Germany feeling the pressure

June 14, 2012 — Mitul Kotecha

Stocks fell back into negative territory following yet more soft US economic data. The 0.4% drop in US retail sales ex-autos was particularly disappointing, once again raising expectations that the Fed may need to deliver another round of quantitative easing. The rally in gold prices overnight was in part related to such expectations. Continued pressure on peripheral Eurozone debt reflects another angle of market pressure, not helped by the downgrading of Spain’s credit ratings by Moodys which effectively highlighted that Spain’s call for external help was a sign of weakness.

A further test of sentiment will be in the form of Italian bond auctions today. Perhaps more worrying is the sell off in German debt over recent sessions, indicating that investors are finally realising that Germany will not be spared from a “Grexit”. Whether this prompts Mrs Merkel into some form of action to help stem the crisis is another question entirely. Ahead of Greek elections on June 17 markets will enter into a state of limbo but the bias remains for elevated risk aversion.

FX markets are similarly rangebound, with the USD capped by hopes/expectations of more Fed QE and the EUR capped by peripheral Eurozone tensions. As a result EUR/USD has struggled to sustain break above resistance around 1.2624 and will continue to fail to the topside given the uncertainty around the Greek elections on June 17th. Bad news in the form of the Spanish debt downgrade and peripheral debt pressures, suggest that the EUR will remain under pressure over coming sessions, making it increasingly difficult to hold above the psychologically important 1.25 level.

The main focus today will be on the Swiss National Bank policy decision. While no policy action is expected attention will focus on the SNB’s stance on its 1.20 EUR/CHF floor. Upward pressure on the CHF has intensified over recent weeks as the situation in the Eurozone has worsened, and latest reserves data highlighted a big jump in reserves during May as the SNB had to buy EUR against the CHF. A shift in the EUR/CHF floor looks unlikely but the recent upward pressure on CHF could pale into insignificant compared to any upward pressure following a Greek Euro exit.

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EUR jumps on Spanish news, but Greek risks ahead

June 11, 2012 — Mitul Kotecha

Spain’s request for a EUR 100 billion bailout for its banks has significantly shifted the bias for markets this week, with risk assets buoyed and safe haven assets pressured. The fact that Spain will receive a bailout ‘light’ in terms of the conditions of the loan, will also have come as good news as the stringent measures associated with bailouts of Greece, Portugal and Ireland, will be avoided. Taken together with mixed (but less bad than feared) Chinese data over the weekend, the scene is set for markets to rally early in the week.

However, plenty of event risk remains, not least of which is the outcome of Greek elections at the weekend and results of French parliamentary elections today, which could easily reverse the positive mood of markets.

The USD has continued to head lower a trend that has been established since the end of May, with its drop set to accelerate at the start of the week following news of Spain’s banking bailout and the subsequent bounce in risk assets.

Although Fed Chairman Bernanke provided some relief for the USD last week by not indicating a desire to embark on fresh quantitative easing, the reality is that US data has been disappointing of late, keeping the door open to such action, restaining the USD.

More damaging to the USD is the bounce in risk appetite even before the Spanish news. Softer US data this expected week including likely sluggish May retail sales, a small increase in industrial production and lower manufacturing and consumer confidence surveys, will keep the debate on QE firmly open, leaving the USD struggling in the days ahead.

EUR/USD lurched higher following Spain banking bailout request. However, the sum of EUR 100 billion is far higher than the EUR 40 billion anticipated and could add around 20% to Spain’s sovereign debt. While the size of the package is significant it is also worrying, a fact that could come back and haunt the EUR.

Undoubtedly the upside in EUR is being helped by the fact that speculative positioning reached a fresh record low last week (according to the CFTC IMM data) leaving plenty of scope for short covering. In the near term EUR/USD will remain buoyed but any gains will be restricted to technical resistance around the EUR/USD 1.2690 level where sellers will emerge, especially given uncertainty surrounding the outcome of Greek elections.

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Risk assets rally, AUD jumps on strong jobs data

June 7, 2012 — Mitul Kotecha

Risk assets rallied hard overnight overcoming, albeit temporarily, fears of a Eurozone calamity. The boost to markets appeared to come from hopes of stimulus on many fronts. Although the European Central Bank (ECB) did not cut policy interest rates President Draghi did note that he ‘stands ready to act’ if needed. This implies that rates cuts are in the pipeline very soon but any more action will require European politicians to act first. Following the G7 conference call there is also speculation that EU officials are coordinating some form of support for Spain, especially for its banking sector but details of what this will entail is lacking.

Meanwhile, speculation that the Fed will at least extend ‘Operation Twist” if not opt for a further round of quantitative easing has helped to support the uplift to sentiment. Further clues will come from Fed Chairman Bernanke’s testimony to Congress today although we don’t expect him to signal a policy shift. Markets are clearly grasping for any potential positives in the form of potential policy support but the risk of disappointment remains high, especially in Europe where policy makers have yet to reveal any fresh plans.

The USD dropped further overnight as risk currencies rallied. Market positioning had become very long USDs and some correction of long positioning / profit taking is obviously taking place Data releases did not provide any support to the currency although the Beige Book did note that the economy was continuing to grow ‘moderately’ which was perhaps less negative than it could have been. The USD may find some support from the Bernanke’s testimony today. Although the Fed chief is set to be cautious in his outlook he is unlikely to point to further stimulus at this stage.

It’s worth highlighting the Australian data this morning. Employment rose by surprisingly strong 38.9k. The details of the jobs report are even better than the headline. Full time employment was up 46.1k, while part time jobs were down 7.2k. The only slight negative is the rise in the unemployment rate to 5.1% but this was largely due to a rise in the participation rate to 65.5% from 65.2%. This is the second solid Australian reading in a row following on from the Q1 GDP data yesterday. Given today’s jump in risk assets the data will help compound AUD gains in the short term. AUD/USD will face strong resistance around 1.0021.

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Euro eyes ECB, Yen intervention risks rise

June 6, 2012 — Mitul Kotecha

Following an onslaught of disappointing economic news globally the outcome of the US May ISM non-manufacturing index came as a relief, with the index rising to 53.7 from 53.5. Taken together with reports of a credit line to Spain from Europe’s bailout fund, it left markets in perkier mood overnight.

As per usual form, the emergency G7 conference call on the Eurozone turned out to be a non event while Fed speakers including Bullard and Fisher downplayed May’s soft jobs report. Much in terms of market direction today will hinge on the outcome of the European Central Bank (ECB) meeting and press conference, with positive sentiment likely to trickle through into trading until then.

The ECB will be under considerable pressure to cut interest rates today and a 25bps rate cut could be delivered. While the outcome is by no means clear cut and not pre-warned by the ECB a rate cut would at least help to alleviate a little of the pain in Europe. The fact that EUR/USD has a reasonably strong correlation with interest rate differentials over the past 3-months suggests that the EUR will actually come under pressure in the wake of such a move.

Even the reaction is not obvious, however. Arguably a rate cut could also be good news for the EUR as it would help to underpin growth. Moreover, a policy rate cut is largely priced in so the impact on the EUR will not be as potent as it could have been had it not been discounted. The accompanying statement will also be of interest. If the ECB indicates that it will cut rates further it will put even further more pressure on the EUR. Near term downside EUR/USD support is seen around 1.2375.

USD/JPY shows little sign of breaking its downtrend. A combination of further yield compression (2 year US bond yield advantage over Japanese yields continues to narrow) and elevated risk aversion has led to a firmer JPY much to the frustration of Japanese officials. Against this background it was perhaps unsurprising that Japanese finance minister Azumi pushed for the G7 to reaffirm its policy stance that excess volatility and disorderly FX movements are undesired. He faced no opposition in his request, paving the way for Japanese FX intervention to weaken the JPY.

The problem for Japan is that the impact of any intervention will be short lived against the factors mentioned above. Nonetheless, intervention fears will at least engineer a degree of two way risk into markets. Technical support for USD/JPY will be seen around 77.95.

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EUR rallies, AUD and CAD eye rate meetings

June 5, 2012 — Mitul Kotecha

Some consolidation and even slightly more upbeat tone have helped risks assets to settle and the outlook today is for more of the same. The respite looks temporary unless followed by concrete measures out of the Eurozone to stem the crisis, however. Attention will focus on today’s emergency teleconference between G7 leaders in which they are expected to put more pressure on European leaders to act.

However, continuing stalemate in Europe, with Spain’s push for an injection of funds from the Eurozone bailout fund into its banks facing resistance from Germany who believe that any funding should come as part of a formal bailout package. Despite the lack of traction in Europe, the EUR has managed to eek out further gains, with the rebound from the lows around 1.2287 versus USD gaining traction. Near term resistance is seen around 1.2625.

There has been a change of heart by many ahead of today’s Reserve Bank of Australia (RBA) meeting. Weaker global data in particular in China, with both the manufacturing and non manufacturing purchasing managers indices (PMI) coming in weaker than expected, have added to worries about the path of the Australian economy.

Taken together with some deterioration in Australian money market conditions, weaker commodity prices and growing European contagion risks, the RBA will probably want to shield the domestic economy, with another 25bps rate cut. Talk of a 50bps easing today has done the rounds but this seems excessive given that it would fall hot on the heels of 50bps rate cut at the beginning of May.

The AUD has priced in some easing and a likely 25bps rate cut is unlikely to put much pressure on the currency but much will depend on the accompanying statement. In any case, downside risks remain in the current environment.

The Bank of Canada also meets today to decide on its policy rate settings. Unlike in Australia there has been no change of heart ahead of the meeting, with the BoC set to keep its policy rate on hold at 1%. The central bank has sounded more upbeat than most and the drop in the CAD over recent weeks has in any case acted to loosen monetary conditions.

Although somewhat resilient compared to its commodity counterparts such as AUD and NZD, the CAD is playing catch up, having been the worst performing currency so far this month. Speculative positioning has drifted lower too, although it is still close its three month average. This implies room for a further reduction in long positions as the CAD fails to outperform.

Recent weakness in US economic data highlights the risks ahead for Canada and the CAD, suggesting that investors will continue to take a cautious tone towards the currency over coming weeks. A more neutral statement from the BoC will likely keep CAD sentiment subdued.

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