Safe Haven Currencies Soar after Malaysian Airline Crash

Daily FX Market Roundup 07.17.14 By Kathy Lien, Managing Director of FX Strategy for BK Asset Management Safe Haven Currencies Soar after Malaysian Airline Crash Why USD/CAD Should be Trading Above 1.08 NZD Extends Losses Despite Uptick in Data AUD Lifted by Higher Gold Prices Euro Holding 1.35 For Now Sterling Drifts Lower, Tests 1.71 JPY: Cabinet Sees Weakness after Sales Tax Easing Safe Haven Currencies Soar after Malaysian Airline Crash The tragic crash of Malaysian Airlines Flight 17 sent currencies and equities sharply lower. Until it is clear how the crash happened and who is responsible, investors will remain risk averse, which means that safe haven currencies such as the U.S. dollar, Japanese Yen and Swiss Franc will outperform.  The fear in the market is that the plane was shot down and the Russians are to blame, which would intensify geopolitical tensions but IF the plane was shot down, fingers will be pointed to the Ukraine Separatist Rebellion. In response, Russia and the Ukraine will most likely be forced to kill the movement as quickly as possible.  As the VIX continues to rise, the overall trend of currencies will be lower.  Ten year treasury yields dropped to a 6 week low today and given how closely the dollar has been tracking Treasuries, the decline in yields should have driven USD/JPY below 101. The problem is that Treasuries are significantly underpricing Fed tightening even though the Federal Reserve doesn't plan to raise interest rates until mid 2015. The unexpected decline in building permits and housing starts was offset by the surprise improvement in jobless claims and the Philadelphia Fed survey.  While activity in the housing market has been disappointing, the labor market and manufacturing sector continue to improve and hopefully these improvements will lift housing market activity.  Weekly jobless claims dropped to a 2-month low, continuing claims fell to a 7-year low and the Philadelphia Fed survey climbed to its strongest level since March 2011.  Although the University of Michigan consumer confidence index is scheduled for release on Friday, with the latest geopolitical uncertainty, the focus will be on Russia / Ukraine and risk appetite.    Why USD/CAD Should be Trading Above 1.08 Given the recent comments from the Bank of Canada and the weakness of Canadian data, USD/CAD should be trading above 1.08.  This morning, BoC Governor Poloz said in an interview with CBC that their first rate hike is approximately 2 years away.  Although the BoC downplayed the recent rise in inflation and said they are neutral on the next policy move yesterday, Canada will still lag the U.S. in tightening which in the long run is positive for USD/CAD.  So while USD/CAD is locked in place by the offsetting impact of risk aversion and higher oil prices, 1.06 could prove to be the bottom for the pair with an eventual move to 1.08 and then 1.09 expected.   Canadian international securities transactions rose by the strongest amount in 2 years with the $21.4B foreign investment into Canada easily exceeding the market's $5B forecast. While encouraging, this data can be highly volatile. Canadian consumer prices are scheduled for release tomorrow and if the data proves that the increase in CPI was temporary, USD/CAD could slowly make its way towards 1.08.  Meanwhile the New Zealand dollar came under additional selling despite a rise in job advertisements and a small increase in consumer confidence.  The Australia dollar on the other hand appreciated on the back of the sharp rise in gold prices and the uptick in leading indicators in the month of May.  The big news out of Australia was the government's decision to repeal the carbon tax which is not motivated by but will help to ease inflationary pressures.                                                      Euro Holding 1.35 For Now After 2 days of losses, EUR/USD stabilized above the key 1.35 level. Despite the risks that U.S. sanctions on Russia poses to the German economy and the negative impact that it could have on risk appetite if tensions increase further, FX traders have taken the developments in stride.  After falling 0.1% in May, Eurozone consumer prices grew 0.1% in the month of June.  Unfortunately even with this increase, price pressures remain very low.  In yesterday's note, we argued that without a significant rally in U.S. yields or a strong signal from the ECB that further easing is imminent a move below 1.35 would be fake-out instead of a breakout. Eventually 1.35 will give way but that may not happen until the fall when the Fed ends Quantitative Easing and shares its exit strategy. For the time being, EUR/USD is holding 1.35 thanks to the Eurozone's massive current account surplus, the downtrend in U.S. yields and reserve diversification.  Recent comments from ECB officials also confirm our belief that while the central bank is ready to increase stimulus, they are not planning to do so for a few more months.  ECB member Hansson said this morning that "ECB asset purchases are not imminent or needed now" and the same is true for QE. The latest current account figures from the Eurozone will also be released tomorrow.  Given the deterioration reported by Germany and France, chances are that the Eurozone's surplus will narrow slightly, keeping pressure on the euro. While 1.35 is significant for the EUR/USD from a psychologically perspective, on a technical basis the February 3rd low of 1.3477 is more important. If this level breaks the next stop for EUR/USD could be the November low of 1.3295. If the Malaysian Airlines crash in Ukraine leads to military involvement of other nations, fundamentals are thrown out of the window and EUR/USD could easily break 1.35. Sterling Drifts Lower, Tests 1.71 With no U.K. economic data released this morning, sterling drifted lower against the euro, U.S. dollar and Japanese Yen. This decline was driven primarily by the steeper slide in Gilt vs. Treasury yields.  While GBP/USD has been confined within a narrow range, EUR/GBP hit fresh 1.5-year lows every day for the past 3 trading days.  The Bank of England and European Central Bank are both comfortable with their current level of monetary policy but with investors looking for the U.K. to raise interest rates next and the ECB talking about easing again (regardless of how serious they made be), monetary policy divergence has driven EUR/GBP down 4.5% over the past 2 months.  The currency pair bounced today but chances are we haven't seen an end to the losses in EUR/GBP.  GBP/USD on the other hand is likely to remain confined within its 1.7060 to 1.7191 range with a small bias to downside as slow wage growth affords the central bank the patience to wait on rates.  The next opportunity for a breakout in the pair will be on Wednesday and Thursday when the Bank of England minutes and retail sales reports are scheduled for release respectively. JPY: Cabinet Sees Weakness after Sales Tax Easing Between the decline in U.S. yields, drop in U.S. equities and slide in the Nikkei overnight, the Japanese Yen traded higher against all of the major currencies.  USD/JPY failed to make a run for 102 and with today's sell-off, the currency pair's recoveries are officially becoming shallower - a sign that the downtrend remains intact.  It will be difficult for USD/JPY to hit 103 without a significant rebound in Treasury yields but even with all of the back and forth in USD/JPY, the currency pair has been confined within a 57-pip range for the past 5 trading days. Last night, the Cabinet released its monthly economic report for Japan and a minor tweak was made to their economic assessment.  For July, they said "the Japanese economy is on a moderate recovery trend and a reaction after a last minute rise in demand before a consumption tax increase in easing." In other words, they believe that the weakness after the burst of spending in March is beginning to fade.  According to the Ministry of Finance's weekly portfolio flow report, foreign investors sold Japanese stocks while Japanese investors increased their exposure to foreign stocks and bonds.  With a relatively quiet U.S. and Japanese economic calendar tomorrow, geopolitical developments and risk appetite should drive Yen flows.  Nationwide and Tokyo department store sales are the only pieces of data scheduled for release from Japan on Friday.