FX Weekly: South Korea Leads The Way

by: Rothko Research

This week has been marked by the Fed 25 bps rate cut on Wednesday, the first in more than a decade, and the NFP coming in on Friday.

The US dollar has remained the preferred currency in this environment and has been strengthening even against the Japanese yen in the past two weeks.

Australian equities continue their strong momentum as the RBA eases and China credit conditions and excess liquidity increase.

Global: As expected, the Fed cut its policy rate by 25 bps on Wednesday, the first cut in 11 years, levitating the US dollar and generating a tiny 'sell-off' in equities. Even though some market participants were betting on a 'large' 50bps cut, we said that a 25bps cut seemed more reasonable as a ‘big’ cut was going to send the market the wrong signal. Investors will now focus on non-farm payrolls on Friday. The US dollar has remained the preferred currency in this environment and has been strengthening even against the Japanese Yen in the past two weeks, levitating slightly Japanese equities. Australian equities continue their strong momentum as the RBA eases and China credit conditions and excess liquidity increase.

Euro: In Europe, market sentiment is still on a negative trend and is not pricing a potential recovery within the next 6 to 9 months. For instance, the IFO business climate index, a closely watched leading indicator for the German and European economic activity, is now below its 2012 level. Figure 1 (left frame) shows that the IFO index is actually expecting the industrial production to weaken in the Euro area in the next 5 months to come. The euro still looks vulnerable in the short run as it has not responded to the recent fall in Italian yields.

Japan: As expected, the Bank of Japan left its policy rate steady at its meeting this week, however Japanese policymakers remain vigilant to a sudden yen appreciation as the Fed starts its easing cycle. The outlook remains mostly unchanged, just a slightly decrease in inflation estimates for 2019 and 2020 (Core CPI is expected to average 1% and 1.1% in FY19 and 20, respectively). We think that the critical level on USDJPY stands currently at 100, and we could see some strong reactions if the exchange rate starts falling below this threshold.

UK: Sterling got sold significantly in this early week as market participants fear that new PM Boris Johnson could plan to leave the EU without a deal. We still expect political uncertainty to remain in the next few weeks, which could send the British pound to lower levels, especially against the euro, the US dollar and the Japanese yen. The 10Y UK yield keeps trending lower and now stands 10bps higher than its historical low of 53bps recorded in the summer of 2016. On the other hand, the FTSE index keeps moving higher helped by Sterling weakness.

Figure 1

Source: Eikon Reuters, RR

US Treasuries Net Specs

Net speculative shorts paused in the past week, down 20K contracts to 1.029M contracts on July 23rd , as US yields have stabilized ahead of the Fed’s meeting. Is the move on the 10Y done , or should we expect more action in August?

Figure 2

Source: CFTC

FX Positioning

EURUSD: The pair has traded below its ST resistance at 1.1185, which corresponds to the 61.8% Fibo retracement of the 1.0340 – 1.2550 range. We took profit on our short position at 1.11 and are waiting for higher levels to start shorting some again. We think that the single currency remains vulnerable to any price sensitivity in this market, especially to a sudden rise in price volatility.

Figure 3

Source: Eikon Reuters

GBPUSD: Cable suffered in the past week, falling to a 29-month low as uncertainty is weighing on the UK market with PM Johnson’s refusal to meet his European counterparts. Even though the currency looks oversold according to a range of indicators such as the RSI, we would stay out of the negative momentum in the short run for the time being.

EURGBP: After a little consolidation to 0.89, the pair took off on the back of the pound’s weakness and broke its ST support at 0.9070 to settle around 0.9160 in the past two days. We were stopped on our short at 0.9110, but we would wait for higher levels to start considering shorting EURGBP again. The next LT resistance stands at 0.93, which was the high registered in the end of August 2017.

Figure 4

Source: Eikon Reuters

USDJPY: The pair has been ranging between 106.90 and 109.15 in the past two months, which correspond to the 61.8% and 50% Fibo retracement of the 99.60 – 118.70 range. The Japanese yen remains strong in this current environment, especially against crosses such as the euro, the pound and the Australian dollar. AUDJPY is now flirting with its 74.50 support, implying that equity investors should be slightly concerned about market conditions.

Figure 5

Source: Eikon Reuters

USDCHF: The Swiss franc has also been oscillating between 0.98 and 0.99 in the past few weeks, and we would wait for a trend confirmation to start building a position.

Chart of the Week

Chart of the week: Last year, Bank of America published an interesting chart looking at the relationship between the YoY growth of South Korean export, sometimes described as a ‘notorious good global cyclical indicator’, and global EPS. Semiconductor sales also tend to lead global earnings by approximately 90 days, hence both the deceleration in SK exports and semis sales raised red warnings signals for global profit and economic growth.

This chart shows an interesting co-movement between South Korea equities (EWY ETF) and the 10Y US yield. In the past few years, South Korea has remained the largest and fastest-growing semiconductor manufacturing equipment market in the world; hence, looking at South Korean equities may indicate a future state of the global economy. Since 2011, SK equities have led US 10Y by 6 months, therefore we will see if the recent rebound in Chinese excess liquidity will offset the impact on Asian tariffs, start levitating SE Asian equities and potentially leading to a rise in US long-term yields.

Figure 6

Source: Eikon Reuters

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in EURUSD over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.