Morning Commentary: Less Safe not Less than Safe

Foreign Exchange - Morning Commentary
Less Safe not Less than Safe
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Since 1980 to the start of Abenomics (~32 years) the yen has traded in a 10% yearly range only twice.  However, USDJPY has traded in an annual range of less than 10% over the past three years, with 2019’s range of ~7.6% the tightest since 1980.  This statistic is even more impressive when you consider all of the geopolitical uncertainty that last year brought.  While there are a number of reasons to explain this, interest rates play a large role. 

Given the low Japanese interest rates, the yen has historically been used as a carry trade funding currency.  When the markets were in a risk on mode, market participants would sell the low yielding yen and buy a high yielding currency to make the difference.  Once a risk off mode hit, the markets would sell the high yielding currencies and buy back the yen to cover their liabilities.  This purchase/sale of yen during risk off/risk on scenarios strengthen/weaken the yen and make it behave like a safe haven asset. 

However, over the past couple of years, interest rates have fallen around the world. Without any G10 currency a high interest currency, the demand for the carry trade has waned.  Additionally, other currencies such as the euro have lower interest rates than the yen.  Therefore, anyone looking to fund a carry trade has options beyond the yen.

Moreover, structurally low interest rates in Japan have led to aggressive demand for external investments.  Because of this, when the yen strengthens during a risk off episode, the upside move is capped as Japanese investors use it as an opportunity to sell yen and invest abroad. 

All of this isn’t to say that the yen doesn’t react to risk events.  This week’s move in response to news regarding US-China trade proves that it does.  What the factors above do is argue that the yen’s safe haven behavior has been muted and helps explain the divergence between the yen’s performance and other safe haven assets.
  • Phase 1 of the US-China trade deal was officially signed with the details of the deal broadly in line with market expectations.  While the deal left many of the most contentious issues untouched, China did agree to increase agricultural purchases by $200 billion (vs. 2017 levels), refrain from competitive currency devaluation, allow for more competition in the financial sector, improve intellectual property protections and end forced technology transfer in exchange for market access.
  • With regards to increased commodity purchases, the two governments announced that they will not publish purchase benchmarks for individual commodities.  Given this, American farmers and energy exporters stand to gain at the expense of South American farmers and Australian energy producers.
  • Continuing with trade, the US Senate is expected to vote and pass USMCA this morning with President Trump set to sign the deal next week. 
  • US December retail sales excluding automotive came in better than expected as it rose 0.7% MoM versus expectations for a 0.5% increase.  Initial jobless claims also beat, falling to 204K against expectations for 218k claims.  Both of these data points continue to show a resilient consumer and labor market. 
  • Japanese core machine orders rose 5.3% YoY against expectations for a -5.3% print.  It should be noted that this is a volatile series and most Q4 data has been weak, making it wise to take this positive beat with a grain of salt. 
  • Canadian ADP payroll data showed that Canada added 46.2k jobs in December with November’s number also revised higher.  While this is a less significant jobs report, it still paints the picture of a strong jobs market.
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