It’s all about communication

June 18, 2013 — Mitul Kotecha

Calm has settled over markets as anticipation builds ahead of tomorrow’s Fed FOMC outcome. Equity markets registered broad based gains globally while US yields rose and the USD stabilized. It’s worth reiterating that effective Fed communication is the key to ensure that this calm continues otherwise market volatility will quite easily return.

Yesterday’s mixed data releases did not offer much to the debate on Fed policy as the Empire manufacturing survey rose more than expected but disappointed on the detail, while home builders’ confidence jumped. May CPI inflation data will perhaps offer more clues today, with a benign reading likely to ensure that markets do not get carried away in expecting any major shift in Fed policy. In Europe, a likely decline in the German ZEW investor confidence survey in June will do little to boost confidence in recovery.

GBP/USD has rallied impressively over recent weeks although much of its gain has been spurred largely by USD weakness rather than inherent GBP strength. Nonetheless, UK data has looked somewhat more encouraging, a fact that has played some role in reinforcing GBP gains. Whether this continues will depend on a slate of data releases this week including retail sales on Thursday. CPI inflation data (today) and Bank of England MPC minutes (tomorrow).

On balance, I look for UK data to continue to paint an encouraging picture of recovery, which ought to provide further support for GBP. However, the risk / reward does not favor shorting the USD at present and I suggest playing further GBP upside versus EUR.

CHF has strengthened as risk aversion has flared up. While I remain bearish CHF over the medium term the near term outlook will be driven by risk gyrations (given the strong correlation between CHF and our risk barometer). Both EUR/CHF and USD/CHF have already fallen sharply having priced in higher risk aversion.

Obviously much in terms of risk appetite will depend on the Fed FOMC outcome tomorrow and I would suggest caution about shorting the CHF just yet. Additionally Swiss data in the form of May trade data and more importantly the SNB policy decision this week will be watched closely, especially given the threat by SNB Jordan of implementing negative interest rates. I don’t expect any shift in policy on Thursday, however, leaving USD/CHF firmly supported around 0.9130.

Since Fed Chairman Bernanke highlighted the prospects of Fed “tapering” during his testimony on May 22 commodity currencies have performed poorly. The notable exception has been the CAD which has eked out gains over recent weeks. Like GBP, the CAD has been helped by relatively positive data releases, which in turn have prompted growing expectations of policy rates hikes from the Bank of Canada. Market positioning in CAD remains relatively short, suggesting more scope for gains over coming weeks. Meanwhile, data this week including May CPI and April retail sales will be scrutinized for clues as to the next move from the BoC and in turn whether gains in CAD are justified.

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Bernanke awaited, RBI stays on hold

June 17, 2013 — Mitul Kotecha

Central banks are very much in the spotlight. Whether it’s poor communication or disappointment over the lack of fresh stimulus measures in Japan or opposition to the European Central Banks’ (ECB) OMT policy being debated in the German constitutional court there is much to focus on. Against the background of heightened volatility and elevated risk aversion the Fed FOMC meeting on Wednesday will garner even more attention than usual.

Although no change in policy settings is expected the ability of Fed Chairman Bernanke to communicate effectively the Fed’s strategy over ‘tapering’ will be crucial to determine whether market volatility persists or lessens. Ultimately markets are likely to successfully transition to a world of reduced Fed asset purchases but this may take a while. In the meantime market stress is set to remain elevated.

Aside from the Fed FOMC meeting US data releases are likely to continue to show encouraging signs of housing market recovery, with US May housing starts and April existing home set to reveal gains. Meanwhile, CPI inflation will remain benign in May while the June Empire manufacturing survey today will reveal a slight improvement.

In Europe, there will be attention on a Eurogroup meeting on Wednesday where banking union will be discussed while data releases include the June German ZEW investor confidence survey (slight drop likely) and the flash estimates of June purchasing managers’ indices. These are likely to look less negative although they are set to remain in contraction territory. In Japan, May trade data will likely show a widening in deficit as weaker external demand outweighs the impact of a weaker JPY.

In FX markets USD selling against major currencies is likely to slow. The 4.4% drop in the USD index from its highs in late May has been rapid but it has led to a major shift in positioning. Speculative USD long positions have been cut back significantly, while EUR positioning is almost back to flat after being extremely short in previous weeks. Similarly JPY short positions are beginning to be pared back. I suspect that the EUR in particular will struggle to make much more headway.

Weakness of the USD against major currencies has contrasted sharply with USD strength against emerging market currencies. The sell off in Asian currencies has been particularly sharp although there was some tentative recovery towards the end of last week. The INR followed by the most risk sensitive currencies including PHP and THB have suffered the most over recent weeks.

The INR’s vulnerability has been particular high due to its external funding requirements although it may show some tentative signs of recovery over coming days as its sell off has looked overdone. The Reserve Bank of India policy meeting today offered no help for the INR. Although it was a close call there was a significant minority looking for a rate cut to boost growth. The lack of action will weigh on the INR in the short term.

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Calmer sentiment

June 14, 2013 — Mitul Kotecha

Gains in US stocks overnight will help to calm sentiment. The fact that US equities were able to shake off the 6%+ plunge in the Nikkei yesterday reveals the different perspectives in both markets. US markets were helped by a bigger than expected increase in headline US retail sales in May and a bigger than expected decline in weekly jobless claims.

A WSJ story that Fed Chairman Bernanke would highlight at next week’s Fed FOMC meeting that a “considerable” amount of time would pass before ending QE and raising rates also likely contributed to firmer sentiment while pressurizing Treasury yields lower. Commodities’ markets also showed some sign of stabilization.

The data slate today consists of mostly US releases including May industrial production and June Michigan confidence both of which are likely to record positive outcomes. Markets are likely to digest the data well and after recent bouts of volatility a period of calm ahead of next week’s FOMC meeting will be welcome.

The USD index has suffered a dramatic reversal of fortunes since reaching a high just under 84.5 on 23 May dropping by around 4.3%. Its tumble has taken place despite higher US bond yields and risk aversion, both of which would usually be expected to boost the currency. Fed tapering nervousness has done nothing to support the USD despite prospects of reduced asset purchases.

The USD’s move should not be seen in isolation, however. In the wake of major position adjustments across many asset classes usually strong correlations have broken down. Given recent record long USD positioning over recent weeks the pull back in the USD versus major currencies may have further to run but we suspect that much of the decline has already taken place. Given that the USD appears to be more strongly correlated to equities at present it may find some support from the gain in US stocks overnight.

Assuming that the USD’s declines begin to slow and even reverse the EUR is unlikely to extend its gains much further. The overall backdrop for the EUR is not particularly positive, with growth data remaining weak, albeit less so than in previous months. Additionally there are renewed concerns about Greece due to protests over the shutdown of the state broadcaster highlighting the difficulty in implementing crucial deficit cutting measures.

Meanwhile, European Central Bank Board member Mersch once again highlighted the possibility of utilizing negative deposit rates, which ought to prove to be a negative influence on the EUR, while other members including President Draghi continue to defend the potential use of OMT. EUR/USD will run into strong resistance around 1.3434 and I expect the upside momentum to fade over coming sessions.

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Risk appetite continues to shrink

June 13, 2013 — Mitul Kotecha

Risk appetite continues to shrink as the ongoing nervousness over Fed tapering continues to provoke significant position adjustments across markets. Markets will have to wait for next week’s Fed FOMC meeting to find to find greater clarity over the timing and extent of Fed tapering although there will be some further input to the Fed decision from today’s US May retail sales release.

In the meantime US Treasury yields continue to move higher even as risk aversion also intensifies, revealing the extent of the shake out that is currently being felt in US bond markets. The USD which would usually be expected to rally on higher yields and elevated risk aversion, remains under pressure against most major currencies although it continues to run havoc against emerging market currencies.

USD/JPY’s decline is showing no sign of abating. The combination of elevated risk aversion and disappointment over recent policy announcements, in particular the lack of detail about Prime Minister Abe’s third arrow, has prompted ever more upside for the JPY. The impact of these factors is negating the impact of higher US Treasury yields, which would usually act to push USD/JPY higher.

As the rout in equity markets appears to be showing little sign of subsiding the JPY looks firmly supported in the near term, especially as the picture is unlikely to change ahead of next week’s FOMC meeting. Additionally, the options market looks to be expecting more JPY upside as reflected in risk reversal skews, with volatility overall continuing to look elevated.

The RBNZ policy decision overnight provided another blow to the NZD, with the central bank highlighting that economic growth is “uneven” and noting that the kiwi remains overvalued, acting as a burden on the tradables sector of the economy. Moreover, in the Q&A session governor Wheeler maintained the pressure on the currency, indicating once again the risks of FX intervention to weaken the NZD if needed.

After dropping by over 8% since its cyclical peak on early April the NZD looks set to remain under pressure in the short term amid elevated risk aversion although it was encouraging that the currency did not fall further following the RBNZ. Our valuation models show that the currency is oversold and if anything the selling pressure will abate over coming weeks.

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US dollar finding its feet

June 11, 2013 — Mitul Kotecha

Markets continue to second guess the Fed but the Fed’s Bullard did not provide much by way of clues overnight. Nonetheless, US Treasury yields continue to push higher. Taken together with an upgrade to US credit ratings by S&P ratings (in light of the better US fiscal outlook) provided some support to the USD. Data releases overnight provides little direction and a similarly lean data schedule today will leave markets without any major directional influences aside from reacting to the rise in US yields.

After dropping by around 3% the USD index looks to be showing greater stability and further gains are likely over coming weeks as the USD tracks US yields higher. Retail sales data on Thursday will provide more direction both to Treasuries and to the USD and a likely healthy reading expected ought to allow the USD to register further gains. Similarly June Michigan confidence data is likely to reveal that consumer sentiment remains at its strongest level since July 2007.

Conversely the EUR is unlikely to react well to the hearing in the German Constitutional court on a number of legal complaints in particular the ECB’s Outright Monetary Purchases (OMT) programme, with the German Bundesbank being of the most vociferous opponents of the programme. While the court is unlikely to rule against OMT, it will at the least highlight the divisions within the Eurozone over this and other policies.

The Bank of Japan’s inaction at its policy meeting today was met with disappointment. There was a significant minority expecting action especially the implementation of 2 year liquidity provisioning operations widely reported by the Japanese press. Consequently the JPY strengthened following the unchanged BoJ decision but its gains are likely to be limited. Relatively higher US yields suggest that the USD will renew its strength versus JPY.

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