Risk off – why EUR/JPY?

Yes, the Chinese data has been a bit soft, and the US manufacturing numbers haven’t been too special either. Plus we had the North Korean “earthquake” to jangle some nerves. But the European PMI data has been solid enough, and the US employment data continues to impress. The oil price is hitting new lows, but that’s double edged for growth and equities. It’s not all great, but it doesn’t all look terrible either. In my book it’s not bad enough to create a major sell off in equities. Yet we are at the lowest level since October. In the US, this may make some sense. Rates are higher and the recent data has been on the disappointing side. But for some European markets, the price action is harder to justify. Sweden in particular is testing the October lows which were also the 2015 lows, but rates are negative in Sweden, the currency is still very low against the USD, and growth is running close to 4% and expected to hold there for 2016. It’s hard for European markets to buck the trend of the US, but it’s hard to understand them underperforming.

This is also reflected in a bit of an FX puzzle. EUR/JPY has been hammered in the last few sessions, but the EUR doesn’t look the obvious currency to suffer from risk aversion. The European numbers have been reasonable, but  in any case, the EUR has tended to benefit from risk aversion in recent months, which makes sense given that it has been the favoured funding currency. AUD, CAD, GBP, USD and NOK all look more obviously vulnerable to risk negative news.

On a fundamental basis, it is also hard to justify EUR/JPY weakness on risk aversion, as the Eurozone is now the biggest current account surplus region, and positioning remains more heavily short EUR. It may be that the ECB does eventually ease more, but at this stage the BoJ is still implementing QE even more aggressively. Valuation wise, I would argue that the EUR is also slightly cheaper than the JPY, and though some will disagree with this assessment, valuation isn’t a major issue. All in all, I can see no real case for major EUR/JPY weakness with the obvious equity correlation looking harder to justify. Yet we are approaching the 2015 low at 126.10. It’s hard to oppose current momentum, but seems to me this should hold until there is clearer evidence of risk aversion extending. So even though the chart looks pretty compelling in favour of the longer term JPY bulls, I’d look for a near term bounce.



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