• A Curate’s Egg For Risk
• Heads And Tails
• USDJPY Rallying

Forex traders with an eye on stock benchmarks have seen indices adding to recent gains in early U.S. trading. Investors have taken kindly to a slew of relatively healthy data, easing concerns about the health of the global economy while not ruling out continuing central bank support. 

From a currency markets perspective, the question of the dayis what to do with the USD when such positive – and somewhat unexpected – U.S. data comes in at the stronger end of the range of the last few years? It’s tough to argue that the greenback should sell-off if this means a delay to QE3. Therefore, is this market so hung up on the central bank liquidity that ‘good is bad’ for risk?

John J Hardy, Head of FX Strategy at Saxo Bank, points out how strong U.S. data is the most difficult kind of data to react to in this market. “On the one hand,” says Hardy, “it is USD positive because it delays the much-touted prospects of QE3. Yet on the other hand, there is still a background fear that global economic growth is weakening, so good data is nominally supportive of risk appetite, which is generally USD negative.”

One could argue, therefore, that the USD reaction is lose-lose on good US data. But that’s only the case if risk appetite continues to bull on higher here, so stay tuned, as we are at multi year highs in complacency in terms of FX and equity implied volatility.

“While the directional USD arguments are somewhat convoluted and confusing,” continues Hardy, “it makes sense that the JPY was the weakest currency on the back of this data, as bonds sold off quite steeply and the recent weak Japanese data highlights the overvaluation of the JPY if risk appetite remains on. There’s lots more wood to chop in USDJPY, but interesting levels are already approaching not far above 79.00.”

USDJPY rallying of the US retail sales data release as bonds sold off heavily, and if bonds are an important coincident indicator for the JPY, there could be some more catching up to do to the upside. Bonds will need to stay on the defensive to see the pair back above 80.00 again.

Looking Ahead

Tomorrow’s U.S. Empire Manufacturing survey and the Philly Fed survey on Thursday are the other two data points to watch to see if the better (increasingly less bad) U.S. data trend continues. “If it does,” says Hardy, “we’ll continue to have a critical test for market sentiment – should we be seeing this as the Tepper trade (Heads: risk appetite wins because the economy is growing better than we feared and this is good for earnings, etc. or Tails: risk appetite wins because the QE3 cavalry will be on the case very soon to support market liquidity.) 

Hardy suggests the Tepper mentality is getting very long in the tooth and wonders if market cycles are about to change here, as evidenced by the continued weakness in bonds and the consolidating Euro. (“There was also this article from Bloomberg this morning that piqued my interest,” says Hardy.) This market is going to be on the hunt for new themes soon – the extremes in complacency of late and this summer drawing to a close suggest that the timing may be rather soon.

Drew Hillier. Editor, ForexSpace.com