Gold stabilizes, euro drops

April 18, 2013 — Mitul Kotecha

The FX world has become somewhat more disturbing over 2013. Implied currency volatility has risen relatively sharply over recent months breaking its relationship with the VIX ‘fear gauge’ in large part due to the sharp drop in the JPY. Additionally the trend of improving risk appetite that was conducive to lower FX volatility has come to an end.

The inability of risk appetite to improve further has led to a declining correlation between various assets including currencies. This opens the door to other factors driving FX markets, with investor discrimination based on relative yield and growth differentials expected to take increasing prominence over coming months.

A big mover overnight was the EUR which slid on comments from European Central Bank official Weidmann that Europe’s recovery from the debt crisis may take years he hinting at a rate cut. He was joined by the ECB’s Smaghi who noted that the ECB must find ways to avoid EUR gains. EUR is likely to remain under pressure over the short term, especially on the crosses against the likes of GBP. Eventually I expect its ECB Outright monetary Transactions (OMT) threat led resilience to fade as Europe’s weak growth trajectory weighs on the currency, leading to an eventual move to EUR/USD 1.25 by end 2013.

The CHF and JPY languish at the bottom of our forecast grid in the medium term as would be expected given both their low yield and relatively lack of sensitivity to global growth. Both currencies will face pressure from relatively higher yields elsewhere given the growing attraction of yield and they are set to regain their lustre as funding currencies. In this respect the USD will begin to lose its allure as a funding currency especially as markets become increasingly nervous of a tapering off of Fed asset purchases later in the year.

The price of gold has stabilized over recent days in a USD 1365-1395 per ounce range following its sharp fall, with buyers creeping back in especially from jewelry demand, with strong purchases from India and China reported over recent days. My quantitative model suggests that the recent decline in gold prices is overdone and it may bounce back slightly. Nonetheless, the prospects for gold prices in the months ahead are still downbeat as expected strength in the USD, higher US bond yields, and expectations of a paring back in the Fed’s asset purchases weigh on the commodity.

News that Cyprus proposes selling its gold reserves over coming weeks will also fuel nervousness that other peripheral Eurozone central banks will follow suit. Finally, exchange trade funds (ETF) and speculative demand according to the CFTC IMM data continue to show a decline in investor demand. Consequently I we have revised down our forecasts for gold prices to reach USD 1350 per ounce by end 2013

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Growth fears intensify

April 16, 2013 — Mitul Kotecha

A bad day for risk assets yesterday threatens to extend further. Weaker than forecast data releases in China and the US weighed heavily on market sentiment supporting the theory that the global economy is repeating the pattern of Q1 strength followed by weakness over the remainder of the year. Growth worries helped to exacerbate the fall in gold prices with the precious metal dropping by 15.5% this month alone while dragging down other commodity prices.

There are plenty of data releases today including CPI inflation in the US, Eurozone and UK as well as the German ZEW investor confidence survey, US industrial production and housing starts. Given market sensitivity to weak data any disappointment will reinforce the risk off tone but this seems unlikely as the data in general is likely to be somewhat better.

AUD was thumped by weaker Chinese data releases and a deterioration in risk appetite. Although the drop has been steep over recent days AUD is unlikely to fall much further, with plenty of appetite for the currency around 1.0300. Nonetheless, AUD/USD has dropped below its 100 day moving average level 1.0414 a breach of which threatens to mark a stronger down move.

For those investors wanting to re-enter long AUD positions I prefer to play the currency on the crosses, especially versus NZD which has also suffered recently. My quantitative model of AUD/NZD suggests some upside scope in the currency pair, with short term fair value seen around 1.24.

USD/JPY’s pull back has extended further as Bank of Japan governor Kuroda’s policy announcement effect has faded and risk aversion has picked up. I look for any slippage in USD/JPY to be limited however, with my quantitative model suggesting that short term fair value for USD/JPY is around 95.68. The currency pair has been undermined by the drop in US Treasury yields over recent weeks resulting in a reduced US yield advantage over Japan.

Moreover, the upcoming G20 meeting this week has also provoked some hesitancy among JPY bears given expected comments aimed at Japan not to engineer a competitive devaluation of its currency. Technical indicators suggest that the primary trend remains higher for USD/JPY, with a break below 96.07 required to signal a change in short term trend.

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USD undermined by data, Gold under pressure

April 15, 2013 — Mitul Kotecha

Risk measures remain generally well supported, with markets remaining fairly resilient to Eurozone concerns as the European Central Bank (ECB) OMT threat continues to do its work to deflate tail risks. Even the EUR continues to sit stubbornly around 1.31 versus USD while Eurozone peripheral bonds remain supported.

The Eurogroup and Ecofin announcement of an extension of Irish and Portuguese loans and the revelation that Cyprus will need even more funds than previous estimates (EUR 23 billion compared to EUR 17.5 billion previously) has been taken in its stride by markets. Eurozone inflation and the April German ZEW investor confidence survey will be the highlights of the calendar in the region this week although neither should dent the generally supportive tone.

Firm risk appetite is contributing to some of the pressure on commodity prices, with the CRB commodities index losing further ground as precious metals slide. Gold prices have now entered a bear market given the more than 20% fall since September 2011 as ETF and speculative investors continue to exit. There is little sign that investors are about to let up the selling pressure, with the trend continuing to be lower.

Data releases this week in the US will be of particular focus to determine whether the economy is entering into renewed downward lurch or is facing a mere blip along the way to recovery. Indeed, the recent run of softer data including weaker than expected March retail sales and April consumer confidence data released at the end of last week have reinforced growth concerns while supporting US Treasuries and undermining the USD.

The Fed’s Beige Book will help give some indication of how growth is faring across the US while industrial production and housing starts ought to show some gains. Q1 13 earnings reports will also be in focus. The weakness in US data over recent weeks is likely to be merely a blip on the path to recovery but nonetheless the impact of the Sequester may be accentuating the softening in the growth indicators.

Elsewhere Japanese FX policy will come under scrutiny at the G20 meeting this week, with officials likely to press Japan to refrain from competitive currency devaluation echoing the message from the US Treasury’s semi-annual currency report to Congress at the end of last week. USD/JPY has lost some upside momentum as a result and is set to slip further, with support seen around 96.71.

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USD/JPY close to breaching 100

April 9, 2013 — Mitul Kotecha

Japan and the JPY continue to garner most market attention as the currency’s weakness continues to extend, leading to pressure in closely correlated currencies and markets especially in Asia, notably in Korea. European tensions have not eased to any significant degree with some praise for Portugal’s attempts to overcome a constitutional court ruling on planned budget cuts but little progress elsewhere including in Italy where there is no sign of any agreement on the formation of a new government.

Equity markets in the US edged higher but direction will come from the host of Q1 earnings announcements over coming weeks as the US earnings seasons kicks in. Commodity prices continue to remain weak, with the CRB commodities index trading its lowest level in several months while the Baltic Dry index also continues to move lower, pointing to a slightly more negative outlook on the growth front.

USD/JPY has continued its ascent following the inspiration provided by the BoJ last week from its surprisingly aggressive new policy measures. The sharp move higher in USD/JPY over recent days is all the more impressive given that the US yield advantage over Japan has actually narrowed over the period while risk aversion has crept higher.

The market is clearly giving BoJ governor Kuroda the benefit of the doubt and it appears that there are plenty of JPY sellers on any rally in the currency. While I am a bit cautious in the near term about the ability of USD/JPY to push much higher it is clear that the trend is well in place for further JPY weakness and it is worth noting that speculative JPY positioning is not yet at extreme levels.

My model on USD/JPY based on yield differential and risk forecasts suggests that USD/JPY will be able to sustain a break above 100 over coming weeks and on this basis I have revised my forecasts. I now expect USD/JPY to reach 104 by end 2013 and 110 by end 2014 from 97 and 101 previously.

I look for further gains in GBP. Against the EUR, GBP has underperformed recently but we do not see GBP weakness persisting especially given the weight of negative factors building up for the EUR. A likely bounce in February UK industrial production today will build on the better than expected reading for UK March house prices as revealed in the RICS data this morning (-1% compared to consensus of -5%) while the BRC retail sales survey also came in better than expected with like-for-like sales rising by 1.9% in March.

The firmer data readings will provide some support for GBP over the short term and will likely help to fuel short covering in a speculative market that is still heavily short GBP according to the CFTC IMM data. I look for GBP/USD to breach technical resistance around 1.5393 over coming sessions, with any pull back likely to be restricted to support around 1.5159.

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USD weaker except versus JPY, EUR gains unsustainable

April 8, 2013 — Mitul Kotecha

Risk aversion is creeping higher whether due to weaker data and budget concerns in the US, political uncertainty in Europe or tensions in the Korean peninsular. Central banks continue however, to do their utmost to keep monetary conditions sufficiently easy to facilitate recovery.

The Bank of Japan was the latest to do its part under the helm of governor Kuroda, with new measures including a major increase in asset purchases, delivering a positive surprise to markets while pushing the JPY sharply weaker.

Only the ECB appears to lag in terms of central bank activism keeping policy on hold last week despite weak economic conditions are ongoing austerity pain. A series of industrial production releases across the Eurozone including German February IP scheduled for release today will not change the picture materially.

The much weaker than expected US March jobs report in which payrolls increased by only 88k, concern that economic activity is following a similar pattern to previous years ie strength in Q1 followed by weakness in Q2, has intensified. I do not believe this is the case but the jury is still out.

At the least the data will embolden Fed doves who will use the data as evidence that any tapering off in asset purchases should not occur quickly. A series of Fed speeches this week including one by Fed Chairman Bernanke tonight will be listened to very closely to determine whether the jobs report has provoked further caution from the Fed. Moreover, Fed FOMC minutes will be scrutinized to determine how the Fed will adjust the flow rate of asset purchases to the changing outlook.

The overall tone to FX markets is one of broad based USD weakness, with the notably exception of the JPY where the relatively aggressive BoJ stance has provoked a bigger reaction. The EUR has taken advantage of a softer USD but is unlikely to sustain gains around the EUR/USD 1.3000 level given the political problems across the Eurozone and relatively weaker economic conditions.

Indeed, news that Portugal’s constitutional court rejected austerity measures has put at risk the ability of the country to achieve its budget targets and regain access to international bond markets. Meanwhile Cyrpus’ bail in continues to leave a sour taste among depositors across the region while Italy continues to edge towards fresh elections.

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