Short Squeeze Lifts Euro, While Falling Yields Weigh On Dollar

The key driver of the global capital market is the heightened geopolitical risks ahead of the weekend.  These now include the US air strikes in Iraq, as well as a sense that the situation in the Ukraine is reaching an inflection point.  Putin needs to step up his support for the insurgents in east Ukraine in some fashion, or risk losing that insurgency effort. 

The rally in debt market has pushed S 10-year yield  to new lows since June 2013 (just below 2.35%) and sent bund yields to new record lows (just above 1.0%).  Equity markets, which we have been highlighting as exceptionally vulnerable from a technical point of view are ending the week on a poor note.  The Nikkei shed almost 3% to two-month lows.   

The MSCI Asia Pacific index was off nearly 1.3%, with only Chinese markets managing to buck the regional move. European bourses are faring only slightly better, with the Dow Jones Stoxx 600 off a little more than 1%.   Losses are led by the telecoms and health care sectors, but all sectors are lower.  After closing at its lowest level since late May yesterday, the S&P 500 may gap lower today.  The 1894.50 area is a retracement level of the rally since the February lows.  Below there, the next retracement target is a little below 1865. 

The dollar-yen rate had been unexpectedly resilient in the face of US equity market losses and the decline in US Treasury yields.  However, it finally succumbed to the pressure and fell to JPY101.50, the lowest level since July 25.  The price action reinforces the JPY101.00-JPY103.00 trading range that has largely confined prices for four months.  

The yen’s gains come despite the BOJ cutting its assessment of exports and industrial output at its policy making meeting in which no new initiatives were taken.  BOJ’s Kuroda continues to sound optimistic and confident that the impact of the retail sales tax is fading and the growth and inflation will return to higher paths.  Many participants are less sanguine, suspecting new efforts will have to be made to achieve the higher inflation goals.  Separately, Japan reported its first current account deficit in five months as the investment income balance did not fully offset the trade deficit.  Next week Japan reports its first estimate of Q2 GDP.  A contraction of around 7.0% annualized is expected.