Chronology of a Crisis

December 10, 2012 — Mitul Kotecha

Chronology of a Crisis
by Mitul Kotecha

Not many would have thought that the global financial crisis stemming from the sub-prime debacle in the US would have spawned such a massive degree of global contagion, the impact of which is being felt to this day. Indeed, it is evident that global markets have had to face crisis after crisis since the sub-prime saga began. It is equally evident that the chances of returning to the definition of normality that we knew prior to the crisis are extremely slim.

Fast forward to late 2012 and one could be forgiven for thinking that markets are still in the midst of crisis. The stark reality is that, despite the massive amount of fiscal and monetary stimulus enacted since 2008, the world economy remains very fragile and while the financial system is arguably in better shape, policy makers have far less ammunition in their pockets than they did at the beginning of the financial crisis. All is not so bad, however, with signs over recent months that the global economy is finally emerging from its quagmire. Even the crisis in the Eurozone is increasingly moving painstakingly towards some form of resolution.

In this book I give a month-by-month analysis of the period following the escalation of the financial crisis, attempting where possible to determine where and how things could have been handled differently. In assessing the market impact, particularly in relation to currency markets, the analysis will hopefully provide some insight into what can be learnt from the crisis and what to expect should a similar situation arise in the future.

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Highlights this week

December 10, 2012 — Mitul Kotecha

Better than expected Chinese data over the weekend, speculation that Greece is close to reaching its debt buyback target and even some signs of progress in reaching a resolution to avert the fiscal cliff set up risk assets for a generally positive start to the week. Talks between the administration and senior Republicans will continue this week but it appears that some senior Republicans are willing to give up their objections to tax hikes on the very wealthy.

The November US jobs report released at the end of last week which revealed a 146k increase in payrolls and a drop in the unemployment rate to 7.7% is likely to have little influence at the turn of the week. The report was met with a muted reaction. While on the face of it the data was better than expected, downward revisions to past months and a surprising lack of impact from Hurricane Sandy left markets somewhat perplexed.

However, not everything is rosy. Last week’s sharp downward growth revisions to Eurozone growth by the European Central Bank (ECB), a plunge in US consumer sentiment and comments from Italian Prime Minister Monti that he intends to resign will cast a shadow over markets, restraining any upside.

Although activity will likely continue to thin as holidays approach there is still plenty too chew on this week. In the US the Fed is set to continue purchasing USD 85 billion of longer dated securities following the end of Operation Twist but this should come as little surprise to the market and therefore will yield little reaction. There will be some encouraging news on the consumer as retail sales bounce back in November.

Across the pond the European Council meeting beginning on Thursday will be in focus, with banking union and bank recapitalisation among the topics up for discussion. Given the hint of monetary easing by the ECB markets will scrutinise upcoming data for the timing but a likely increase in the German ZEW investor confidence survey in December and stabilisation in the Eurozone composite purchasing manager’s index will not prove compelling enough to warrant an imminent rate cut.

Elsewhere in Japan the upcoming elections will mark the highlight of the calendar over the weekend although the weaker than expected Q3 GDP reading this morning (-0.9% QoQ) and expected deterioration in the Tankan survey later in the week will maintain the pressure for more aggressive policy action and a weaker JPY.

EUR took a hit from the ECB’s dovish stance last week and will not take too kindly to the news of Monti’s intended resignation after the fiscal 2013 budget in Italy. EUR/USD 1.2880 still marks a solid support level for the currency.

USD/JPY continues to probe higher but extreme short market positioning will likely limit the ability of the currency pair to push higher. On the topside 83.15 will market strong resistance for the currency pair.

AUD and NZD look generally well supported, with Chinese data over the weekend giving further support although for AUD/USD 1.0519 will continue to act a tough technical barrier to crack.

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Bullish INR but other Asian currencies held back

December 7, 2012 — Mitul Kotecha

Although the European Central Bank (ECB) left policy rates unchanged the post meeting press conference effectively opened the door to a rate cut in Q1 next year following sharp downward revisions to growth projections and well below target inflation projected over the medium term. A major casualty of the shift in ECB tone was the EUR which dropped over one big figure from a high of around 1.3089. Technical support for EUR/USD is now seen around 1.2885.

The Baltic Dry Index has continued to decline over recent days sending an ominous signal for growth ahead. Meanwhile, once again politics cast a shadow over European markets as Italy’s government overcame a confidence motion, with ex Prime Minister Berlusconi’s PDL party threatening to withdraw support and bring down the government.

Trading is likely to remain thin today as markets await the US November jobs report. The report will undoubtedly be soft (consensus is for an 85k increase in November payrolls) but as much of the weakness in jobs growth will be due to Hurricane Sandy the market impact is likely to be muted leaving a likely constructive tone to risk appetite going into next week.

Asian currencies continue to take direction from the CNY, with the lack of upside traction in this currency leaving most Asian currencies within ranges despite the fact that equity flows to Asia have been very strong over recent days, with inflows of over $2 billion registered this week alone. The implication is that central banks in the region have become increasingly active in preventing Asian currency strength.

One currency that has a limited influence from the CNY is the INR and this currency continues to outperform on reform hopes. The passage through India’s lower house of parliament allowing foreign investment into retailers was encouraging and hopes have grown that it will be followed by passage in the upper house. Further gains in the INR are seen over coming sessions, with a short term break below USD/INR 54.00 looming.

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USD under broad based pressure

December 5, 2012 — Mitul Kotecha

There remains a great deal of angst in markets due to the lack of resolution to the US fiscal cliff, which is putting pressure on overall market sentiment as reflected in the multi day rise in the VIX fear gauge over recent days. The fact that both the US administration and senior Republicans are giving little ground in discussions suggests a deal is not in sight although the pressure for compromise will intensify as year end approaches.

The news in Europe is a little better as reflected in the narrowing in peripheral bond yields. There will be little directional influence on markets today, with trading likely to be subdued ahead of the US jobs report on Friday, with any news on the fiscal cliff also closely watched.

The USD continues to come under broad based pressure, with the USD index having lost around 2% of its value since 16 November. The lack of traction in terms of resolving the fiscal cliff and the weaker US data this week, namely the November ISM manufacturing index have weighed on the currency.

How much of the USD move is due to position adjustments as year end approaches fast or renewed confidence in the EUR is debatable but it is clear that the USD looks like it will end the year in a bad state. The ADP jobs report today may give further direction but it seems unlikely that pressure on the USD will abate ahead of the November payrolls data on Friday.

While the EUR’s gains are beginning to look overdone, the momentum for the currency continues to be to the topside as short positions continue to be covered into year end. The EUR’s appreciation is taking place hand in hand with the drop in peripheral bond yields. A positive reception for Greece’s debt buy back as well as Spain’s request for aid for its banking sector has also helped the currency.

Rumours of a German debt downgrade have done little to diminish the EUR’s appeal. An upcoming meeting of EU finance ministers next week ahead of the EU leaders’ summit to try and make some progress towards banking supervision is also hoped to deliver some good news. A test of sentiment will come from a Spanish bond auction today but this is unlikely to be much of an obstacle to the EUR. Near term EUR/USD resistance is seen around 1.3172.

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