Equity flows to Asia surge

January 20, 2012 — Mitul Kotecha

Equity flows to Asia have begun the year in solid form. Although not quite as strong as in 2010 the pace of recent acceleration in flows has been more rapid, suggesting that it will soon overtake the year to date inflows seen over 2010. In total Asia has registered around $4.955 billion in foreign equity inflows. Korea has received the biggest inflows at $2.4 billion followed by India $1.04bn and Taiwan $1.03 billion.

The Indian rupee (INR) has been a clear beneficiary of such flows while the Korean won (KRW) has also strengthened. I suspect that official resistance may have limited Taiwan dollar (TWD) gains but clearly the risk on start to the year has resulted in strengthening inflows and in turn stronger Asian currencies.

Unless there is a disaster in Greece or elsewhere in Europe next week there is little to stop the short term trend but I remain wary over coming weeks and am cautious about extrapolating this trend forward. Like in 2010 and 2011 equity flows began the year strongly only to drop over following weeks and currencies were not slow to follow.

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Sell Risk Currencies on Rallies

November 3, 2011 — Mitul Kotecha

The Federal Reserve FOMC outcome and Greece’s travails failed to dampen the recovery in risk appetite overnight. The Fed highlighted downside risks to growth and revised lower its forecasts. However, positively for risk appetite the Fed left open further policy easing options, hinting at more quantitative easing if needed.

Meanwhile European leaders tightened the noose around Greece by cutting off EUR 8 billion in aid payments and threatening to cut of all aid if the country’s referendum now scheduled for December 4 fails to endorse the EU rescue package announced last week.

At the emergency meeting of European leaders yesterday Greece’s Prime Minister also admitted that the referendum will not only decide the fate of the rescue package but also whether Greece wants to remain in the eurozone. Greece was not only the eurozone country in focus as Italy continues to be racked by political uncertainties, with Prime Minister Berlusconi failing push through legislation on structural reforms ahead of the G20 meeting beginning today.

The risk rally is highly unlikely to last, with the EUR, commodity and high beta emerging market currencies to face further pressure. Although the immediate market focus will be on the G20 meeting beginning today the fact that leaders are now seriously beginning to consider the prospects of a Greek exit from the eurozone while taking a tougher stance on the country highlights how important the December 4 referendum will be.

Ahead of the vote markets will remain highly nervous and risk aversion will remain elevated. Consequently risk assets are set to face further pressure. Moreover, the fact that China has downplayed the prospects of further bond purchases from the EFSF bailout fund suggests there will be no help from this quarter any time soon.

Aside from the G20 meeting markets will pay attention to Draghi and Co. at the European Central Bank (ECB) today as well as bond auctions in France and Spain but we do not look for much excitement from the ECB despite the increased uncertainty within the eurozone. While an interest rate cut today cannot be ruled out given the increased market uncertainty the ECB is likely to wait until December before cutting policy rates.

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Plenty of event risk

October 17, 2011 — Mitul Kotecha

This week is heavy with event risk, with a lot expected from EU leaders. So far the risk on tone to markets has held up, with for example the VIX fear gauge resting below the key 30.0. The G20 meeting over the weekend set the deadline for action for concrete solutions to the eurozone debt crisis for the October 23 EU Summit.

However, there will be little detail on issues such as banking sector recapitalisation, private sector involvement in any debt restructuring or ‘leveraging’ the EFSF bailout fund until the report on Wednesday night by the Troika on Greece. The reward to EU leaders would be the potential for more aid from the IMF but even now it seems that a German government official has poured cold water of a plan being announced at the EU Summit which will disappoint markets.

There are also plenty of data releases for markets to digest over coming days including inflation releases, manufacturing surveys and industrial production data in the US while in Europe the German IFO and ZEW surveys are scheduled for release. The data will follow on from the better than expected September US retail sales releases at the end of last week continuing to dampen expectations that the global economy is falling in recession though there will be a marked deceleration in European data.

Meanwhile the US Q3 earnings season rolls. The risk on tone will likely continue to weigh on the USD and weigh on bonds but unlike a few weeks ago when a lot of bad news was priced in, the scope for disappointment is becoming increasingly high.

Many currencies remain highly correlated with gyrations in risk and in this respect the improvement in risk appetite is good news for high beta / commodity. AUD, NZD, CAD and JPY are amongst the most sensitive currencies and therefore prone to a bigger reaction as risk improves, with the former three strengthening and the JPY weakening. Asian currencies poised to benefit from firmer risk appetite include INR and KRW, both with relatively high correlations with risk.

EUR/USD has made a solid recovery over recent days from its lows around 1.3146 spurred by hopes of action by European officials. Such hopes may yet be dashed but the EUR looks supported over coming days ahead of the EU summit Speculative positioning also reflects a slight improvement in EUR sentiment as IMM short positions have declined in the last week but its worth noting that this week’s European data are unlikely to be supportive for the EUR.

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Fed does the Twist, markets do the Shake

September 22, 2011 — Mitul Kotecha

Although it was widely expected the Federal Reserve’s decision to implement a fresh version of Operation Twist together with a downbeat assessment of the economy came as a disappointment to equities and risk assets in general. The only surprise was the larger size of the operation at $400 billion.

Moody’s downgrade of three US banks added to the malaise as US equities dropped sharply, commodities slid, longer term Treasuries rallied whilst shorter term bonds dropped. The USD registered broad gains both on the back of the fact that no more quantitative easing was announced and due to a shift away from risk assets. At least there was no more negative news out of the eurozone as talks between the Troika (ECB, IMF, EC) and Greek officials continue on the next tranche of the bailout.

Markets will continue to digest the Fed’s outcome today and the negative tone will likely filter through markets today. There is little on the data front to result in a shift in this tone. In the US data includes weekly jobless claims while in Europe attention will be on manufacturing and service sector confidence measures.

While the potential for a positive outcome to talks in Greece may provide a short term boost to sentiment the overwhelming tone is likely to remain negative especially as Operation Twist is unlikely to change the dynamic of a weak growth trajectory for the US and developed economies over the coming months. Against this background, selling risk assets on rallies remains the preferred option.

The USD will continue to look firmest against high beta emerging market currencies in the current environment. Currencies in this group are those that have the highest correlations with risk (as m measured by my in house risk barometer) over the past 3 months including CAD, ZAR, TRY, INR, MXN, ARS & RUB. In contrast currencies that also have high correlations but actually strengthen as risk aversion increases are CNY and JPY.

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Asian currencies at multi-year highs

July 4, 2011 — Mitul Kotecha

Asian currencies are stronger in the wake of a sharp improvement in risk appetite following the approval of Greece’s austerity measures. The rally in Asian FX is revealed in the ADXY (an index of Asian currencies) index which is approaching a test of its 2nd May high around 119.26 around its highest level since August 1997. Technical indicators have turned more bullish, with the ADXY breaking above its key moving average levels (20, 50 & 100 day) and the 14-day relative strength index also turning higher.

The Asian FX rally has been led by the KRW, the Asian currency that has had the highest correlation with risk over the past few weeks. Given that risk aversion has dropped sharply since mid June it is no surprise that this currency has strengthened the most. USD/KRW is trading around its lowest level since August 2008. Strong equity capital outflows had kept the KRW on the back foot over much of June but there has been a bounce back in flows recently. However, USD/KRW is likely to find it tough to break below 1060 over the short-term, especially given likely resistance from the local authorities.

The THB, the worst performing Asian currency in June, has rapidly reversed some of its losses. The THB looks set to consolidate its gains following a decisive election result which saw the opposition Puea Thai Party gain control of parliament. The biggest relief for markets was the fact that the outcome was relatively clear cut, suggesting a potentially a smooth handover of power. Nonetheless, the currency has already jumped and after having dropped to around 30.40 from a high of around 31.01 USD/THB is likely to trade off gyrations in risk appetite.

The fact that the USD has lost some ground in the wake of firmer risk appetite and better news in Greece has also allowed Asian currencies to strengthen although it’s worth noting that amongst Asian currencies only the MYR has maintained a significant correlation with the USD index over the past 3-months. In other words, although USD weakness has helped to facilitate Asian currency strength, the recent strengthening in Asian FX is more likely to have been due to a rebound in capital inflows to the region.

Further Asian FX gains are likely over the near term especially as China continues to fix the CNY higher versus USD but given the recent rapid gains in some currencies, there is a risk of growing official resistance and intervention to slow or stem Asian FX gains. Moreover, the end of QE2 in the US suggests that the downside risks for the USD in general are not likely to be as prevalent, with a potential recovery in the USD over H2 likely to stand in the way of strong Asian FX gains over coming months.

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