US dollar languishing at multi month lows

October 21, 2013 — Mitul Kotecha

Following the resolution to the uncertainty and stress surrounding the political conflict on raising the US debt ceiling and thereby avoiding a US debt default markets will likely take a more upbeat tone this week extending last week’s rally in risk assets. We will also be able to scrutinise delayed US data releases, in particular the US September employment report which will be released tomorrow and possibly September US retail sales this week.

These and other US data may however, take some of the shine off buoyant equity markets given that they are unlikely to be particularly impressive. Indeed, clues will now be sought to determine exactly what impact the government shutdown and protracted political friction will have had on the economy but the news may not be particularly good in terms of US recovery hopes.

On the plus side and as reflected by the bull flattening in US interest rate markets, markets appear to be pushing back expectations of Fed tapering especially as US politicians will likely gear up for another fight over coming months when the debt ceiling / budget will need renewed agreement.

Fed tapering by December now looks highly unlikely unless the US delivers a series of very positive data surprises. The net impact on the USD is clearly a negative one, with the currency continuing to languish at multi month lows and showing little sign of turning around over the near term.

Elsewhere, in Europe the data will be a little more encouraging, with the ‘flash’ purchasing managers’ indices and the Germany IFO business confidence survey expected to show further improvement while in the UK a healthy reading for Q3 GDP is likely to add to the view that further Bank of England asset purchases are moving off the table. The EUR will likely benefit from the weakness in the USD and relatively better data releases although the sharp increase in EUR positioning suggests that further upside momentum may slow.

Asian currencies will continue to benefit from a double dose of good news from the US debt ceiling agreement as well as a run of positive Chinese releases over recent weeks. This is set to continue this week, with solid Chinese purchasing managers indices (PMI) data expected on Thursday and firm Q3 Korean GDP data on Friday. Meanwhile the central bank BSP in the Philippines is likely to keep policy on hold this week given the well behaved inflation backdrop.

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USD edges higher, AUD supported, KRW in focus

October 10, 2013 — Mitul Kotecha

US equities and risk assets in general edged higher overnight as US politicians edged towards a budget deal. The nomination of Janet Yellen as next Fed Chairman was met with a positive reaction from risk assets as it was perceived that she would be more likely to maintain the easy policy of her predecessor, with markets in any case delaying expectations of tapering into next year.

The Fed FOMC minutes released overnight gave little clarity on the timing of Fed tapering however, but it did highlight the split within the FOMC between those wanting to begin tapering in September and those preferring to wait. More consolidation is likely today as markets await political developments in the US.

Contrary to our expectations the USD has actually edged higher over recent days shaking off some the pressure associated with the budget impasse in the US. News that President Obama will meet around 20 senior Republicans from the House following a similar meeting with Democrats highlights progress of sorts, with hints of compromise in the air.

A slight uptick in US bond yields has managed to provide the USD with a semblance of support and further consolidation is likely in the short term as market fears over a US default gradually recede. Indeed, it appears that the USD is in a bottoming out process at present, with short term pain likely to give way to medium term gain.

GBP has lost ground over recent days undermined yesterday by disappointing August manufacturing/industrial production data and a worse than expected trade deficit. The data is unlikely to affect the outcome of today’s Bank of England MPC meeting however, with an unchanged outcome both on policy rates and asset purchases on the cards.

Despite yesterday’s data disappointments UK data has been improving and point to a reasonably good growth outcome in Q3 and a reduced likelihood of further asset purchases by the BoE. Nonetheless, GBP’s gains look overdone, with scope for short covering having diminished. Further pressure is expected against both EUR and GBP in the short term.

Australian jobs data revealed an increase of 9.1k in employment evenly split between full time and part time jobs and a surprise drop in the unemployment rate to 5.6%. The headline increase in employment was below consensus. Moreover, there was a marginal drop in the participation rate which helped to push the unemployment rate lower. On balance, the data will leave the AUD unperturbed, with the AUD/USD likely to remain supported over the short term. AUD/USD looks primed to test resistance around the 0.9530.

Asian currencies are on the back foot in the face of a slightly firmer USD. KRW will be in focus, with the Bank of Korea delivering an unchanged policy outcome but revising lower its growth and inflation forecasts. Against this background KRW appreciation looks overdone and appears to face strong resistance on any breach down to USD/KRW 1070. Nonetheless, downside risks will be limited. Encouragingly Korea has been a major beneficiary of the prospects of a delayed Fed tapering, with the country recording a strong return of equity portfolio flows over recent weeks

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Bracing for the worst

September 30, 2013 — Mitul Kotecha

There was little progress over the weekend during discussions between US politicians attempting to agree on a budget deal and thus avoiding a partial government shutdown by the end of today. The US Senate is now set to reject a House of Representatives plan to delay President Obama’s Affordable Health Care Act while renewing funding for the government until December 15, leaving an ongoing stalemate in discussions.

Markets are bracing for the worst, with risk aversion rising, US equities and the USD falling. Meanwhile US Treasury yields remain capped having dropped sharply since early September. Political shenanigans in the US threaten to overshadow the US September jobs report at the end of the week. Nonetheless, the data will provide major clues to the timing of Fed tapering regardless of the budget/debt discussions.

It’s not just in the US where politics is fuelling market tensions. In Italy former Prime Minister Berlusconi withdrew his party’s support from the coalition government, leaving current Prime Minister Letta scrambling to form a new parliamentary majority in order to avoid snap elections. The impact will likely be felt on Italian and peripheral bond yields over coming days.

Meanwhile following elections in Germany last week coalition discussions to form a new government are ongoing although no deal is in sight yet and talks could go on for some time yet. Political uncertainties are unlikely to alter the European Central Bank’s (ECB) course this week, with an unchanged policy decision expected although benign inflation and weak credit growth will reinforce the need for an easing bias and forward guidance. Political issues are set to dominate markets over coming days, leaving risk aversion elevated and risk assets under generalised pressure.

The USD index lurched lower in the wake of the uncertainties in the US, extending its drop from early September. The near term prospects for the currency are bleak, with limited potential for any upside unless a budget deal is reached. Safe haven currencies in particular the JPY will be buoyed in this environment. The EUR will not fully be able to take advantage of USD weakness however, given the political tensions within the Eurozone.

In terms of high beta emerging market currencies including Asian currencies, any positive impact from the fact that US yields are capped, with 10 year treasury yields dropping sharply recently (higher US yields have been negative for EM currencies over past weeks so a drop will be positive for them) will be outweighed by rising risk aversion, leaving most Asian currencies vulnerable.

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Fed keeps the party going

September 19, 2013 — Mitul Kotecha

The party goes on! The Fed decided to play on the side of caution by not acquiescing to market expectations. The FOMC maintained its current USD 85 billion of asset purchases wanting to see more evidence of economic recovery before pulling the trigger. Market expectations centred on a USD 10-15 billion paring back of asset purchases. Clearly worried about a rise in market interest rates Fed Chairman Bernanke strengthened the Fed’s forward guidance by highlighting that the first rate increase may not come until the unemployment rate is “considerably below” 6.5%. A downgrade in the Fed’s economic forecasts will also have helped to justify the inaction by the FOMC.

Clearly risk assets loved what they saw, with equities and commodities rallying and US Treasury yields dropping. Gold prices in particular jumped on the news while the VIX ‘fear gauge’ dropped. The USD was a major casualty losing ground to most currencies, with notably EUR/USD spiking above 1.35 and GBP/USD to above 1.60. High beta emerging market currencies were big winners, given the positive impact of lower US yields and prospects of ongoing capital inflows. While the Fed has merely delayed tapering this will not stop markets from following through on the positive dynamic today. The positive tone will be reinforced across Asian and European markets.

The sharp drop in US Treasury yields hit the USD hard and it is likely to remain under pressure over the short term against a variety of currencies. Although the drop in US yields is likely to prove temporary it is difficult to go against the move in the near term. In order to identify which currencies will benefit the most versus USD I have looked at their sensitivity to US 10 year Treasury yields. The biggest beneficiaries will be Asian currencies given that they register the strongest correlations. The IDR, THB, MYR and INR are at the top of the list in this respect. In any case Asia was already experiencing a resumption of capital inflow as tapering expectations were being priced in and the Fed inaction will reinforce this trend.

GBP bounced following the unanimous vote for no policy shift revealed in the Sep 3-4 Bank of England MPC meeting minutes. Its gains were reinforced by Fed inaction overnight, with GBP/USD breaking through key levels above 1.60. Although the MPC’s 9-0 vote for no change was in line with expectations there was a minority looking for one of two MPC members to have voted for increased asset purchases. Citing upside risks to the growth outlook the BoE appears more confident about the UK’s economy. However, this all but makes a mockery of “forward guidance” and attempts to cap market interest rates. A further test for GBP will come from today’s August retail sales release. There are downside risks to consensus but even this may prove to a temporary stumbling block to a resurgent GBP.

The Swiss National Bank is widely expected to keep policy unchanged today and will make no changes to the CHF ceiling. The desire to keep the ceiling in place remains strong even though the economy is showing signs of recovery, deflationary pressures are receding and capital inflows from the Eurozone have diminished and in fact showing signs of reversing, albeit slowly. Reflecting this SNB reserves growth has slowed while Swiss banks’ foreign liabilities have decreased. The fact that the currency remains overvalued however, means that there is only an extremely slim chance that the ceiling will be removed over coming months. Although the SNB will likely revise upwards its growth forecasts, expect a cautious tone to emerge from the meeting. Accordingly EUR/CHF is set to remains capped around 1.2400 over the near term.

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Dollar undermined by outflows, while flows return to Asia

September 17, 2013 — Mitul Kotecha

The Lawrence Summers’ effect (ie his withdrawal from the race to be next Fed Chairman) rippled through markets, with risk appetite improving, buoying equities as well as bonds. As noted yesterday he is perceived to be less in favour of quantitative easing compared to the other leading contender Yellen. Commodity prices including gold prices slipped while the USD remained under pressure. Meanwhile, keep an eye on the Baltic dry index which has risen sharply since the beginning of September, indicating a positive bias for global economic activity in the months ahead.

As markets brace for the Fed to announce modest tapering plans tomorrow risk assets are set to remain supported, especially given expectations that the Fed will counter tapering with reinforced forward guidance. Effectively this means that the negative impact on the market from less Fed asset purchases will be offset by more reassurance that policy will not be tightened too quickly. Additionally helping the tone of positive risk sentiment is the expectation that a deal on Syrian chemical weapons is moving ahead.

The USD has been undermined by capital outflows from the US, improving risk appetite and US data disappointments. While we do not expect the USD to slide much further it is likely to remain under pressure over the short term before resuming appreciation later into Q4 and next year. The USD has failed to benefit from the rise in US Treasury yields over recent months due to foreign sales of Treasuries. The Fed FOMC meeting tomorrow is unlikely to offer the USD any support.

Further evidence of Treasury outflows is likely to be revealed in today’s releaser of the August US Treasury TIC flows data. Eventually I expect higher US yields to attract foreign flows, especially from Japan as life insurance companies etc, boost their holdings of US Treasuries, but over the near term the USD will be undermined by capital outflows.

GBP has rallied strongly over recent weeks both against the USD and EUR but the currency faces some risks from August CPI inflation data today and Bank of England Monetary Policy Committee minutes tomorrow. While a series of positive data surprises has made the job of the MPC harder in terms of establishing its forward guidance, a slight dip in CPI and possible shift of a couple of MPC members to restart voting for more asset purchases (no votes for further purchases at the last meeting) likely to be revealed in the minutes of the September meeting, could provoke some profit taking and act as a short term cap on GBP.

Despite the ongoing pressure on the USD, the rally in Asian currencies appears to have stalled although they continue to remain well supported amid a generally positive risk environment. Returning portfolio investment flows have helped, with the INR in particular benefitting from renewed inflows. The INR took the above consensus August WPI inflation reading in its stride although the data did reinforce the view that the central bank (RBI) will refrain from shifting policy rates at its meeting later this week.

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