DOLLAR-YEN PAIR BENEFITS FROM US RECOVERY THEME AS OIL CASTS ITS SHADOW
DESPITE the generally positive tone of recent global economic data, analysts remain concerned about the prospect of sustained growth in 2012. At the moment, their chief source of worry is the surging price of oil. In the US, West Texas Intermediate has risen to nearly $110 a barrel, while in Europe the price of Brent is now trading above $125 a barrel.
On the one hand, the spike in crude can be viewed as a reflection of better economic conditions across the G20, specifically stronger than expected demand from China, which continues to be the marginal buyer on the global stage. On the other hand, the rapid rise in oil prices threatens to snuff out the nascent US economic recovery if gasoline price rises curb consumer spending during the key summer driving season.
The sudden rise in crude prices is a function of several unrelated factors. Geopolitical tensions in Iran have no doubt added some risk premium to the price of oil.
However, the primary factor is more a function of strong demand from Asia. Last year, Chinese consumers bought 2.1m SUVs, up 25.3 per cent from 2010 and representing 11.6 per cent of light vehicle sales, according to J.D. Power and LMC Automotive. That is about half of the 4.1m SUVs sold in the United States, where SUVs were 32 per cent of the light vehicle market.
Much like their US counterparts, Chinese consumers like the safety, luxury and durability of the SUV. If this trend persists it will likely add further upward pressure to the price of oil as more of these gas guzzling SUVs hit the Chinese roads.
Gas prices in the US have now hit $3.65 per gallon. While this is not yet a prohibitive cost for the US consumer, analysts worry that prices could continue to rise to $4.00 per gallon as the summer driving season approaches. At $4.00 per gallon, the substitution effect is likely to kick in as US consumers begin to curtail spending in order to pay for fuel costs – a non-discretionary good for many. This chain of events could cast a pall over the US economic recovery and threaten global growth as the year proceeds.
In the FX market, the biggest beneficiary of the US recovery theme has been dollar-yen which yesterday hit a fresh yearly high of ¥81.70. The pair has not been above the ¥81.00 figure since July 2011 and has just recently broke above its 4.5 year downtrend.
This rally in dollar-yen has been driven by speculation that the Federal Reserve will no longer provide monetary stimulus in the form of QE3 as the US recovery generates sustainable growth. However, the breakout in dollar-yen could quickly falter if currency traders begin to fear another Federal Reserve policy action as the US economy slows. That’s why dollar-yen may be the most oil-sensitive pair in FX at the present time.
With little material US economic data until next week’s non-farm payrolls, oil prices rather than economic releases could be the key to the pair’s direction this week. As long as dollar-yen can hold support above the ¥79.20 level, its uptrend remains intact and it may make a run towards the ¥82.00 figure as the week proceeds. However, if the pair breaks down below the ¥79.20 level, it could signal yet another false dawn for the beleaguered dollar-yen shorts as the long term downtrend remains in place.