Aside from Syria-inspired risk aversion, big losses in emerging market currencies, jitters about Japan’s consumption tax, and falling US Treasury yields caused a massive unwind of short yen positions.
For many Japanese yen (JPY) pairs including USDJPY, Tuesday’s selloff was the largest one-day decline in nearly three weeks. The more-than-1% selloff in USDJPY and nearly 2% drop in AUDJPY and NZDJPY was caused by a confluence of factors.
Markets around the world sold off on concerns about an international military response to Syria, but that was not the only reason for the poor performance in the yen pairs. The yen crosses were also hit by a meltdown in emerging market currencies, uncertainty about the consumption tax in Japan, and the decline in US Treasury yields. At the end of the day, all of these factors led global investors to unwind their short yen positions.
Selling the yen against the US dollar (USD) and other major currencies was among the most popular trades this year, and even though there's still trillions of dollars in the short yen trade, if none of the recent uncertainties are resolved in a positive way, more investors could opt to unwind their long USDJPY positions in the near term.
In the long run, however, fundamentals still support a rally in USDJPY, but at this stage, buying on strength is probably smarter than buying on weakness unless the pair drops down to exceptional value points.
See also: The “Fear Trade” That’s Back in Play
Economic data in Japan continues to improve, with the country's small business confidence index ticking slightly higher. No data is scheduled for release overnight, but Bank of Japan (BoJ) Deputy Governor KikuoIwata will be speaking at the Kyoto Chamber of Commerce this evening.
Euro Stands Tall While Others Fall
While all other major currencies endured steep declines against the US dollar on Tuesday, the euro (EUR) recovered earlier losses to end the day higher against the greenback. For EURUSD, the 1.34 level is like a magnet for the pair, but Eurozone data has been good, which provides the underlying basis for euro strength.
According to the IFO Institute, German businesses grew more optimistic about current and future conditions in the month of August. The IFO index rose to 107.5 from 10.6.2, with improvements seen in both sub-indices.
This report is consistent with other releases in the Eurozone, showing that the recovery is gaining momentum. However, the 1.34 level in EURUSD is still being tested, and without stabilization in sentiment, it may be difficult for this level to be breached in a meaningful way, even if the rest of this week's Eurozone economic reports are good.
All of the major Eurozone stock market indexes closed the day down more than 2%, while bond yield spreads in the region widened. The Eurozone is not of the woods yet, but compared to other parts of the world, its outlook is brighter, which could help the euro outperform other currencies besides the US dollar.
No Eurozone economic reports are scheduled for release on Wednesday, but German unemployment and retail sales numbers are expected later this week.
By Kathy Lien of BK Asset Management