Two other devaluations are much more important than GBP’s
In the wake of the UK’s vote to leave the EU, which set GBP crashing to record lows, two even more important devaluations also occurred with potentially far greater consequences for forex markets.
Under the cover of all the noise surrounding Brexit, China allowed CNY to fall and according to a Reuters report the People’s Bank of China is willing for it to weaken further to USD/CNY 6.80. It closed on Friday at around 1.6550. The news immediately had a negative knock on effect on AUD.
The other ‘devaluation’ is that of the EUR with Brexit likely to hurt European economic growth and highlights the increasing risk that the Eurozone will break up in the face of populist anti-EU movements in a number of its key member states.
The big winners from these moves have been JPY and USD – though exchange rates did stabilise last week. Chances are with the European continent in the grips of political uncertainty, USD and JPY could well start appreciating again – particularly against GBP with the UK’s worryingly huge current account deficit of 6.9% of GDP in Q1, compared with 7.2% in Q4 2015. It’s also unclear if weaker GBP will help exports much – it hasn’t done a great deal in the past, suggesting the massive current account deficit could linger at very high levels or even increase due to higher import prices.
All this makes GBP the more vulnerable of the two as the Bank of England very clearly signalled a rate cut or even a return to quantitative easing. The European Central Bank, no doubt also cognizant of maintaining confidence in the EUR, dismissed calls to add to its existing stimulus programme. However, if the world is slipping towards a global slowdown it could revise that stance in the months ahead.
If European currencies, particularly the EUR, sink lower then pressure will build on the Bank of Japan to curb the strength of JPY – and it could argue that it has special circumstances in which to do so. A softening CNY will certainly add to the pressure and on the other Asian currencies if it really does slide to USD/CNY 6.80.
It’s highly likely that stories of currency wars will resurface in the media if EUR and CNY continue to weaken in the months ahead and central banks will become even more activist spelling volatile and choppy markets.
TECHNICAL ANALYSIS: EUR/JPY – Trade AUD/JPY on CNY devaluation
As the major safe haven currency of choice JPY is a good counterpart when trading against currencies tied to political and economic uncertainty, such as GBP and EUR. Another ‘at risk’ currency could be AUD following news that China appears to be guiding CNY lower. AUD is often seen as a trading proxy to CNY given the importance of China as a trading partner for AUD.
With some recovery in risk assets last week and talk of further accommodation from central banks should be supportive for risk currencies, such as AUD. Nonetheless, it looks as if markets have entered a period of sustained volatility and uncertainty and the likelihood is that this will not help AUD or demand for commodities.
Therefore, the recovery of AUD/JPY could be relatively short lived. The recovery could go a bit further taking it past the middle Bollinger band if not touch the upper one – after which it could start weakening again. Indeed, AUD/JPY has been weakening since mid-November 2014 when it topped out at levels of around 101.00.
Those downwards moves have been punctuated by quite strong counter-rallies of JPY 5-6 in magnitude and lasting up to two months. Though such a counter rally could be due soon, the long-term trend remains downwards. Much will depend on CNY and global risk appetites as the debacle over the UK’s separation from the EU plays out.
Support is seen at 74.71, 72.56 and resistance at 77.75, 78.15 and 80.22
By Justin Pugsley, Markets Analyst MahiFX