the year. As the first month of improvement in the service sector, the data should have been received warmly but the rally in GBP was extremely short-lived. Instead, the sell-off in sterling coincided with the rally in the euro, which tells us that the move was caused by money flowing out of GBP and into EUR. Even with the improvement in service sector activity, the Bank of England may have to consider easier monetary policy. Incoming BoE Governor Mark Carney will be speaking on Thursday on his approach to monetary and regulatory policy and we will be listening in closely to see if he suggests policies that may be applicable to the Bank of England. BRC shop prices are due for release this evening followed by the Halifax House Price index on Wednesday.

AUD: RBA Open To Additional Stimulus

With no major economic data on the calendar, the Canadian and New Zealand dollars benefitted from the rally in U.S. equities. The Australian dollar on the other hand suffered greatly from the Reserve Bank of Australia’s dovish comments and remains weak going into the Asian trading session. While Australian economic data beat expectations, concerns about a potential peak in mining investment and weak private investment makes them weary about the outlook for the Australian economy. Inflation is also trending lower and according to the central bank, “The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand.” The RBA’s dovish bias contrasts sharply with the steady hand of the Fed, ECB and RBNZ, which explains why the AUD continued to lose value against those currencies. Nonetheless it is worth noting that the country’s PMI services index rebounded in January from 43.2 to 45.3. House prices also increased 1.6% in the fourth quarter and the trade deficit narrowed significantly to only -427 million at the end of last year, up from -2.79 billion the previous month. Retail sales are due for release this evening and based on the decline in the sales component of service sector PMI and the decline in job growth, consumer spending should be weak but we can’t ignore the fact that the RBA said spending has picked up. Canada’s IVEY PMI report is due for release Wednesday along with New Zealand’s unemployment report. This should make for some interesting trading in AUD/NZD and AUD/CAD.

USD/JPY Hits Fresh Highs After Shirakawa Announces Early Departure

The Japanese Yen ended the North American trading session at multi-year lows against the U.S. dollar. The uptrend in USD/JPY is very strong with no signs of abating. The latest round of Yen weakness was caused by the announcement that Bank of Japan Governor Shirakawa will be stepping down 3 weeks early on March 19th. As reported by our colleague Boris Schlossberg, “Mr. Shirakawa was viewed as a reluctant participant in Prime Minister Abe’s plan to reflate the Japanese economy and sharply weaken the yen. His departure will now pave the way for a more accommodating monetary policy and perhaps fuel the rise in USD/JPY towards the 95.00 level as the markets continue to respond to Mr. Abe’s policy changes.” In our opinion, his decision to leave at the same time as his Deputy Governors suggests that the Japanese government is close to announcing a successor who will undoubtedly reinforce the central bank’s dovish message.