US dollar pull back to prove short lived

January 13, 2014 — Mitul Kotecha

Having spent the tail end of last week in Singapore and Phnom Penh presenting the Global outlook for 2014 to clients as part of our Asian roadshow it struck me that there is a strong consensus view about a number of market movements this year. In particular, most expect the USD to strengthen over 2014. Indeed just as it looked as though the USD was going to surge into the new year, along comes the US jobs report to spoil the party. Clearly, it’s not going to be a one way bet in 2014.

The surprisingly weak US December payrolls data in which only 74k jobs were added compared to consensus expectations of close to 200k helped to support expectations that Fed tapering would take place only gradually, lending a helping hand to risk assets at the turn of this week.

I don’t believe the jobs data materially changes the picture for the Fed. Adverse weather may have played a role in the weakness in jobs while complicating matters was the drop in the unemployment rate to 6.7% largely due to around 350,000 people leaving the labour force. The data resulted in a drop in US bond yields and a weaker USD although equity market reaction was more mixed. Meanwhile gold and other commodity prices rose.

While risk assets may find some support in the wake of the jobs report this week much of the US data slate will if anything highlight that economic growth is strengthening, suggesting a reversal of some of the price action in US Treasuries, USD and gold. Data releases include a likely healthy increase in core US retail sales in December together with gains in manufacturing confidence surveys (Empire and Philly Fed) and industrial output as well as a further increase in consumer confidence (Michigan sentiment survey).

Additionally several Fed speakers are on tap over coming days, which may give more colour on Fed thinking in the wake of the jobs report. However, it is doubtful that they will indicate that the Fed will not taper as expected in January.

Clearly markets were caught overly long USDs last week as reflected in CFTC IMM speculative positioning data as of 7th January which showed that net USD long positions had reached their highest since September 2013. The pull back in the USD is set to be short lived, however, especially if US data over coming days reveals further improvement as expected.

USD/JPY in particular bore the brunt of the pull back in US yields, as long positions were unwound. A Japanese holiday today may limit activity but much will depend on the propensity for US yields to bounce back, with 10 year US Treasury yields currently around 2.85% compared to around 2.97% on Friday.

Asian currencies have been the most sensitive to US Treasury yields gyrations over the past three months. In order of sensitivity to US 10 year Treasury yields the highest is the JPY, followed by MYR, THB, PHP and SGD. These currencies would be expected to benefit the most in the wake of the drop in yields at the end of last week although as noted any pull back in US yields is likely to prove temporary. While the THB may suffer from political concerns in the near term the other currencies are likely to see some short term gains.

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Cautious start to the year

January 2, 2014 — Mitul Kotecha

Happy New Year!

2013 ended with a solid performance by US equities and further pressure on US Treasuries helped by a bigger than expected increase in US December consumer confidence. The S&P 500 ended close to 30% higher over the year while 10 year Treasury yields rose above 3%, registering an overall rise of around 108 basis points over 2013. In contrast commodity prices dropped sharply, with the CRB index recording a sharp drop and ending 5% lower over the year. Meanwhile the USD index ended the year close to where it began although this performance belies some significant volatility over the year, with losses against the EUR and gains against the JPY.

The first trading day of 2014 begins on a more cautious note as a disappointing reading for the December Chinese purchasing managers’ index (51.0 versus 51.2 consensus forecast) will cast a shadow over markets today. Indeed, the data alongside weaker commodity prices will weigh on AUD. Japanese markets will be closed over the rest of the week, while many market participants will not return until next week, suggesting limited activity. Nonetheless, as far as the JPY is concerned the currency is set to remain on the back foot versus USD given the ongoing widening in real yield differentials between the US and Japan.

Meanwhile EUR/USD looks like it will struggle to make much headway over the short term, with only the final reading of the December Eurozone PMI due for release today. The data will likely confirm a relatively healthy looking reading of 52.7, its highest reading since May 2011 but will unlikely provoke much of a market reaction. Instead markets will look ahead to the European Central Bank meeting next week. Recent ECB comments suggest little chance of another rate cut anytime soon despite a very subdued inflationary backdrop. Against this background any EUR slippage in the short term is likely to be limited although further out the relatively inferior Eurozone growth outlook compared to the US, highlights plenty of scope for downside EUR pressure.

Asian currencies will also look somewhat subdued in the wake of China’s softer PMI reading. Additionally a bigger than expected decline in Singapore Q4 GDP release (-2.7% QoQ annualised) will also not bode well although the drop in GDP will be seen as temporary, with official estimates still pointing to growth around 2-4% for 2014. In contrast robust export data from South Korea will be positive for the KRW in line with our view that the currency will be one of 2014’s outperformers along with the TWD and CNH. Elsewhere the THB continues to be hamstrung by political concerns, which are showing little sign of easing ahead of planned elections February 2.

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On track for a positive end to the year

December 23, 2013 — Mitul Kotecha

A solid revision higher to US Q3 GDP at the end of last week sets up a positive tone for risk assets into year end even as they digest the imminent onset of Fed tapering. The data revealed a revision higher to a 4.1% QoQ annualised pace of growth and if anything lent credence to the Fed’s decision to begin tapering. The GDP data will be followed by a series of positive data releases in the US this week including November personal income and spending and a likely upward revision to December Michigan consumer confidence both on tap today.

Tomorrow, November durable goods orders and next week December Conference Board consumer confidence will also paint a picture of broadening improvement in economic conditions, providing further validation to Fed tapering. Against this background US yields should be well supported along with the USD. Into next year US economic outperformance will continue, leading to both higher US yields and a firmer USD.

A Japanese holiday (Emperor’s birthday) today will dampen market action although Japanese data releases over the rest of the week will highlight further progress on the economic front, with November inflation pushing higher and industrial output expanding at a healthy clip. USD/JPY retained a foot hold above 104 but the large extent of short JPY positioning highlights scope for profit taking. Even so, the rise in US Treasury yields suggest limited downside risks for USD/JPY.

There is on little on tap on the data front in the Eurozone allowing markets to digest the steps towards banking union announced last week. Consequently EUR/USD is set to remain rangebound around 1.3650-1.3750.

There may be more interest in events in China as money market conditions and confidence surveys garner interest. Tight money market conditions will weigh on regional sentiment. A likely decline in both the manufacturing and service sector purchasing managers’ indices will also act to dampen Asian currencies reinforcing the pressure already in place from a broadly stronger USD. News in Thailand that the opposition Democratic Party has decided to boycott the Feb 2 elections will add to political uncertainty and pile more pressure on the THB although the regional underperform remain the IDR.

Overall, a thinning in market conditions as both liquidity and market participants disappear for the holidays imply limited activity over coming days. The fact is that the end of the year will market a solid year for equities and a poorer year for bonds but at least the debate over Fed tapering timing has finally been put to the rest. More of the same is likely next year but notably the growth gap between developed and developing economies will narrow, which at a time of heightened competition for capital amid Fed tapering, suggests that capital flows will increasingly be steered towards developed economies.

Dear readers, this is my last post for 2013. Thank you for taking the time to read my blog posts. I wish all Econometer readers happy holidays, success, prosperity and good health in the year ahead.

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Beware of yield sensitive currencies

December 10, 2013 — Mitul Kotecha

Markets are becoming increasingly accustomed to the idea of an imminent Fed tapering as reflected in ongoing gains in risk assets. Indeed, these gains have taken place even in the face of comments by Fed officials overnight including Bullard and Fisher which on balance supported the view of beginning tapering sooner rather than later.

The fact that US bond yields continue to decline despite the release of a slate of firmer US and global data also suggests that a lot in terms of tapering expectations are priced in. Nonetheless, year end position adjustment may also account for some of the moves, particularly with the USD coming under near term pressure against most currencies except JPY as US yields slip.

I remain constructive on the USD given that US growth will outperform, with an attendant rise in US yields. Not only am I constructive on the USD against many major currencies, I expect the USD to strengthen versus many emerging market currencies too.

Those currencies most sensitive to US yields (10 year US Treasuries) will be among the biggest underperformers in 2014. This list includes the INR, TRY, MYR, and BRL. The rationale for weakness in these currencies is that Fed tapering and higher US yields will further increase capital outflows or at least reduce inflows to many countries.

Conversely some of the currencies least effected by tapering / higher US yields are in the top half of the likely outperformers next year including KRW and TWD.

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Rising risk aversion

December 5, 2013 — Mitul Kotecha

The US ADP November jobs report and October new home sales both beat expectations yesterday piling on the pressure on US Treasuries and adding further weight to support those looking for the Fed to taper at the December 17-18 FOMC meeting. Consequently non farm payrolls expectation will likely be revised higher from the current consensus of around 180k. In contrast the ISM non manufacturing index came in below consensus, with the jobs component slipping. US equities ended marginally lower while the USD held its ground. However, risk measures such as the VIX “fear gauge” moved higher. Rising risk aversion may reflect expectations of imminent tapering and some angst ahead of US budget talks.

US November payrolls data to be released tomorrow will be crucial to provide more decisive clues to the timing of Fed tapering. Attention ahead of the jobs report will turn to the European Central Bank policy decision where no action is expected although some downward revisions to staff forecasts are likely. We continue to expect a more aggressive ECB stance into 2014. The Bank of England and Norges Bank will also decide on policy rates but no change is expected in both cases. In the US an upward revision to Q3 US GDP is expected to around 3.1% QoQ annualised while jobless claims will also be in focus. Market nervousness is likely to continue today although activity is likely to be limited ahead of the US payrolls data tomorrow.

The USD should be supported due to higher US Treasury yields although USD/JPY has lost some ground in the wake of higher risk aversion. The large short JPY market position may also be limiting the JPY’s downside for now. EUR/USD is trading shy of its recent highs above 1.36 and could be vulnerable to a dovish ECB statement today as well as to growth forecast downgrades by the ECB. AUD continues to remain under pressure having traded just below 0.90 overnight in the wake of disappointing GDP data yesterday and is likely to remain vulnerable to further slippage. CAD was further undermined by a relatively dovish Bank of Canada statement following the decision overnight to leave policy rates unchanged.

Given that US Treasury yields have risen by around 33bps since the end of October it is worth looking at which currencies are most sensitive to rising yields. In Asia the most correlated currencies with 10 year US Treasury yields over the last 3 months and therefore most vulnerable currencies are the SGD, THB, and MYR. The least sensitive have been CNY, IDR and KRW. Playing long KRW / short SGD appears to be a good way of playing an environment of rising US yields, especially given that yields are set to continue to rise over the coming months.

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