Catching a falling knife

May 21, 2013 — Mitul Kotecha

USD/JPY’s pull back is proving short lived as Japanese Economy Minister Amari attempted to backtrack from his earlier comments that warned about the negative impact of a weaker JPY on “people’s lives”. His comments today suggest that Japan’s stance on a weaker JPY has not changed.

Nonetheless, there may be some consolidation in the near term as likely inaction from the Bank of Japan at it policy meeting this week will mean no new stimulus. While no policy change ought to be unsurprising given recent aggressive actions it appears that the market has become addicted to stimulus.

In any case US Treasury yields will need to be eyed for further USD/JPY direction, with a break of the psychologically important 2% level in the 10 year Treasury a likely trigger for a further up move in the currency pair.

GBP has held up well on the crosses while like many other currencies has faced a resurgent USD. Little impact on GBP is expected from today’s April CPI inflation data especially given that any expected decline is set to prove temporary (Bloomberg consensus 2.6% YoY).

More importantly a likely more optimistic set of Bank of England MPC minutes on Wednesday and rebound in April UK April retail sales on Thursday will provide GBP will further support although we suggest looking for any upside on the crosses rather than versus USD.

Is it time to buy AUD? While I don’t want to be accused of catching a falling knife AUD looks reasonably good value especially against other commodity currencies, especially NZD and CAD. While there have been plenty of negative factors pressuring the currency including prospects for more RBA rate cuts, weaker commodity prices, and softer domestic and Chinese data, much of this is in the price.

My AUD/USD quantitative model estimate based shows that it is oversold relative to its short term fair value estimate. Moreover, speculative positioning according to the CFTC IMM data has turned negative for the first time in almost a year. The RBA May meeting minutes (the meeting during the RBA surprisingly cut its cash rate to 2.75) reelased today did not change this perspective given that markets have already priced in one more rate cut in the cycle.

Asian currencies will likely continue to retrace some of their recent losses in the near term. However, domestic factors and growth worries will provide an importance influence, with the IDR for instance failing to benefit from any USD pull back as the government continues to wrestle with a fuel subsidy cut. Meanwhile, weaker than expected growth in Thailand in Q1 2013 cast a shadow over many Asian currencies as concerns of a wider growth slowdown in Asian intensify.

Posted in Asian currencies, Australia, Bank of England, Bank of Japan. Tags: , , , , , , . Leave a Comment »

Not so straightforward

May 20, 2013 — Mitul Kotecha

To casual observers the global market picture look very good, reflective of an improving growth and earnings story; risk assets continue to rally as central banks keep the liquidity taps open. In reality the picture is not as black and white as the US economy appears to be doing better than most other major economies despite the impact of the sequester and tax hikes while other economies are in differing states of health.

Japan’s turbo charged stimulus measures have helped contribute to a solid GDP growth outcome in the first quarter and to the rally in risk assets but much needs to be done in terms of reforms. Indeed, the jury is still out whether growth recovery can be sustained (just look back at the growth spurts and subsequent declines following past stimulus).

Europe remains in the doldrums as the impact of austerity weighs heavily, with even the core economies facing growing economic pressures. It’s no wonder that the anti austerity backlash continues to grow. While Eurozone data this week may look a little perkier than usual, with gains in the May purchasing managers’ confidence indices and the German IFO business climate confidence survey (both good forward looking indicators) likely, the overall picture will remain one of contraction. All of this will be unhelpful for the EUR which looks set to test its year low around 1.2745 versus USD.

US outperformance is fuelling a rise in US bond yields and consequently a stronger USD as expectations that the Fed will want to taper off asset purchases sooner rather than later grows. Fed Chairman Bernanke’s testimony this week will therefore be closely regarded as clues are sought However, he is unlikely to suggest that the Fed is verging on any reduction in asset purchases. Although US data was mixed last week the recovery theme will continue this week, with housing data and durable goods orders set to record gains.

In Japan the highlight of the week is the Bank of Japan policy meeting. Given the aggressiveness of recent measures expect a pause from the central bank at this meeting although the JPY will remain under pressure as the US / Japan yield differential continues to widen in favour of the USD. Nonetheless, comments by Japan’s Economy Minister Amari emphasising the negative impact of a weaker JPY may help to slow the pace of JPY decline.

The general strength in the USD has contributed to growing pressure on many Asian currencies. Only the THB, CNY and MYR have recorded gains this year. Other currencies including the KRW, TWD, and SGD have been particularly vulnerable to a weaker JPY. A slower pace of JPY decline will help these currencies although the prospects of further monetary easing and regional tensions will dampen any upside in the short term.

Posted in Asian currencies, Bank of Japan, Federal Reserve. Tags: , , , , , , . Leave a Comment »

Risk assets rallying on trust and hope

May 16, 2013 — Mitul Kotecha

The rally in risk assets continues unabated, with equity markets continuing to post record highs. The fact that this is occurring in spite of weaker data from both the US and in particular Europe, highlights the trust and hope that is being placed on central banks to continue to deliver monetary stimulus in the months ahead. While many will question the dichotomy between equity markets, bond yields and economic data, there is little sign of this changing any time soon.

Spurred by a rise in US Treasury bond yields which in turn has been fuelled by better than expected US economic data the USD index has been driven higher. Disappointing data overnight in the form of the May Empire manufacturing survey, US Treasury TIC capital flows, and April industrial production led to a pull back in US bond yields.

Going forward much in terms of USD direction will depend on upcoming data and Federal Reserve speeches, with a relatively full calendar today including April CPI, housing starts and the May Philly Fed manufacturing confidence survey. Additionally there are no less than five Fed speakers on tap today, with any clues on a tapering off of asset purchases sought. The USD index is set to test its 2012 high of 84.10 but is likely to consolidate in the near term given the pull back in yields.

EUR continues to remain under pressure as it edges towards its 2013 lows around 1.2745, with a test of this level expected soon. Weaker than expected Q1 GDP readings from France, Germany, Italy and the over Eurozone dampened any ability of the currency to reverse losses.

The Eurozone has registered six straight quarters of contraction and any recovery is likely to be limited in the months ahead. Pressure on the European Central Bank to provide more monetary policy accommodation will only be reinforced by today’s release of the April CPI data (likely to be confirmed at 1.2%) leaving the EUR under further pressure. Near term technical support for EUR/USD is seen around 1.2772.

The JPY is facing a perfect storm of negative factors including a widening in US Treasury / Japanese JGB yield differentials, improving risk appetite and portfolio capital outflows from Japan. I expect capital outflows from Japan to intensify. Japanese life insurers have accounted for more than 20% of the net foreign securities purchases since 2011, and recent indications show that they are planning to increase their foreign bond buying.

Additionally the Japanese Government Pension Investment Fund has already begun to increase its proportion of foreign asset holdings. Portfolio data released this morning revealed that Japanese investors continued to channel money overseas. Near term resistance for USD/JPY is seen around 103.50.

Posted in Bank of Japan, ECB, Economics, Federal Reserve. Tags: , , , . Leave a Comment »

US dollar surges through key levels

May 13, 2013 — Mitul Kotecha

Demand for risky assets continues to strengthen as reflected in various indicators including my Risk Aversion Barometer which has moved deeper into risk loving territory while equities remain on an upward trajectory. Central banks are providing the main source of support for investor risk appetite, with a combination of lower policy rates and quantitative easing providing a major fillip.

Additionally various central banks appear to be talking down their currencies and/or intervening (note RBNZ and Riksbank) adding to the downward pressure versus USD. In Japan’s case the G7 appeared to give its blessing to Japanese policy over the weekend, aiding in the decline in the JPY.

Usually the USD would not benefit in times of improving risk appetite but it is finding plenty of support from the fact that Fed policy is set to diverge with other central banks, with the currency breaking key levels against major currencies including EUR (below 1.30), JPY (above 100) and AUD (below 1.00). The surge in US Treasury yields is underpinning the USD helped by firmer US economic data in particular on the jobs front.

According to a Wall Street Journal article over the weekend the Fed is already formulating an exit strategy from QE although the timing is still being debated, another factor supporting the USD at the beginning of this week. Various Fed speeches over coming days will likely provide more clues on any timing or plans for an exit policy. Meanwhile, higher US yields and a firmer USD continue to pile on the pressure on gold prices.

There may be a little caution in pushing the USD higher this week as US data releases are likely to look softer, with retail sales, industrial production and housing starts set to record declines. Nonetheless, any pull back in the USD or yields may simply provide better levels for investors to go long the USD and short Treasuries especially as data elsewhere will not look much better. Indeed, while in Europe there will be a likely bounce in the German ZEW investor confidence index in May, Q1 Eurozone GDP will record a contraction for the sixth consecutive quarter.

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Taking the wind out of the EUR, JPY watching the flow, AUD watching RBA

May 7, 2013 — Mitul Kotecha

Market activity was limited yesterday due to holidays in the UK and Japan but will pick up today as both markets reopen. The positive reverberations from the US April jobs report continue to provide a fillip to markets but the impact is already fading.

Once again risk assets are relying on central banks to provide the steroids for further support. In this respect it was the turn of European Central Bank President Draghi to take up the baton yesterday as he noted that further interest rate cuts are possible. Today’s data slate is thin, with the Reserve Bank of Australia policy decision and German March factory orders the main highlights.

ECB President Draghi took the wind out of the EUR’s sails as he highlighted the possibility of further policy easing. Also helping to keep the EUR under pressure was the rise in US Treasury yields; the 10 year yield differential with bunds has widened to close to 52 bps, which due to the strong correlation with EUR/USD is likely to cap any gains in the currency pair.

As Draghi noted prospects for further easing will be highly data dependent which in turn means that the EUR will be more data sensitive in the weeks ahead. The prospects of negative deposit rates in particular will continue to send shivers down the spines of EUR bulls. Look for EUR/USD to be capped around 1.3168.

As Japan returns from holiday USD/JPY is verging once again on a test of psychologically important 100 level. The trigger for the renewed bounce in USD/JPY was a jump in US bond yields following the better than expected US jobs report. In the absence of major US data releases this week Fed speakers including Chairman Bernanke will give further direction to bonds and in turn USD/JPY.

A further widening in the US yield advantage over Japan will be required to push USD/JPY higher especially as recent flow data have shown both Japanese investor repatriation and net foreign buying of Japanese portfolio assets. Despite these inflows we expect a break of 100 to occur very soon, with appetite for foreign assets from Japanese lifers and government pension fund, providing much of the ammunition for a sustained move higher.

AUD has started the week badly having suffered in the wake of the weaker than expected Chinese service sector confidence data and the surprise drop in Australian retail sales in March. Reports that the Australian Treasury will lower growth forecasts for the next two years in part due to AUD strength does not bode well for the currency either.

The data has emboldened doves looking for a policy rate cut from the RBA today and while the decision is a very close call as reflected in market pricing and consensus expectations, the balance of risks suggests that the RBA will hold off this month. This may however, come as scant relief for AUD as markets will likely push back easing expectations to the next meeting on 4 June.

Nonetheless, downside for AUD is likely to be limited, with speculative positioning already at a relatively low level. Strong support for AUD/USD is likely around the 4 March low at 1.0115.

Posted in Australia, ECB, Japan. Tags: , , , , . Leave a Comment »
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