Germany To Champion EURO’s Growth?

Spain, or Barcelona in particular, no longer rules – Bayern Munich won it all in last weekend’s Champions League cup. The German nation, the backbone of Europe, is on such a high that the German government is contemplating backing away from austerity and spending billions to stimulate the ailing economies of Southern Europe. In truth, it has nothing to do with football and everything to do with it being a German election year and Chancellor Merkel struggling in the polls. She needs to firmly unite her coalition party and close its “open flank” in plenty of time ahead of this September’s federal election.

Finance minister Schauble, otherwise known as the austerity commissioner to Europe’s southern brethren, is humming a new tune – he and Germany want to be perceived as the new “champions of growth,” and not just the ‘European Champions.’ Finally, after three years of austerity hardship, resulting in record unemployment figures amongst the youth across the European divide, the German government is running election scared. Both Schauble and Chancellor Merkel are worried that their austerity-obsessed image could solidify throughout Europe and “do some irrevocable political damage” ahead of the election. Berlin it seems is making an about face despite sticking to its current austerity plan.

The market is already assuming that this week is going to be vital in confirming the direction of the next significant leg run of USD/JPY. The currency from the “rising sun” has been seen to ‘ebb and flow’ with the Nikkei of late, similar to its overnight move. The outright currency pair managed to end last nights quiet session on a high note after the Nikkei flipped from negative territory (-1.4%) to end up positive (+1.3%) on the day. To most investors, the recent pullback of the Nikkei was seen as a sign of doubt around the radical recovery strategy outlined by Japanese PM Abe.

USD/JPY has managed to stage a recovery from support offered by tech ops -50% retracement of this month’s advance at ¥100.38. Significantly, the overnight dollar bullish move is approaching resistance at ¥102.21 on the top side. In recent sessions, trading in Japan has been somewhat volatile, ever since their equity market plummeted -7.3% in one session last week – the first significant retreat from a market that has know only one direction and that’s up +65% from mid-November. Partial blame to the lack of volatility may in part be due to the lack of an overnight financial lead from the US and UK who were on public holiday’s. Also, investors were somewhat tamed by Japan’s Economy ministers comments that the country’s equity market was in “an adjustment phase and that it should stabilize.”

As noted yesterday, the last week of May sees the release of a slew of Japanese April data including industrial production, consumer prices, retail sales, household spending and unemployment. The market should expect that most of the releases would get extra attention, as investors will want to gauge how Abenomics is doing on the World’s third-largest economy. Later this evening, Bank of Japan Governor Kuroda gets to speak at a conference in Tokyo entitled, “The Financial Crisis and the International Financial System.”

A threat to Abenomics is the spike in long-term domestic bond yields. Japanese policy makers have been trying to use rhetoric to ease some of Japan’s debt products price fall, believing that their financial system, as a whole, seems to possesses sufficient resilience against such shocks as a rise in rates and a deterioration in economic conditions. Policy members this week will get to meet JGB market participants to discuss this recent rise in yield phenomena, a constant threat to QE. Be prepared, the long end of the US curve will be blamed and what about Bernanke tapering QE? Will this not only add to Japan’s persistent headache?

The Euro investor’s own confidence levels got a boost yesterday from comments by ECB board member Asmussen, who said that “the bank will keep to its accommodative monetary policy for as long as necessary.” The 17-member single currency has yet to find its “real sea legs” as markets remain hypersensitive to the Fed’s true intentions – will their QE support be wound down? The single currency’s recent move left cannot be described as a convincing ‘bear’ move. However, expect dealers to continue to add weight to this direction, insisting that intraday single currency sellers at 1.2985-90 “remain out of the game”- while lauding of offers building around 1.2935-45 as they look for a sub-1.28 on the remainder of the week as long as the USD play extends.

A major threat to this move is the current outright IMM position sheet which points to an “overlong dollar market.” On the flip side, there is a train of thought that believes that the forex market remains under-positioned for a move higher in the USD. The US rate path should be expected to remain dollar supportive. A threat of tapering or persistent US economic growth will support a move higher in yields in the short end of the US curve. The yield differential argument will support US dollar flows across all of the G10 and most EM currency pairs at least until the next near term event risk. Perhaps that is next weeks ECB meet and NFP report?

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Dean Popplewell, Director of Currency Analysis and Research @ OANDA MarketPulseFX

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