The story of the night has been the diverging paths of the USD. On one hand the USD lost ground against the EUR and GBP, but rallied with strength against the CAD and AUD, as well as certain emerging market currencies. GBP/USD broke out above the recent high of 1.6605 and the underlying strength is there for all to see. Picking tops is ill advised, that is until we see signs of exhaustion, but my feeling is this pair heads to 1.6700 in the short-term. Many investment banks will look at the difference between UK two-year gilts and US two-year treasuries, and the wider the yield spread the more compelling it is to hold a currency. Last night we saw the spread blow out to 18 basis points in favour of the UK, which shows that the move higher in GBP was supported by favouring economics and therefore fundamentals.
China is rebalancing its economy and this is having a clear impact on Chinese growth, as seen in yesterday’s HSBC flash manufacturing PMI. There are other factors that are causing negative sentiment such as a potential default in a certain investment trust; however one thing is clear, the AUD is being sold by money managers to hedge emerging market risk. Technically there isn’t much reason to be long and shorts are clearly preferred, although a daily close (09:00 AEDT) above Monday’s low of 0.8756 would be modestly positive. A sustained break of this level would bring the 50% retracement of the 2008 to 2011 bull trade into play. Long GBP/AUD still in my preferred play despite being over owned and overbought.
It is going to be a clear risk off day in Australia, with our call being 0.6% lower. On the downside traders will be watching for a move to 5207 (the January 14 low), with this low also being the 50% retracement of the 7.1% Christmas rally. BHP should open 0.6% lower, based on its ADR, while gold plays look to be the outperformers today. China will play an integral part in price action today, as will Japan, so watch the open of the Chinese market, with A50 futures coming on-line at 12:15 AEDT. I also question whether traders will be keen to sell certain stocks and run a more neutral book ahead of the long weekend in Australia, which in theory could see weakness into the afternoon.
Japan is going to be sold aggressively on the open of its cash market, with the index falling 2.4% overnight. USD/JPY has reacted to a rampant buying spree in the US treasury market (yields lower) and is looking set to print yet another bearish outside day. Perhaps the moves were only dwarfed by moves in USD/CHF with traders simply wanting to gain exposure to countries with external capital. Japan is going to be the key volatile market today.