AUD/JPY a sell on rallies and COVID-19 optimistic positioning in markets

• The COVID-19 risk is a fluid situation and markets hate uncertainty, hence the bid in the yen.
• AUD/JPY gains could well be shortlived and sell-on rallies.

We have a balanced risk profile and scenarios in play as the week progresses. Global yields are slightly lower, stocks have been perky in their opens, risk FX is accumulating a bid, (The yen was the biggest G10 long as of 24 March), an unwind of the US dollar due to strategic liquidity campaigns by a uniformed global central bank movement is rolling out and the commodity complex is looking to stablise.

As a result, AUD/JPY is hanging in the balance of an economic crisis and what could be the beginnings of an ebb in the pace of contagion of COVID-19 in Italy and other European hotspots. At the time of writing, AUD/JPY is trading at 65.70, down 1.22% having travelled from a high of 67.27 to a low of 65.58 as the market takes the Chinese manufacturing and non-manufacturing PMIs rebound with a pinch of salt. 

Risk appetite was stronger after a higher the expected Chinese manufacturing PMI report and signs the pace of contagion may be slowing. European equities started out in the green while Asian equity benchmarks closed mixed. US stocks are sturdy albeit slight down in a lower volatility environment with the VIX - 5% in a topping formation on the medium-term charts which should take some sting out of the FX volatility as well, bullish/neutral for AUD/JPY.

However, as analysts at TD Securities explained, "global equities have seen sharp declines and portfolio rebalancing flows will certainly be necessary. These may be more concentrated within and across asset classes, however, rather than expressed entirely as one-sided FX moves."

There has been a pent up anticipation for the Chinese economic result since having returned back to business, (albeit not quite as usual), and yesterday's data came as follows:

• China's manufacturing PMI strengthened to 52.0 in March from 35.7 in February, the strongest reading since September 2017 and higher than consensus (44.8).
• major bounce back in output to 54.1, its highest since May 18.
• New orders also bounced back to 52.0, its highest since September 18.
• Incredibly, manufacturing employment rose to its strongest since April 2012 and was the first time its been in expansion since March 17.
• Input prices. New export orders and imports recorded gains, but both remained in contraction.

"Clearly a much better than expected reading overall, which corresponds with recent official optimism about recovery," analysts at  TDS explained but warned, "gains are not likely to last."

Trade with major economies is likely to drop off a cliff as G10 economies shut up shop. Without a demand side pull, its hard to see how China's supply side opening can be sufficient to sustain manufacturing growth. Markets are likely to react positively to the data in the near term while officials will likely take this data as further reason not to ramp up stimulus. Separately the March non-manufacturing PMI recorded an even bigger jump to 52.3 from 29.6.

Overall, we can expect short term gains in the cross to be shortlived as the situation remains fluid and markets hate uncertainty. The JPY has room to appreciate in the near future as speculators continue to increase their long JPY bets ahead of the looming global recession.

AUD/JPY levels