Currencies in focus
It‘s challenging to disentangle where the adverse reaction in US equities (S&P 500: -1.75%) to Fed Chair Powell's speech on Wednesday stems from: a gloomy economic outlook, or a reluctance to open the door to negative rates?
Markets are running with the assumption that equity market weakness and modest broad-based USD strength can be chalked up to Fed Chair Powell's pushback against negative interest rates, arguing that the effectiveness of the policy "is very mixed." Powell's views on negative rates do not depart from previously stated opinions on the subject, but are welcome nonetheless.
The BoJ, ECB and Riksbank's forays into NIRP suggest that their such policies do not pump inflation expectations and have a limited impact on the velocity of mind.
For FX markets specifically, that’s not to say EM carry trades against the US dollar will not be attractive if FX and rates vol continue tracking lower. The Fed has a deep policy arsenal without resorting to NIRP.
The New Zealand Dollar
By contrast, the RBNZ is leaving the door open to negative rates, which should drive further NZDUSD downside below 0.60 and lead to AUDNZD consolidating above 1.07.
The Australian Dollar
Australian employment in April had a massive decline: -594.3k vs. -575k consensus. The downside surprise is not huge, so the AUDUSD has only moderately sold off. The rise in the unemployment rate was less than expected, at 6.2% vs. 8.2% consensus and 5.2% prior, reflecting a considerable drop in the participation rate, to 63.5% from 66.0%, which means lots of people packed it in and left the labor force.
The Japanese Yen
What’s surfacing is the protective tape on the wimbling well of the JPY haven, as abnormally large Japanese capital outflows which were supporting USDJPY, even though US interest rates have plunged close to Japan's levels. The Yen now has a favorable balance between a currency that’s cheap on most metrics but doesn’t have a cost of carrying disadvantage acting as an anvil on its back.
Besides, the closer we get to 105, which is widely seen as the low end of the current range, the higher the chance for Japanese hedge ratios to increase on USD assets will drive the USDJPY lower. In this complex chain it will result in a virtuous circle for the Yen.
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Sometimes you have to throw conventional wisdom out the door and just let the good times roll