There’s a feeling of regime change again in FX markets, just as we were getting comfortable with the “currency wars” dynamic. There are three main reasons why this is happening now.
The first is that there are reasons to be more cautious about the world. The US has entered the budget sequester, which in theory will chop around 0.5% off growth for this year, but in practise there a lot of uncertainty surrounding this and it’s not a conducive activity towards investment and more hiring. This is making equities look more vulnerable. Secondly, those currencies that were supposedly winning the currency war (i.e. depreciating), namely the yen and sterling, are starting to look less like one-way traffic. Finally, the favoured means by which bearish views on these two were being expressed (euro strengthening) looks far less favourable, primarily owing to the uncertainties caused by Italy.
What does this mean for the majors? Sterling and the Aussie look to be the more vulnerable, more so the latter as the 1.0150 – 1.06 range for AUDUSD that has dominated for over 6 months having been breached. Sterling has a modest cushion from both positioning and is also still managing to attract some ‘safe haven’ flows from the uncertainty prevailing in the Eurozone. Note that Gilt yields are back below 2% on the 10 year, having largely ignored the recent downgrade by Moody’s. The yen is the more difficult one, because it depends whether it’s still going to behave like the safe haven it was once perceived to be or reflect the potential for more policy measures from the Bank of Japan. The message from the BoJ nominee Kuroda overnight was that he would do “whatever we can do” to end deflation, although he appears to edge away from some of the more radical policies being suggested.
Some may cite the fiscal year end as a reason to be more cautious on the potential for a weak yen (as money flows back to Japan), but on a trade weighted basis, the yen has weakened every March for the past four, something not seen for any other month. But it’s the dollar that will really determine the direction of currencies, more so than has been the case for many months as it has stood on the sidelines of the currency wars playing field.