Yen Sold Off Broadly Following US Treasuries, Aussie Reversing

The biggest development last week was the broad based selloff in the Japanese yen, which followed rally in US Treasury yield on receding expectation on additional easing from Fed. Another development to note was aussie's decoupling with risk markets and the selloff intensified after treasury noted RBA could cut rates due to the currency's strength. The euro, on the other hand, remained steady with Spanish yield continuing to dip on expectation of ECB actions in September.

Sterling was supported by solid economic data. Nonetheless, strength in European majors were generally limited. Technically, while stock markets extended recent up trend with S&P 500 edging higher to close at 1418, we'd maintain our view that reversal is imminent as it should face strong resistance from 1422 high. And should stocks reverse, the already weak aussie will be sold off deeper and such development could limit yen's weakness.

Even though we're favoring more upside in European majors, the current development doesn't give us much confidence in it. So, firstly, we'd prefer AUD/USD short in the near-term. Secondly, while we'd also favor USD/JPY long, we'll be cautious at it hits 80 psychological level. Thirdly, we'd avoid European majors.

Recent economic data from US were mixed to positive, with strong retail sales figures in July even though regional fed surveys disappointed. A key event ahead in the month is Fed Chairman Bernanke's speech at Jackson Hole conference in August 31. And, recent developments dented the hope for Bernanke to announce anything significant in this traditionally important event. The markets are still leaning towards the case for the Fed to do another round of easing. But that would require some substantially weak economic data to push Fed to act.

The receding expectation of QE3 from Fed was clearly reflected in the surge in treasury yield last week. 10-year yield jumped to close at 1.816%, comparing to prior week's close of 1.649%. The move was even more impressive when comparing with the intraday historical low of 1.394% made on July 24, that is, less than a month ago. The 30-year yield rose to close at 2.934%, comparing to prior week's close of 2.806% and the intraday low of 2.452% made on July 25. The jump in yield pushed USD/JPY and other yen crosses higher with USD/JPY set to taken on 80 psychological level soon.

BoJ minutes also exerted some pressure on the yen. Minutes of the July 11-12 meeting of BoJ unveiled that a few members warned that Japan's economy "could be adversely affected through various channels if, for example, a substantial risk materialized, stemming from the European debt problem." And, these members urged to bank to "stand ready to take appropriate actions without ruling out any options in advance." Nonetheless, the bank's view is that "growth prospects will likely remain broadly unchanged."

Regarding inflation, CPI is expected to be "broadly inline with the April forecasts." At that meeting, BoJ voted unanimously to keep rates unchanged at 0-0.1% and maintained the scale of stimulus program at JPY 70T. Japan's GDP grew only 0.3% qoq in 2Q12, well below expectations of 0.6% qoq and 1.2% qoq in the first quarter. The major disappointment came from weak consumer spending. Although the government has been giving subsidies on a number of green products since the earthquake last year, the impact on stimulating spending has been limited. As the positive effect of the subsidies fades, Japan's consumption outlook is expected to weaken further in coming quarters, an outlook that would hurt investors' confidence.

In the eurozone, Spanish 10-year yield dipped further to settle at 6.443% last week, and is now comfortably below the 7% unsustainable level. Spanish bonds was supported by news that Spanish is ready to seek a sovereign bailout at a meeting of finance ministers next month. And as Spain requests for aid, ECB would restart bond purchase as part of an overall package. Also, it's reported that Spain's Bankia will receive an emergency disbursement from the EUR 100b bank bailout program soon due to dropping for the plan for Bankia to get loan from ECB due to restrictions imposed on bank borrowings.

Meanwhile, sentiments were generally lifted after German Chancellor Merkel voiced her support to ECB's effort on fighting the debt crisis. Merkel stated that policymakers "feel committed to do everything" they can "in order to maintain the common currency." She also affirmed that Draghi's decisions have "made it clear that the ECB is counting on political action in the form of conditionality as the precondition for a positive development of the euro." These comments indicated that Germany has moved away from the opposition position over the ECB's purchases of Spanish and Italian bonds and further affirm the chance that ECB will be acting soon. Though, a risk to note is that Greek prime minister Samaras, facing deepening recession in the country, is set to meet with Luxemburg prime minister Juncker, German chancellor Merkel and French president Hollande next week to persuade eurozone leaders to extend the time of austerity from two years to four years, up till 2016.

Meanwhile, eurozone data showed French GDP was flat qoq in Q2, comparing to expectation of -0.1% qoq contraction. German GDP grew 0.3% qoq comparing to consensus of 0.1% qoq. Greek GDP contracted -6.2% yoy in Q2, suggesting the recession continued and implementation of fiscal austerity measures would be more difficult. Eurozone Q2 GDP showed -0.2% qoq as expected.

August BOE minutes indicated that policymakers voted unanimously to leave the Bank rate unchanged at 0.5% and adopt no change in asset purchases. Yet, it also unveiled that some members favored more easing. Unlike previous minutes, the August one did not hint that the BOE is biased for further rate cut. We believe the BOE would gauge the impact of the new Funding for Lending (FLS) scheme before implementing additional easing measures. As such, the most likely of further easing would be in November, when the 50B pound of asset purchases is completed and the impact of the FLS would be reflected in the economy.

Economic data from UK was also solid. Claimant count unexpectedly dropped -5.9k in July and unemployment rate also unexpectedly improved to 8.0% in June. Headline retail sales rose 0.3% mom, 2.8% yoy in July versus expectation of 0.0% mom, 1.5% yoy. Ex-auto, fuel sales was flat mom, rose 3.3%, also better than consensus of -0.2% mom, 1.7% yoy. CPI unexpectedly rose back to 2.6% yoy in July while core CPI also rose back to 2.3% yoy. Both were much higher than expectation of 2.3% yoy and 2.0% yoy respectively. RPI also beat expectation and rose more than expected to 3.2% yoy.

The Australian dollar dipped sharply against US dollar after an Australian treasury report noted that RBA could cut rate further on aussie's strength. The report noted that aussie is "well above its post-float average" and is "overvalued compared to its medium-to-long run equilibrium value." While Treasury economist thought that intervention might lead to market instability, they do believe that thee are rooms for RBA to cut rates if the strength of aussie inflicts too much pressure on the economy.