Global Themes

February 11, 2011 — Mitul Kotecha

It’s definitely been a strange start to the year, with markets taking plenty of time to get their bearings. Some general themes have developed but none have provided clear direction. As a result, the path over coming weeks and months is likely to remain highly volatile and in this respect, currencies, equities and bonds will continue to see strong gyrations.

One theme that has been evident since the start of the year is an improvement in sentiment towards the eurozone periphery as hopes of an enlargement/extension of the European Union bailout fund (EFSF) have increased. This is a key reason why the EUR has strengthened this year although nervousness on this front appears to have returned over recent days (note the recent widening in peripheral bond spreads, drop in EUR and European Central Bank purchases of Portuguese debt). It seems that a lot of good news has already been discounted in relation to the eurozone periphery and now markets are in wait and see mode for the EU Council meeting on 24/25 March. There is a strong chance that eventually market expectations will prove overly optimistic and the EUR will drop but more on that later.

The second theme is global inflation concerns, driven by higher food and energy prices. Certainly this has had an impact on interest rate expectations and in some cases resulted in a hawkish shift in central bank language, notably in the eurozone and UK. Although European Central Bank (ECB) President Trichet has toned down his comments on tighter monetary policy compared to the more hawkish rhetoric following the last ECB council meeting, expectations for monetary tightening in the eurozone still look overly hawkish, with a policy rate hike currently being priced in for August/September this year, which looks way too early. The EUR has benefitted from the relative tightening in eurozone interest rate expectations compare to the US but will suffer if and when such expectations are wound down.

Elsewhere in many emerging markets the impact of higher food prices is finding its way even more quickly into higher inflation, forcing central banks to tighten policy. In Asia, the urgency for higher rates is even more significant given that real interest rates (taking into account inflation) are negative in many countries. China has accelerated the pace of its rate hikes over recent months and looks set to continue to tighten policy much further to combat inflation. In India, worries about inflation and the need for further monetary tightening have clearly weighed on equity markets, with more pain to come. Although not the sole cause by any means, in the Middle East and Africa higher food prices are feeding social tensions such as in Egypt.

Another clear theme that has developed is the improvement in US economic conditions. The run of US data over recent months has been encouraging, confirming that the economy is gaining momentum. Even the disappointing January non-farm payrolls report has not dashed hopes of recovery, with many other job market indicators pointing to strengthening job conditions such as the declining trend in weekly US jobless claims. Manufacturing, business and consumer confidence measures have strengthened whilst credit conditions are easing, albeit gradually. The US economy is set to outperform many other major economies this year, especially the eurozone, which will be beset with a diverging growth outlook between northern and southern Europe.

Although the US dollar has not yet benefitted from stronger US growth given the still dovish tone of the Fed and ongoing asset purchases in the form of quantitative easing, the rise in US bond yields relative to other countries, will likely propel the dollar higher over 2011 after a rocky start over Q1 2011. In contrast, the EUR at current levels looks too strong and as noted above, hopes of a resolution of eurozone peripheral problems look overdone. EUR/USD levels above 1.3500 provide attractive levels to short the currency. Other growth currencies that will likely continue to do well are commodity currencies such as AUD, NZD and CAD, whilst the outlook for Asian currencies remains positive even despite recent large scale capital outflows. The JPY however, will be one currency that suffers from an adverse yield differential with the US as US bond yields rise relative to Japan.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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China Hikes Rates, More On the Cards

February 9, 2011 — Mitul Kotecha

In an otherwise unexciting day China livened things up by raising its 1 year deposit and lending rates by 25 basis points. The hike, the third in the last four months, should not have come as a surprise, given the growing emphasis by China’s central bank PBoC, to dampen inflation pressures. Indeed, more hikes are on the cards, with at least another two more in prospect over H1. The other tool to combat inflation is CNY appreciation further gains in the currency over coming months should be expected to around 6.3 by year-end versus USD.

Global markets largely shrugged of China’s move, with generally positive market sentiment continuing. Even in the eurozone, where there was some disappointment at the surprise drop in German December industrial production, market sentiment continued to improve as Egypt and local debt worries eased further. EUR was particularly resilient despite calls from a Belgian think tank that Greece needs to restructure its debt to avoid a long and painful path ahead. Commodity currencies also showed impressive resilience to China’s rate hike, with both the AUD and NZD holding up well.

The overall positive risk background is supportive for Asian currencies and other risk trades. Currencies in Asia remain highly correlated with portfolio capital inflows and so far this year the weakness in the INR and THB has matched the strong equity outflows from India and Thailand. However, this appears to be reversing, especially in the case of India registering positive equity flows this month, helping the INR to reverse some of its losses.

In the absence of key data releases markets will turn their attention to the testimony by Fed Chairman Bernanke to the House budget committee where he will give comments on the economy, jobs and the budget. Dallas Fed’s Fisher stated overnight that whilst he expects the Fed to complete QE2 he would not support another round of quantitative easing. Fisher’s comments on QE were similar to Atlanta Fed’s Lockhart who notes there is a “high bar” for more QE. Bernanke is unlikely to deviate from this tone in his speech today whilst also maintaining his view that there should be a long term commitment to fiscal retrenchment.

Against the background of improving risk appetite the USD is likely to stay under mild pressure although it is difficult to see a break of recent ranges for most currency pairs. EUR/USD ought to find strong support around its 100-day moving average 1.3535 whilst USD/JPY will be supported around 81.10. Equity sentiment is being supported by US data which remains encouraging. On cue the NFIB Small Business Optimism index duly rose in January to 94.1 as sentiment in this sector continued its improving trend.

Taken together with firmer equities, encouraging data is taking its toll on US bond markets, resulting in a back up in yields. Bond market sentiment wasn’t helped by a relatively poor 3-year auction. For example, US 2-year bond yields have backed up by over 30bps since 28 January. Bad news for bond is good news for the USD however, as higher relative US bond yields will likely help prevent a deeper USD sell-off, with EUR/USD in particular most reactive to relative eurozone / US bond yield differentials.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

Posted in Asia, Australia, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Greece, India, Interest rates, Japan, Monetary Policy, South Korea, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Asian Currency Differentiation

January 25, 2011 — Mitul Kotecha

Asian currencies have started the year in mixed form, but it would be wrong to generalize the performance of Asian currencies as weak. There have been marginal gains recorded year to date vs. USD in the KRW, TWD, MYR and SGD, reflecting strong capital equity inflows. This contrasts with losses in the IDR, INR, PHP and THB versus USD. Compared to the beginning of 2010 equity capital flows have been far weaker overall, with India, Indonesia, Philippines and Thailand, recording outflows, matching the performance of their currencies.

Clearly investors are discriminating more at the turn of 2011. For example Taiwan has recorded solid equity inflows over recent weeks (over $2 billion year-to-date), matching the strength of inflows registered at the beginning of 2010. It appears that Taiwan stocks have started the year as the Asian favorite, helped by growing expectations of further door opening to mainland investment and tourism. Korean equities have also registered inflows helping to support the KRW, which looks to be good buy over the short term above 1120.

This contrast with outflows registered in other Asian equity markets. A major concern responsible for some of the weakness in capital flows to Asia is the threat of inflation. For example, the selling of stocks in India appears to be closely related to inflation concerns and the hawkish rhetoric of the Reserve Bank of India, which is continuing its tightening path this year. Similarly, the PHP may be vulnerable over the short term following a failed T-bill auction on Monday. Inflation worries have clearly led to a push for higher yields but the bids were labeled as “unreasonable” by the government.

Over coming weeks, further EUR strength will likely give Asian currencies more support as the USD succumbs to further pressure. Continued strengthening in the CNY will also support other Asian currencies given that the CNY fixing has reached its highest level since the July 2005 revaluation.

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Currencies At Pivotal Levels

November 3, 2010 — Mitul Kotecha

Ahead of today’s highly anticipated Fed FOMC meeting markets are holding their breath to determine exactly what the Fed will deliver. The consensus view is for the Fed to announce a programme of $500 billion in asset purchases spread over a period of 6-months. The reaction in currency markets will depend on the risks around this figure. Should the Fed deliver a bigger outcome, say in the region of $1 trillion or above, the US dollar will likely come under renewed pressure. However, a more cautious amount of asset purchases will be US dollar positive.

It has to be noted that the Fed will likely keep its options open and keep the program open ended depending on the evolution of economic data which it will use to calibrate its asset purchases. The USD will likely trade with a soft tone ahead of the Fed outcome, but with so much in the price, it may be wise to be wary of a sell on rumour, buy on fact outcome.

Whatever the outcome many currencies are at pivotal levels against the USD at present, with AUD/USD flirting around parity following yesterday’s surprise Australian rate hike, EUR/USD holding above 1.4000, GBP/USD resuming gains above 1.600 despite a knock back from weaker than forecast construction data, whilst USD/JPY continues to edge towards 80.00. Also, both AUD and CAD are trading close to parity with the USD. The Fed decision will be instrumental in determining whether the USD continues to remain on the weaker side of these important levels.

Going into the FOMC meeting the USD has remained under pressure especially against Asian currencies as noted by the renewed appreciation in the ADXY (a weighted index of Asian currencies) against the USD this week. Although it appears that the central banks in Asia have the green light to intervene at will following the recent G20 meeting the strength of capital inflows into the region is proving to be a growing headache for policy makers. One option is implementing measures to restrict “hot money” inflows but so far no central bank in the region has shown a willingness to implement measures that are deemed as particularly aggressive.

There has been some concern that Asia’s export momentum was beginning to fade as revealed in September exports and purchasing managers index (PMI) data in the region and this in turn could have acted as a disincentive to inflows of capital, resulting in renewed Asian currency weakness. The jury is still out on this front but its worth noting that Korean exports in October reversed a large part of the decline seen over previous months. Moreover, the export orders component of Korea’s PMI remained firm suggesting that exports will resume their recovery.

Nonetheless, manufacturing PMIs have registered some decline in October in much of Asia suggesting some loss of momentum, with weaker US and European growth likely to impact negatively. However, China’s robust PMI, suggests that this source of support for Asian trade will remain solid. Similarly a rise in India’s manufacturing PMI in October driven largely by domestic demand, highlights the resilience of its economy although with inflation peaking its unlikely that the Reserve Bank of India (RBI) will follow its rate hike on Tuesday with further tightening too quickly.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Federal Reserve, FX, India, Interest rates, Monetary Policy, South Korea, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Resisting Asian FX Appreciation

September 7, 2010 — Mitul Kotecha

The upward momentum in Asian currencies has continued unabated over recent weeks the gyrations in risk appetite. Most Asian currencies have registered gains against the USD over 2010 with the notable exception of one of last year’s star performers, KRW which after gaining by close to 9% last year has weakened slightly this year. Last year’s best performer the IDR which raked in close to 20% gains over 2009 versus USD has continued to strengthen this year, albeit to a smaller degree. Another currency that has extended gains this year has been the THB, which is on track to beat last year’s 4% appreciation against the USD.

The strength in Asian currencies has in part reflected robust inflows into Asian equity markets. For example Indonesia has been the recipient of around $1.7 billion in equity inflows so far this year. However, India and Korea have registered even larger inflows into their respective equity markets, at around $13 billion and $7.7, respectively, yet both the INR and KRW have underperformed other Asian currencies. The explanation for this is largely due to deteriorating current account positions in both countries. Further deterioration is likely.

The fact that equity flows have had only a small impact on the INR and KRW is reflected in their low correlations with their respective equity market performance. For most other Asian currencies the correlation with equity performance has been quite high, with the THB and MYR having the strongest correlations with their respective equity market indices over the past 3-months although the SGD, PHP and IDR have also maintained statistically significant correlations.

Clearly, for many but not all Asian currencies equity market gyrations are important drivers but at a time when growth is slowing more than many had expected in the US and governments in the eurozone are implementing austerity measures which will likely result in slowing growth and a worsening trade picture in the region, central banks in Asia will become increasingly wary of allowing their currencies from strengthening too quickly.

Increasingly Asian currency strength is being met with intervention by central banks in the region buying USDs against a host of Asian currencies. Over recent weeks this intervention appears to have become more aggressive. Nonetheless, any FX intervention led weakness in Asian FX is likely to prove short lived, with renewed appreciation likely over the coming months unless risk aversion increases dramatically. In other words a drop in Asian currencies will provide better opportunities to go long.

The CNY will play an important role on the pace and pattern of Asian currency movements. Investors in the region will also have one eye on developments on the visit of US National Economic Council director Larry Summers to Beijing. The CNY has firmed over recent days but this appears to be the usual pattern when a senior US official is in town and ahead of a G20 meeting. The fact is however, that the lack of CNY appreciation since the June CNY de-pegging remains a highly sensitive issue.

China is unlikely to yield to US pressure and is set to continue to act at its own pace and comments from officials in China over the past couple of days suggest no shift in FX stance. Although the CNY has not appreciated by as much as many had hoped for or expected since the June de-pegging the path is likely to be upwards, albeit at a gradual pace. For Asian currencies a slow pace of CNY appreciation implies further reluctance to allow a fast pace of appreciation so expect plenty of FX intervention in the weeks and months ahead.

Posted in Asia, Bond markets, central banks, China, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, India, Interest rates, Monetary Policy, Singapore, South Korea, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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