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.

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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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GBP facing resistance, CHF pressured

May 9, 2013 — Mitul Kotecha

The Bank of England is unlikely to provide much influence for GBP unless there is a change in monetary policy settings. I think this is unlikely and if anything GBP is set to take a slightly weaker bias against both EUR and USD although I still look for GBP to make headway against CHF. GBP bulls appear to be taking profits in frustration at the inability of GBP to push higher over recent sessions although the large extent of short speculative market positioning suggests that downside risks are limited. The IMF’s annual health check of the UK economy beginning today will provoke some interest especially given the IMF’s recent criticism over the extent of UK austerity measures but I don’t expect it to provoke much GBP reaction.

FX intervention by New Zealand’s central bank shook up the kiwi. The threat of more intervention to weaken the NZD will result in some caution among bulls, but the RBNZ is smoothing the currency rather than attempting to halt its gains. Nonetheless, I would caution against playing long NZD/USD positions given the intervention risk prefer to go long AUD/NZD. Although the cross pulled back following the strong NZ jobs report overnight this was matched by a similarly strong Aussie jobs report.

EUR/CHF has risen over recent days and looks set to break above the 25 April high around 1.23495. The ongoing reversal in safe haven flows as Eurozone peripheral bonds continue to heal is helping to weaken the CHF. Additionally, the weaker than expected reading for April CPI highlights the persistent deflationary pressures inherent in the economy, something that may reverse if the CHF weakens. Additionally interest rate differentials continue to point to a higher EUR/CHF, with the differential widening in favour of the EUR over recent weeks.

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NZD hit by FX intervention

May 8, 2013 — Mitul Kotecha

Following previous warnings threatening intervention to weaken the NZD the Reserve Bank of New Zealand (RBNZ) intervened to sell the currency. The impact was sharp, with NZD falling versus USD and against key crosses including AUD. The NZD has been one of the best performing major currencies this year although its appreciation of 1.33% is not dramatic. However, going back to its cyclical low in March 2009 NZD had appreciated by a massive 72.6% versus USD prior to today’s intervention.

Previous warnings by RBNZ governor Wheeler include a speech in February when he noted that the “kiwi is not a one-way bet”. However, he noted that while the central bank is prepared to intervene to weaken the NZD any intervention would “only attempt to smooth the peaks”.

The last time that the RBNZ confirmed that it had intervened was way back in June 2007 when NZD/USD was trading around 0.75. The intervention failed to prevent further NZD strengthening until late July 2007 when the kiwi slid around 17% against the USD but this fall was notably not due to FX intervention.

Although Wheeler noted today that the RBNZ is capable of more intervention he added the intervention is “designed to take the top off the currency” consistent with his earlier comments. The bottom line is that more smoothing is likely but a significant push to change NZD direction is highly unlikely. The overall trend in NZD is likely to remain gradually upwards although gains will likely be more gradual given likely market caution over further RBNZ smoothing operations.

Taking a broader view the RBNZ is playing a similar game to many other central banks in attempting to weaken or at least prevent strength in their currencies. The Bank of Japan (BoJ) is clearly succeeding in finally weakening the JPY, while the RBA in part cut policy rates yesterday due to the strength of the AUD. While a full blown currency war remains unlikely currency frictions are picking up. I prefer to play the latest move in NZD by selling it versus AUD where we I see more value.

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