FX Commentary – May 9th 2014

By
Ronald Huddleston

beijing-hedgethink

Overview

Without any overarching themes, country-specific factors have been the most notable influences in the last fortnight.  Generally, the USD has been on the defensive.  After some good Eurozone data, the single currency rallied to a seven-week high vs. the greenback before rebounding on Wednesday after comments by Federal Reserve Chair.  Ms. Yellen, who told a congressional panel that the Fed believes data shows “solid growth” for the U.S. economy in the second quarter which bolsters the case for a faster expansion this year.  Her ‘poised for growth’ comments eased pressure on the U.S. dollar, which recently has been under market pressure as others believe data hasn’t been coming in as strong as expected or needed.  For example: the Jobless rate fell to 6.3%, but the labor force participation rate is at a historic low of 62.8%. This is a problem.

To put the labor force rate in a real life context, if at the beginning of the year I had three unemployed relatives (let’s say…brother-in-laws), and now, one of them has a job (albeit at a fraction of the pay of his previous job), one says that he is still looking for a job, and the last one, who after 6 months of looking for a job, says he doesn’t see the point in looking right now (so, he has decides to stay at home and watch Oprah), would this mean that I now have only one unemployed brother-in-law?  According to the Bureau of Labor Statistics, yes, that’s what it means; but in reality, I still have 3 brother-in-laws looking for work. One is actively looking, one is actively looking to upgrade, and the last one is unofficially looking, and his wife is actually looking on his behalf.  The Fed Chair gingerly acknowledged the elevated ‘real’ unemployment rate saying, “We’ve never really seen a situation where long-term unemployment is so large a fraction of unemployment.” However, it is sanguine and rudimentary to categorize the American economy with a 62.8% labor participation rate as showing ‘solid growth.’

The Fed Chair stated that “Sufficient underlying strength” makes measured reductions in bond purchases “appropriate;” and even after the asset buying ends, interest rates are likely to remain close to zero for a “considerable time.” The bottom line is that the Fed will maintain what FT calls its “devoutly dovish” stance.  No surprises here.

USA

Despite isolated gains versus select currencies the USD has encountered resistance developing an appreciating trend against most majors. The greenback seems generally disconnected from ‘good’ data.  Technicals and market demand for safe havens have dictated short term moves.  The U.S. March trade deficit improved with exports up and imports also up, but by less than exports.  So, the trade deficit in 2013 contracted to 11.2%.   But fortunately, people are feeling better:  April consumer confidence was at 83.2, and March was revised to 83.9, which was the highest reading since January 2008.

  • Labor costs rose 4.2% q/q.
  • U.S. March trade deficit narrowed to US$40.4B.
  • Jobless rate fell to 6.3%, due in part to the low lower labor force participation rate.
  • March personal income rose 0.5% m/m.
  • Personal spending rose 0.9% m/m.
  • Core PCE prices edged up to 1.2% y/y.
  • U.S. February Case-Shiller house prices eased to 12.9% y/y.
  • February personal income rose 0.3% m/m.
  • Q4 GDP growth was revised up to a 2.6% q/q annual rate.

Russia (RUB)

On Wednesday tensions eased on the Russian / Ukrainian front.  Russian President Vladimir Putin said he was pulling troops away from the Ukrainian border while urging separatists to delay a referendum.  However, according to the FR, the separatist turned Putin down request for a delay and are going ahead with the vote on Sunday.

Nevertheless, Putin’s new tactic signals a shift that may lower the likelihood the U.S. and European Union will impose further sanctions on Russia.  The RUB immediately strengthened over 1.25% versus the USD on the news as the market cut the probability of further resulting economic hardships. Additionally, implied volatilities in haven pairings currencies immediately softened.  President Obama aboard Air Force One said that while the United States would welcome a Russian military pullback from the Ukraine border region, “there has been no evidence that such a withdrawal has taken place.” Is he channeling Reagan’s use of the Russian proverb, “doveryai, no proveryai,” (Trust, but verify)?

  • Current USD/RUB rate is 35.0227 Spot.
  • Mid implied volatility is 10.13%.

The position below, which was highlighted on 4/22 commentary, currently has a 1.80 % net gain.

Long RUB forward and Long USD Call/RUB Put, which is a long synthetic straddle. The structure benefits from a discount in the forward rate of the long RUB forward.

  • Sell USD/RUB 1-Month forward at 36.2015 for (Get long RUB, which is at a .085% discount to the spot rate).
  • Buy 1-Month USD Call / RUB Put with 35.6890 Strike (54.60 Delta).
  • Forward’s implicit deposit rate is 16.98% annualized, or 1.4150% per month.
  • Yield from US dollar cash position 0.24%.
  • Downside Breakeven (if the RUB appreciates) is USD/RUB 35.6648.
  • Upside Breakeven (if the RUB depreciates) is USD/RUB 36.2257.
  • Maximum Gain:  Unlimited through RUB appreciation or depreciation vs. the USD.
  • Maximum Downside:  1.52% of invested USD amount.

China

China’s April trade surplus was more than double that of March as exports rose by 0.9% and imports rose by 0.8%. There remains plenty of reason for concern and confusion in China: manufacturing PMI  suggested the pace of economic expansion remains subdued and the country’s weakening property market poses danger to local governments.  On the confusion front, trade data is suffering accuracy problems around last year’s over-invoicing and HSBC revised manufacturing PMI downward, while the official PMI actually rose. Incidentally, the central bank raised the daily reference rate following mixed PMI figures, and the CNY rallied.

According to the WSJ, the People’s Bank of China (PBOC) says company-to-company lending (“entrusted” lending) in China is up by ¥715.3 billion y/y in the 1st quarter, and last year it was 30% of bank lending.  Lending is illegal in China unless a bank arranges it. (I just learned this.)  Separately, last week FT reported China lobbied against the World Bank’s International Comparison Program that puts China as the biggest economy in the world, disapproving of the methodology and preferring to avoid annoying the U.S.

Euro (EUR)

The euro is higher despite a downside inflation surprise that keeps open the possibility of some form of ECB action. Recent indicators suggest that economic activity in the Eurozone continues to expand, albeit at a rather modest pace.  The European Commission issued revised forecasts. Inflation will be 0.8% this year and 1.2% in 2015; the composite points to Q2 GDP of 0.5%, which will be the best in three years.

That said, inflation remains very low, and credit growth is benign. Economic activity must accelerate  in order for the ECB not to be inclined toward further easing.

Eurozone

  • Composite PMI came in at 54, in line with forecasts and up from 53.1 in March.
  • Eurostat reported industrial PPI fell 0.2% y/y in March
  • March CPI slowed to 0.5% y/y, the lowest reading in four years.
  • Core CPI slowed to 0.8% y/y.
  • Industrial PPI fell 0.2% y/y in March.
  • March retail sales unexpectedly increased by 0.3% m/m.
  • April economic sentiment unexpectedly fell to 102.0.
  • March M3 money growth eased to 1.1% y/y
  • February M3 money growth firmed slightly to 1.3% y/y.

Germany

  • Factory orders fell 2.8% in March over Feb when a rise of 0.3% was forecast.
  • April CPI rose 1.1% y/y, compared to an expected 1.3% y/y gain.
  • February retail sales had an unexpected gain m/m of 1.3% .
  • May consumer confidence was steady at 8.5.

France

  • Bank of France reported that business sentiment rose to 99 in March.
  • April consumer confidence fell to 85.
  • Industrial production fell 0.7% m/m in March when a raise of 0.3% was forecast.

Portugal, Ireland, Greece and Spain

The head of the Munich-based Ifo Institute for Economic Research has accused the European Union of meddling with the figures for Greece’s public finances to portray a rosier picture.  Surprise.  Surprise.  Is someone cooking the books?

  • Rates of growth were the fastest Spain and Ireland for seven and eight years respectively.
  • Greece will ask for revision to the loan repayment schedule from 30 years to 50 years.
  • Portugal will exit the bailout program without buying default insurance.
  • Spanish service sector PMI rose to 56.5 from 54 in March, the best since before the sovereign debt crisis.
  • Italy’s PMI was 51.1 from 49.5 in March
  • Italy’s March business confidence edged up to 99.2
  • Italian February retail sales fell 1% y/y.
  • Current EUR/USD rate is 1.3857.
  • Mid implied volatility is 5.26%.
  • Current EUR/JPY rate is 140.80.
  • Mid implied volatility is 6.56%.

Recommended Enhanced Yield structure:  See Long EUR/JPY structure.

Australian dollar (AUD)/ New Zealand dollar (NZD)

The Reserve Bank of Australia kept its policy rate steady at 2.50% and reiterated a likely period of stability in interest rates.  Politics are heating up in the land ‘Down Under.’  The PM called for big tax increases to balance the budget, and even his fans consider the proposal a betrayal.  For the week the AUD/USD soften to 0.9371 in sympathy to the decline of the kiwi dollar (NZD), which slid versus all 16 of its major peers after the New Zealand Reserve Bank Governor Wheeler said the central bank may consider selling the currency, if it fails to respond to worsening fundamentals.

  • Australian building approvals fell 3.5% in March when a rise of 1.5% was forecast.
  • Australia’s March trade surplus narrowed to A$731M.
  • Australia’s April services PMI fell to 48.6.
  • March building approvals unexpectedly declined 3.5% m/m.
  • Q1 PPI firmed to 2.5% y/y.
  • February employment rose 47,300.
  • Q1 export prices rose 3.6% q/q.
  • Import prices rose 3.2% q/q.
  • Current AUD/USD rate is 0.9373.
  • Mid implied volatility is 6.90%.

Recommended Enhanced Yield structure:  Long AUD forward.

  • Long AUD/USD forward at 0.9365 for 2-Weeks.

 

  • Sell 2-Week AUD Call / USD Put with 0.9415 Strike (38 Delta).
  • Forward’s implicit deposit rate is 2.21%.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium 7.07% annualized.
  • Structure’s yield is 9.28% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium) plus potential capital gain from AUD appreciation to 0.9415.

Great British Pound (GBP)

Sterling continues its bounce back to pre-financial crisis levels hitting a 5-year high vs. the USD at 1.6979 and the strongest level in nine weeks peak against the EUR.  Supporting the pound in the fortnight was PMI and Manufacturing Production, which both surpassed expectations and reinforced a sense of optimism surrounding the outlook for the UK economy. The data also increased pressure for an increase in interest rates from the Bank of England. Policy maker have signaled no rush to raise rates, but markets are on high alert for any shift in tone.

    • April services PMI increased by more than expected to 58.7,
    • February industrial out rose by a larger than forecast 0.9% m/m.
    • February retail sales were firmer than expected, rising 1.7% m/m.
  • UK car registrations in April are down from the 10-year high in March but still up 8.2% y/y (Ok, I know, but it was light period for UK data.)
  • Current GBP/USD rate is 1.6940.
  • Mid implied volatility is 4.57%.

Recommended Enhanced Yield structure:  Long GBP Forward

  • Long GBP/USD forward at 1.6940 for 3-Weeks.
  • Sell 3-Week GBP Call / USD Put with 1.7020 Strike (30 Delta).
  • Forward’s implicit deposit rate is 0.00%.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium is 4.60% annualized.
  • Structure’s yield is 4.84% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from GBP appreciation to 1.7020.

Canadian Dollar (CAD)

The CAD made some progress against the US dollar breaking below the key 1.10 level, but its strength is mostly riding on the weakness of the USD and CAD short covering. There was a WSJ article suggesting a more positive light for Canada’s oil sector which also worked in favor of the CAD.  But we must remember; it’s down 11% from its 2013 highs vs. the USD; so, a 1.0% move for the week is hardly a breakout.  Unless there is a significant shift in the BoC policy, the loonie will struggle to sustain a break below 1.0800.

  • Canada’s March trade surplus narrowed to C$79M.
  • March housing starts slumped by 17.7% m/m.
  • February building permits fell by 11.6% m/m.
  • January GDP rose by 0.5% m/m and 2.5% y/y, a bit more than expected.
  • USD/CAD rate is 1.0861.
  • Mid implied volatility is 4.83%.

Recommended Enhanced Yield structure:  Short CAD forward

  • Long USD/CAD forward at 1.0866 for 2-Weeks.
  • Sell 2-Week USD Call / CAD Put with 1.0900 Strike (35 Delta).
  • Forward’s implicit deposit rate is -1.10%.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium is 6.46% annualized.
  • Structure’s yield is 5.34% annualized (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from CAD depreciation to 1.0900.

Japanese Yen (JPY)

The yen is up (vs. the USD, but down vs. the EUR) since our last commentary as the Bank of Japan kept its monetary policy stance steady as expected. The BoJ will likely provide additional monetary stimulus and the government aims to offset private consumption by supplementary public infrastructure spending, if it’s shown that the tax hike lead to a stalling of economic momentum.  It’s generally accepted that the tax hike from 5% to 8% will have an adverse impact on household spending in the second quarter of the 2014.

  • Japan’s March household spending jumped 7.2% y/y ahead of the April consumption tax hike.
  • February current account deficit narrowed to ¥41B.
  • March economy watchers survey rose to 57.9.
  • March jobless rate was steady at 3.6%.
  • April monetary base rose 48.5% y/y.
  • Current USD/JPY rate is 101.67.
  • Mid implied volatility 5.47%.
  • Current EUR/JPY rate is 140.70.
  • Mid implied volatility is 6.34%.

Recommended Enhanced Yield Structure:  Short JPY vs. EUR

  • Long EUR/JPY forward at 140.70 for 3-Weeks.
  • Sell 3-Week EUR Call / JPY Put with 141.40 Strike (41 Delta).
  • Forward’s implicit deposit rate is 0.00 %.
  • Yield from US dollar cash position 0.24%.
  • Yield from option premium is 8.12% annualized.
  • Structure’s yield is 8.36% (from forward deposit rate, U.S. deposit rate, and option’s premium), plus potential capital gain from EUR appreciation to 141.40.  Additionally, structure benefits from potential appreciation vs. USD.

Mexican Peso (MXN)

Bank of Mexico kept funding rate at 3.5%. Higher shipments of manufactured and agricultural goods offset a decline in petroleum exports and increased imports to boost trade surplus.  Imports of consumption goods fell 8.1 percent y/y, while purchases of intermediate and capital goods grew 10.3 % and 8.2 %, respectively.

Long awaited secondary legislation for the energy reform was presented on April 31. It should trigger substantial amounts of investment.  The question is, how will major global players react? A possible upgrade from Fitch or S&P would lead to inflows.  Expect continued moderate MXN strength.

  • Mexico recorded a trade surplus of 1.02 USD Billion in March.
  • Exports rose 4.5 % year-on-year. Non-oil sales advanced 6.9 %, while oil shipments fell 11.1 %.
  • Mexico’s April consumer confidence rose to 90.3
  • Mexico’s January investment spending fell 2.4% y/y
  • Exports rose 4.5 percent year-on-year to USD 33.314 billion, as non-oil sales advanced 6.9 percent, while oil shipments fell 11.1 percent.
  • Current USD/MXN rate is 12.9456.
  • Mid implied volatility is 7.03%.

Recommended Enhanced Yield Structure:  Sell MXN Put against U.S. deposit, not a forward.

  • Sell 2-Weeks USD Call / MXN Put with 13.10 Strike (34 Delta).
  • Yield from US dollar deposit 0.24%.
  • Yield from option premium is 17.07% annualized.
  • Structure’s yield is 17.31 % annualized (from deposit and option’s premium). If option is assigned, result will be long MXN at 13.20.

This article was originally published on Forexthink, a digital forex thought leadership platform. To view their full range of daily content, visit forexthink.com.

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