Risk off more likely a positioning phenomenon than a real reassessment of fundamentals
JPY strength still has further to go, particularly against the USD
Commodity currencies can stabilise against the USD
GBP and CAD more focused on global risk than Friday data
Friday lacks major data, but as Thursday showed, big FX moves are just as likely to happen when there is no news as when there is significant news.
The risk off move this week has been attributed by some to rising concerns about the spread of the delta variant. This may be a factor, but at this stage we are more inclined to treat it as a natural market correction. Certainly, we would regard the recovery in the JPY as significantly overdue, with JPY weakness in recent weeks exceeding even the normal relationship with risk measures. The rise in the JPY on the crosses has gone a long way to reinstating the fairly stable relationship we have seen between equity risk premia and JPY crosses in recent years, but we still see some more upside for the JPY from here, both on the crosses and against the USD. Further weakness in equities or declines in yields will increase the scope for JPY strength on the crosses, but even if risk premia stabilise at current levels there should be another 2% or so of JPY gains before crosses like AUD/JPY and GBP/JPY have reconnected with their normal risk relationships.
For USD/JPY, the relationship has tended to be more related to yield spreads, and at this stage USD/JPY has only scratched the surface of the potential move. Shorter term correlations suggest scope to the 106 area, but a longer term perspective suggests scope for a much bigger JPY gain sub-100. We would see scope for the move to 106 to happen fairly quickly, over the summer, but the bigger picture JPY gains may only come with more general USD weakness.
As well as JPY strength we saw general strength for the safe havens on Thursday and weakness for all the risky currencies, notably the commodity currencies. This was accompanied by some weakness in commodities, but the decline in commodity prices is still quite modest compared to the huge gains seen in the last year. This supports our view that the decline in the commodity currencies is essentially corrective, and that a base is likely to be formed close to current levels near 0.74 in AUD/USD and below 1.26 in USD/CAD. If we see a much bigger risk sell off, triggered by real concerns about the impact of the delta variant, then there may yet be more significant downside for the commodity currencies, but we believe the risk correction against the USD is largely complete if we see equities and bond yields stabilise near current levels.
Friday’s main events datawise are the UK GDP and trade data for May and the Canadian employment data for June. UK GDP disappointed market expectations with a 0.5% rise in May, and this caused a modest dip. However, EUR/GBP will be more driven by the general risk tone, and looks likely to stabilise near 0.86 unless we see an extension of Thursday’s risk sell off.
The Canadian employment data is likely to show a strong rebound from weakness in April and May due to COVID-induced restrictions, but is also unlikely to be the main issue for USD/CAD, which will be very much focused on the general risk tone and the oil price. Despite the softer oil price this week, current prices are still plenty high enough to be seen as CAD supportive with USD/CAD still having some way to decline to move back in line with yield spreads. The 1.26-1.2650 area ought to provide good resistance.