Clinton Trump Debate, EMFX, JPY and the EUR


The outcome of the Clinton – Trump TV debate saw the USD staying nder selling pressure, but unlike yesterday it was the higher yielding and NAFTA currencies (CAD, MXN) reporting strong gains. Once again, USDJPY rebounded from the near 100 level, but this currency pair has to overcome 102.50 to free itself from the risk breaking lower. Yesterday’s BoJ quarterly Flow of Funds report suggesting corporate cash levels reaching a record USD2.2trn is a symptom of declining monetary velocity. The decline of monetary velocity explains why the increase of the BoJ’s base money has not yet filtered through into broader money supply growth and therefore JPY weakness. Authorities will have to work on increasing monetary velocity to turn around the JPY.

There are three important topics when it comes to JPY valuation, namely global deflation/inflation dynamics, the performance of the CNY and, last but not least, Japan’s domestic price expectation. Over the past 10 months these three factors helped to create a perfect storm for the JPY to appreciate. Worse, the combination of JPY strength, import price weakness and declining bank profitability has created a bearish Japan feedback loop which will be difficult to break. Should the current USDJPY rebound fail to move above 102.50, the risk of breaking below 100.00 will increase, opening downside potential to near 95.00. Due to the existing bearish feedback loop, risks over the next couple of weeks are on the downside, but the medium term outlook is expected to turn around from here.

International factors to turn USDJPY around include a stabilisation of the global inflation outlook and the RMB reducing its pace of depreciation. Here China’s overnight news was constructive. Due to accelerating sales by industrial producers; continued price rises; falling costs; a favourable basis for comparison in the year-on-year gauge of growth; and greater activity in auto, steel and refined oil production China’s industrial profits rose by 19.5%Y in August reaching its highest level since September 2013. Israel, which is one of the bellwethers for global trade, kept its interest rate unchanged at 0.1%, but increased growth projections for this year (from 2.4% to 2.8%) and next year (from 2.9% to 3.1%). The ILS tends to shadow the EUR, but recently the two currencies have diverged with the EUR lagging the shekel’s rebound.

The weakness of EMU’s financial sector (Eurostoxx financials lost 2% yesterday) suggests the traditional exporters of EUR denominated capital staying on the side lines, limiting the downside for the currency. Meanwhile, EMU’s economic activity seems to be picking up as indicated by yesterday’s strong reading of the September IFO (109.5 after 106.3). Headline inflation should do better helped by stronger commodity price and base effects making markets to speculate that the ECB may reduce the volume of its security purchases. Markets tend to be forward looking. Any sign of the back end of the EUR sovereign debt curve steepening could see the EUR breaking higher. EURGBP is setup for further gains after yesterday’s daily closing price above 0.87. ECB’s Draghi urging that there should be no exceptions to EU single market rules after Brexit and increasing signs the UK moving towards ‘hard Brexit’ have created a toxic mix for GBP, but support our view seeing EURGBP reaching 0.92/94.