FX Alpha 20 August 2013

Sell Cross – JPY. ASAP

US yield developments are a bad omen for risky currencies. Positioning is still massively short JPY and will be subject to the mother of short squeezes.

Coming into September it is instructive to look at currency performance to see what dynamics are dominating within the G10 and EM space. Rather than simply following rate spreads, G10 currencies exhibit distinct signals of risk aversion. USD-JPY in particular fails to break higher despite the surge in US yields, gold enjoys an Indian summer and the USD is neither here nor there. Risky currencies, in particular EM currencies such as BRL and MXN continue to lose ground, despite the fact that the USD has not as yet staged its long awaited rally. Should the Fed decide to taper QE3 from September onwards this will arguably make a bad situation worse within the FX space.

US rates have already begun to price in Fed moves on the taper front, such that shorter dated yields remain well anchored in line with the Fed’s forward guidance policy, whilst the longer end of the yield curve has seen considerable moves, with US 30 year yields trading significantly higher over the last few weeks. These developments are likely to be a burden for risk assets in general meaning that safe haven currencies will likely benefit. Given that downside in EUR-CHF is capped this means that JPY should stand to benefit. More to the point, market participants are still resolutely short JPY meaning that should a down move in USD-JPY come to pass, investors will have to cover their shorts leading to an even more aggressive move.
To know more click here PDF