Currencies | May 14 2009
By Chris Shaw
Whether it be via the emergence of so-called ”green shoots” or via comments from those in positions of authority, there are increasing signs the global economic downturn, while still strong, has passed its worst point.
As TD Securities analyst Shaun Osborne notes, the OECD has suggested there are signs the downturn is moderating in nations such as France, China and the UK, at the same time as evidence indicates an improvement in the global financial sector given a narrowing in bond spreads and the TED spread, which measures the difference between interest rates for 3-month Treasury securities in the US and the 3-month Eurodollars contract.
According to Osborne, this suggests the downturn is moving into a more common recession phase rather than a potential depression, the result of this move being some “safe ” relationships currency markets have been utilising for trading are now at some risk.
As an example Osborne notes the financial crisis saw the US dollar in favour given its liquidity premium to other currencies as deleveraging became the order of the day. With this process now largely completed he sees the greenback’s liquidity premium as likely to decline going forward.
One possible implication of this, in his view, is the relatively reliable inverse relationship between the US dollar and equities may start to weaken, a view supported by his analysis showing the short, medium and long-term rolling correlation studies between the currency and the S&P500 Index are moving to relative extremes. All are significantly negatively correlated at present.
What this implies, in Osborne’s view, is the solid relationship between the US dollar and risk aversion is itself at risk, so if the US dollar cannot benefit from market uncertainty moving forward the key becomes identifying those currencies that can.
Osborne suggests the most likely to become the currency of refuge at present is the Japanese yen given high levels of domestic savings and stabilisation in Japan’s external accounts. With TD Securities already being long the yen against the US dollar via options positions, Osborne sees scope for adding to its long yen exposure via a trade on the British pound (GBP), which he suggests has moved a little ahead of the curve following the Bank of England’s quarterly inflation report.
Osborne sees the current GBP/Yen rate as above what is justified by short-term interest rate spreads and with the pair struggling to push through 151.00/50 in recent sessions, a correction towards the April low of 139 is most likely to occur. Osborne’s recommendation is to sell the GBP/Yen at 146.40, with a stop at 147.85 and a target of 139.00.
