Following thin trading to start the week that saw the euro floundered against several major currencies including the U.S. dollar, the Australian dollar was the star attraction on Tuesday as investors appear content to look elsewhere for elusive yield. Forex traders are biding their time, waiting for what comes out of the next Bank of Japan meeting on Wednesday, followed by the release of the Federal Reserve’s minutes from its last policy meeting on Thursday.
In largely quiet trading in Europe, the Aussie dollar dropped below the psychological $0.93 cent mark after the Reserve Bank of Australia said it expects “interest rates will likely remain at record low levels for some time as the economy faces a slowdown in mining investments, cuts to government spending and weaker export growth.” This has allowed the fixed-income teams to scale back Aussie rate expectations despite the AUD longs proving vulnerable to dovish central bank comments, short Aussie positions are proving to be an unattractive bet to many while volumes are so low (one-month 7.1%). With forex market interest dipping, the summer carry trade could prove profitable, as lethargic trading tends to drive volumes even lower.
Falling Bond Yields Rain Down
Last week’s theme was the ‘pain’ trade – vulnerability of trades where positioning remained overweight/extreme – dominated by the long peripheral bond-trade exit. Throughout the various asset classes, speculators have been throwing in the towel either because of profit-taking (USD short) or short-covering (stocks and bonds). In the U.S., the market witnessed one of the biggest short covering scrambles on U.S. bonds. For instance, the market became too bearish on U.S. 10’s – yields were supposed to back up with tapering and the market seems to have gotten ahead of itself while ignoring the lower-for-longer mantra somewhat. U.S. 10-year Treasurys are trading near +2.5%.
The same applies to the eurozone’s periphery debt, with investors being too bullish, having priced in too much good news for Italian, Greek, and Spanish debt in particular. Last week closed out with yields aggressively backing up. This week’s short-lived nature of buying would suggest that the market is somewhat uncomfortable to put new money to work in these areas; investors prefer to trim long positions. Do not underestimate the importance of bond yields to current forex positions. The correlation between JPY and U.S. 10-year yields seems to be back in play again today. With the latter slipping to a fresh day low of +2.535%, it has USD/JPY trading near its intraday low of ¥101.29 and EUR/JPY, which is also weighed down by heavy selling of EUR outright, falling to a fresh three-month low of ¥138.55.
British Inflation Rises
As expected, fresh data delivered a higher U.K. inflation number this morning. The April number at +1.8%, year-over-year, was slightly above March’s +1.6%, however, the print is unlikely to influence Governor Mark Carney at the Bank of England (BoE) on rates. The rise was mainly due to the base effects. Easter was in late April versus March last year, and transport costs typically rise over the holiday period. Lower commodity prices and a stronger pound (£1.6830) would suggest that inflation is likely to remain subdued for some months. Expect the BoE to be watching the key variable wages over the coming months – more jobs and higher wages could fuel inflation.
The U.K. headline print saw gilt sellers extend futures losses, while cash 10’s moved through February’s base of +2.592%, and with momentum, the technicals could open up to test the top yield of +2.64% of the same month. Cable did threaten £1.6871 immediately after the print; however, subsequent profit-taking on GBP longs has managed to push the currency back by 50 cents. Many do expect the BoE’s Monetary Policy Committee (MPC) to act next month by tightening lending criteria — expect June 26 to have the market’s full attention for those revelations. A rate hike is still being priced in for the second quarter of 2015, but the focus for the interim remains on “macro-prudential measures as opposed to rate hikes.”
Do not be surprised to see some cautious buying ahead of the release of tomorrow’s MPC minutes. The minutes will provide a better indication of the spectrum of views within the MPC as “to spare capacity and the size of the minority supporting earlier tightening.”
Will The BoE Show Dissent? 
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