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AUD/USD extends the upside despite mixed data

The Aussie dollar is the best perfomer against the greenback on Thursday, extending its positive momentum, after the Employment Change in Australia posted +14.5K, beating forecasts at +3.75K and way up August’s -9.1K. The unemployment rate however, rose to 5.4% from 5.1%. Continuing with the data October Consumer Inflation Expectation rose 2.6% from 2.4%.

I.Spivak, Currency Strategist at DailyFX, says “prices are staging shallow recovery followeing a test support at 1.0136… Initial falling channel resistance is at 1.0279, a barrier reinforced by the 23.6% Fib at 1.0322. A push above that exposes major trend line resistance at 1.0537. Alternatively, a reversal through support aims for the 50% expansión at 0.9986”.

AUD/USD is advancing 0.38% at 1.0273 as of writing, with the next resistance at 1.0292 (hourly lows Oct.2) followed by 1.0325 (low. Oct.1) then 1.0342 (MA200d) and 1.0366 (MA21d).
On the other hand, a breach of 1.0210 (hourly high/lows Oct.10) would expose 1.0175 (low Oct.9) then 1.0149 (low Oct.8) and 1.0123 (low Jul.13).

USD/CHF back to 0.9400

From a first rise back to 0.9400 ground, the USD/CHF was capped at 0.9419 in the Asian morning and plunged to 0.9389, where it spent the rest of the session, before retesting 0.9400 on the German CPI inflation report and European flows.

The German data came in line with consensus, unchanged on the month of September, with the annualized figure softening from +2.1% to +2.0%. The EU normalized CPI report in France softened to +2.2%, instead of rising from +2.4% to +2.5% in September. The monthly change was a -0.3% contraction, below the unchanged consensus.

“Assuming a close is seen above the downtrend and the 1st October high at 0.9438, we should see the market base and head higher to initially 0.9520 then 0.9600/35, the 50% retracement”, wrote Commerzbank analyst Karen Jones.

EUR/GBP drops to 0.8030

The EUR/GBP has been held in tight consolidation Thursday, trading between a tightened range of 25 pips (0.8022 intraday minimum, 0.8047 intraday maximum). Amidst this seemingly sideways movement one day removed from a fresh downgrade of Spain, the pair has settled in the region of 0.8030 on the heels of economic data in the Eurozone, principally Spain in recent moments.

The cross is now entrenched in negative territory this morning during European trading, vastly underperforming both its 50 and 100-hourly SMA (down -15 pips and -27 pips respectively). Furthermore, at the time of writing the pair is incurring a loss of -0.18% on the day.

In Spain, the Consumer Price Index (YoY) grew only +3.4% in the month of September, missing consensus expectations of +3.5%. Conversely, the Consumer Price Index (MoM) advanced only +1.0% in September, against an expected rise of +1.1%. Finally the HCIP (YoY) yielded a result of +3.5% in September, which was precisely in line with expectations.

From a technical perspective, Mataf.net analysts highlight the additional propensity of supports at 0.8013, the 0.7999, and finally 0.7974. On the ascension, a break above 0.8052 will initiate added resistive means at 0.8077 and 0.8091

Spanish downgrade fallout – UBS

At the end of the US session yesterday, S&P downgraded Spain's sovereign rating by two notches to BBB-. In the aftermath of this movement, the EUR/USD was slow to react, but eventually fell 30 pips. According to Research Analyst Gareth Berry at UBS, “The ratings agency cited deepening economic recession and rising unemployment, which are limiting the government's policy options and adding to the frictions between the central and regional governments.”

S&P further noted that the hesitation of the government to request a bailout increases the downside risks to Spain's rating, which remains on negative outlook. “We think the announcement has hurt the euro as much as it is going to though, given that no important levels in the ratings table were crossed and that the downgrade arguably marginally raises the likelihood that Spain will request a rescue sooner rather than later, which would fulfill one of the necessary conditions for the ECB to begin bond buying.” Berry adds.

Breaking down the S&P downgrade in Spain

According to Macro Strategy Analyst J. Reid at Deutsche Bank, “With the ECB liquidity program on standby it's unlikely markets will aggressively sell-off in the near-term, however we can't help thinking that we will remain in a mild risk-off phase until Spain requests aid.”

On this theme S&P downgraded the sovereign 2 notches last night after the US closing bell) to BBB- outlook remains Negative. In addition, “S&P had a higher rating to start relative to Moody's (Baa3/review for possible downgrade) and Fitch (BBB/Neg) so the magnitude of the cut overnight perhaps shouldn't be seen as a huge surprise.” Reid notes. In terms of commentary, S&P stated "The negative outlook on the long-term rating reflects our view of the significant risks to Spain's economic growth and budgetary performance, and the lack of a clear direction in euro-zone policy".

They also added "The deepening economic recession is limiting the Spanish government's policy options." Much is resting on how close Spain gets to its growth and budget targets next year, not just the rating but it will probably be a review point for any future ECB bond buying program.

GBPUSD - Double Bottom and AB=CD Complete; Bullish

GBPUSD – Although upside pressure was posted in cable during the European session, investors sold the rally close to Tuesdays high. This resulted in the pair posting little net change for the day. However, a downside dip has been bought overnight and posted a bullish outside bar on the intraday chart. 1.5965, (38.2% pullback) is still a mild concern as market tend to trend towards these Fibonacci levels. Risk/reward is more than ample top call a Buy. Our call is bullish above a stop of 1.5974.
The profit targets are 1.6047, 1.6095 and towards 1.6129.

EURUSD looks headed to extend its decline

Even as a doji star has emerged ahead of near term support, EURUSD looks headed to extend its decline towards 1.2732 38.2% fib support. The notion is being reinforced by the major pair’s break through 1.2255-1.2500 ascending trendline. A close below the 1.2732 would force a test of 1.2596.

Support levels: 1.2835 1.2803 1.2745

Resistance levels: 1.2880 1.2910 1.2950

USD/JPY

Closing below 78.15 resistance, USDJPY is set for an extension lower through 77.79 support. A close below the support level would open scope for a retest of 77.50 support. Any retracement would see a test of 79.

Support levels: 78.10 77.90 77.65

Resistance levels: 78.50 78.80 79.10

AUD/USD

Climbing higher for the fourth straight session, AUDUSD is advancing on the 1.0300 psychological figure. A close above the level would open scope for a move to 1.0333 38.2% fib resistance. Declines look to be limited by the 1.0148 October 8th low.

Support levels: 1.0200 1.0160 1.0120

Resistance levels: 1.0235 1.0270 1.0300

How to profit from the decline of the Japanese yen

Back in July I drew reader’s attention to an assortment of factors that are potentially very bearish for the Japanese yen. These factors remain in place and if my assessment of them is correct, then the decline of the Japanese yen could be one of the most profitable trades of the decade.

Background
In June 2007 the Japanese yen began a sustained rise and by October 2011 it had risen by 39% versus the US dollar. It also rose considerably against many other world currencies, notably the New Zealand dollar and Australian dollar.

As the chart below shows the yen rose against the greenback for more than four years, establishing a powerful trend channel. However in February of this year the Japanese currency broke decisively out of this channel, and since then it has been trending sideways.

The unwinding of the yen carry trade
The primary factor that contributed to the Yen’s rise was the unwinding of the yen carry trade, and that has now come to an end.
A carry trade is a strategy in which an investor borrows money in a country with a low interest rate and uses the money to invest in assets in a country yielding a higher rate. The investor then attempts to capture the difference between the two rates, which can be substantial, depending on the amount of leverage used.

This investment strategy was used extensively between 1998 and 2007 to borrow money in Japan and invest in countries with much higher yields, such as Australia, New Zealand, the BRIC countries, and the United States.

This investment strategy was used extensively between 1998 and 2007 to borrow money in Japan and invest in countries with much higher yields, such as Australia, New Zealand, the BRIC countries, and the United States.

In an attempt to spur economic growth, Japan lowered its interest rates close to zero making it profitable to borrow Japanese yen and invest in resource rich emerging markets, and activities such as subprime lending in the US.

The trade proved so lucrative that by early 2007 it was estimated that as much as $1 trillion may have been staked on the yen carry trade.
However, thanks to the arrival of the global financial crisis in the summer of 2007, these risky, leveraged bets, started to be unwound, marking the beginning of the end of the yen carry trade. The unwinding of hundreds of millions of dollars worth of investments created tremendous demand for Japanese yen, since in order to repay the low-interest loans, foreign currencies first had to be converted into yen. This caused the Japanese currency to rise considerably against other world currencies.

It now looks as though the unwinding process has come to an end and with it the support for the Japanese currency.

The end of the unwinding of the yen carry trade is no the only reason that the trend change on the chart above is potentially highly significant. There are a host of other factors that are bearish for the Japanese currency.

Factors that are bearish for the Japanese yen
As we have pointed out before, on aggregate Japan is now the most indebted nation in the world, and according to the IMF’s latest forecast their situation will get considerably worse over the next four years.

In May of this year the unsustainable nature of Japan’s debt caused Fitch to cut its rating to A+ from AA and further downgrades are more than likely.

It’s not merely the size of Japan’s debt that poses a serious threat; it’s also the average maturity. Japan has $11.3 trillion in outstanding sovereign debt (over 990 trillion yen), the majority of which matures in the next 2.5 years. That means that by the end of 2015 Japan will have to find buyers for a total of $5.75 trillion in maturing debt. That’s in addition to around $1.4 trillion that it must borrow to cover its budget deficit over that period.

Japan is also suffering from demographic pressures with its Baby Boomers beginning to retire and draw down on their pension funds, rather than paying into them. As a result Japan’s Government Pension Investment Fund (GPIF) – the largest pension fund in the world – has been forced to begin selling Japanese government bonds (JGBs). This is a major issue since the GPIF owns almost 12% of all outstanding Japanese debt and it now looks as though it will be a net seller. The precarious nature of Japan’s fiscal position makes it all the more likely that the nation will soon run in to funding difficulties. At which point they will have to choose between austerity (and economic contraction), or money printing. However the latter seems much more likely

Why more monetary easing is on the cards for Japan
Earlier today the Bank of Japan's policy board voted unanimously to leave the target of its financial asset-buying program at 80 trillion yen after raising it from 70 trillion about two weeks ago. The board also decided to leave its overnight interest rate at 0 to 0.1%, where it has been since October 2010.

The BoJ also downgraded its economic assessment for the second month in a row, saying that, “Japan's economic activity is levelling off”, while last month the bank said, “the pick-up in economic activity has come to a pause.”

Both Morgan Stanley and Credit Suisse are forecasting that Japan’s economy will contract in both Q3 and Q4 this year.

Speaking back in July, Deputy Governor of the BoJ, Hirohide Yamaguchi, said “When the outlook turns out to be weaker than expected or the risk associated with it intensifies, the bank will not hesitate to implement additional monetary easing.”

The latest forecasts indicate that inflation in Japan will stay below the BoJ’s 1% target for the next two years, and it’s becoming increasingly clear that the central bank is prepared to try new ways to try to end more than a decade of deflation.

Takahide Kiuchi, a former Nomura Securities economist who was appointed to the BoJ policy board in July said recently that after almost two years “of monetary easing centered on asset purchases, the time is coming to examine the impacts of the policies”. Mr Kiuchi continued, “If we conclude that the chance of achieving our target isn’t so high by extending the current policies, I think we of course need to consider new forms of monetary easing in a flexible manner.”

Japan is faced with an enormous debt burden, slowing economic growth (both globally and domestically), and the demographic pressures of an ageing population. And whether it chooses austerity or further monetary stimulus, the outlook for the Japanese yen looks distinctly negative.

It is my opinion that Japan will choose to inflate away a good portion of its debt. I therefore expect the BoJ to pursue ever more aggressive stimulus measures which will debase the value of the Japanese yen sending it into a long downtrend.

How to play the coming decline of the yen
There are several different ways to capitalise on a weaker yen. Longer-term investors might want to consider owning a selection of Japanese exporting companies that stand to benefit from a lower yen. Some names to consider include car companies such as Toyota, Mitsubishi and Nissan, as well as electronics manufactures like Canon, Panasonic, Sony and Nintendo.

These companies are likely to see greater demand for their products thanks to the greater relative purchasing power of foreign buyers. In fact, some of these companies are already beginning to raise their profit forecasts.

Those with trading expertise might consider shoring the yen against the US dollar in the futures market.

Dennis Gartman, publisher of the Gartman Letter, is also bearish on the Japanese currency. Back in March of this year he stated that, “the yen is doomed fundamentally. Japan just has so many problems, none of which are going to go away anytime soon.” Mr. Gartman has been shorting the yen on the currency markets and has placed trades that effectively allow him to buy gold and agricultural commodities in yen terms. If the yen falls and the price of these other assets rise, then he ought to do very well indeed.

It will take quite a lot of skill to profit from it, but in my assessment the decline of the Japanese yen could be one of the most profitable trades of the decade.