Catching a falling knife

May 21, 2013 — Mitul Kotecha

USD/JPY’s pull back is proving short lived as Japanese Economy Minister Amari attempted to backtrack from his earlier comments that warned about the negative impact of a weaker JPY on “people’s lives”. His comments today suggest that Japan’s stance on a weaker JPY has not changed.

Nonetheless, there may be some consolidation in the near term as likely inaction from the Bank of Japan at it policy meeting this week will mean no new stimulus. While no policy change ought to be unsurprising given recent aggressive actions it appears that the market has become addicted to stimulus.

In any case US Treasury yields will need to be eyed for further USD/JPY direction, with a break of the psychologically important 2% level in the 10 year Treasury a likely trigger for a further up move in the currency pair.

GBP has held up well on the crosses while like many other currencies has faced a resurgent USD. Little impact on GBP is expected from today’s April CPI inflation data especially given that any expected decline is set to prove temporary (Bloomberg consensus 2.6% YoY).

More importantly a likely more optimistic set of Bank of England MPC minutes on Wednesday and rebound in April UK April retail sales on Thursday will provide GBP will further support although we suggest looking for any upside on the crosses rather than versus USD.

Is it time to buy AUD? While I don’t want to be accused of catching a falling knife AUD looks reasonably good value especially against other commodity currencies, especially NZD and CAD. While there have been plenty of negative factors pressuring the currency including prospects for more RBA rate cuts, weaker commodity prices, and softer domestic and Chinese data, much of this is in the price.

My AUD/USD quantitative model estimate based shows that it is oversold relative to its short term fair value estimate. Moreover, speculative positioning according to the CFTC IMM data has turned negative for the first time in almost a year. The RBA May meeting minutes (the meeting during the RBA surprisingly cut its cash rate to 2.75) reelased today did not change this perspective given that markets have already priced in one more rate cut in the cycle.

Asian currencies will likely continue to retrace some of their recent losses in the near term. However, domestic factors and growth worries will provide an importance influence, with the IDR for instance failing to benefit from any USD pull back as the government continues to wrestle with a fuel subsidy cut. Meanwhile, weaker than expected growth in Thailand in Q1 2013 cast a shadow over many Asian currencies as concerns of a wider growth slowdown in Asian intensify.

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US dollar helped by higher yields

May 6, 2013 — Mitul Kotecha

The dichotomy between hard economic data and asset market performance continues but unlike over past weeks at least there was some justification for the rally in equity markets following the stronger than expected US April jobs report. US non farm payrolls rose by 165k while revisions added 114k to previous months and the unemployment rate dropped further to 7.5%.

The data will offer the Fed some comfort perhaps reducing the need to expand further asset purchases in the months ahead. Nonetheless, the jury is still out and following the shift in Fed language at the FOMC meeting last week, in which they opened the door to increasing quantitative easing, it may take more than one, albeit important data release to completely erase expectations of more QE.

Further Fed thoughts on the jobs data as well as the plethora of disappointing data releases over previous weeks could emerge from the Chicago Fed conference this week, with several Fed speakers including Chairman Bernanke scheduled to speak. Given that there is little else on the data front market direction will take it cue from Fed comments.

Aside from central bank meetings in the UK and Australia the data slate is similarly thin elsewhere. No change is expected from both the Band of England and Reserve Bank of Australia but the latter is a much closer call given weaker data both domestically and in China. If the RBA does not move AUD will find some further support after rallying on the back of the jump in copper prices last week although gains will be limited as markets may just push back Australian easing expectations to the next meeting.

In the Eurozone, the final services confidence indices and German industrial data will be on tap and will add more evidence of the weaker economic trajectory and likely restrain the EUR and keep Eurozone core bonds supported. EUR/USD will find little else to give it direction, with higher US yields also likely to help keep any gains in EUR/USD capped, with resistance seen around 1.3220.

Japan has little on the data front too with trade and current account data in focus. The jump in the USD/JPY following the US jobs report will mean that attention will be on whether the 100 level can finally be cracked, with the spike in US 10 year Treasury yields likely keeping the USD supported versus JPY. I suspect that this level will not be breached unless US yields rise further.

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Cyprus hits EUR, GBP retracing lower, USD firm ahead of FOMC

March 18, 2013 — Mitul Kotecha

There are plenty of events and data to digest on both sides of the pond this week. In Europe, Cyprus’ bailout will be a key focus. The decision to ‘bail in’ in bank depositors aimed at raising EUR 5.8 billion by imposing a levy on deposits will be voted on today in Cyprus. While the EUR 10 billion bailout is small change compared to other Eurozone bailouts the deposit levy could have wide ranging repercussions on Eurozone bank deposits in other peripheral countries despite Cyprus’ case being labelled as “unique”.

Meanwhile, politics in Italy remains unpredictable, with discussions tomorrow between the President and political parties to try and form a government. There is little to suggest a deal is in the offing with the risk skewed towards protracted negotiations and fresh elections.

Data in the Eurozone is expected to a little more encouraging, with gains in Eurozone manufacturing confidence (albeit still in contraction territory), German ZEW investor confidence and IFO business confidence surveys likely. Also of note this week is the Bank of England MPC minutes and UK 2013 Budget and in particularly any change to the BoE’s mandate contained within the budget.

Markets likely to tread water ahead of Fed FOMC outcome. While no change to the USD 85 billion asset purchase program is likely the Fed may actually revise slightly lower their near term growth forecasts due mainly to fiscal policy developments despite recent encouraging data. It seems unlikely that the Fed will hint at any tapering off of QE but nonetheless, it will be difficult for the Fed to ignore recent positive data. On the data front, housing data in the form of housing starts and existing home sales will reinforce evidence of recovery in the housing market.

The EUR has already come under pressure as a result of Cyprus concerns and will struggle to reverse its losses. EUR/USD 1.2876 will offer some support in the near term and the fact that the speculative market has been short EUR over recent weeks may also limit some of the downside pressure. Nonetheless, any gains are likely to be sold into.

GBP/USD is also set to retrace lower, especially if the MPC minutes reveal a more dovish bias and/or any new mandate for the BoE is perceived to enable more policy easing. All of this leaves the USD in good form, with the USD index setting its sights on the psychologically important 83.00 level.

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USD buoyant

March 13, 2013 — Mitul Kotecha

After finally returning from a two week trip visiting clients across North America it appears that the USD continues to remain in buoyant mood. I have been highlighting the prospects for a stronger USD against major currencies for some time and this has been borne out by the strong USD performance since early February.

Despite a lackluster performance for US stocks overnight overall sentiment remains largely upbeat as reflected by the fact that my risk barometer has breached its lower threshold and has moved into risk loving territory. Similarly the VIX fear gauge is trading at multi year lows although it did move higher overnight.

The sharp drop in UK industrial production and a warning by the Bundesbank’s Weidmann that the Eurozone crisis was not over added a dose of caution to the market. On a more positive note the Baltic Dry Index is at its highest level so far this year, sending a positive signal for global growth expectations.

While there is still much wrangling in the US over budget proposals, and in Europe, Italian political uncertainty continues, markets remain focused on the positives of improving growth against the background of highly accommodative monetary policies. Nonetheless, the divergence between the US and Europe in terms of growth is set to continue. A likely bigger than forecast increase in US February retail sales in contrast to a bigger than forecast fall in Eurozone industrial production in January will attest to this.

EUR/USD has managed to garner a semblance of stability over recent days, with the currency pair finding it difficult to sustain any decline below the psychologically important 1.3000 level. The drop in EUR/USD over much of February has been more aggressive than implied by the performance of Eurozone peripheral bonds but this is no surprise given that this is not the biggest influence on the currency.

Instead the explanation for the EUR decline is found when viewing the move in US 2 year Treasury yields relative to 2 year bunds. The strong correlation with EUR/USD highlights this relationship, reflecting the impact of lower bund yields and higher Treasury yields. The EUR’s stability over recent days is therefore a function of a slight drop in the US yield advantage.

Given that the trend of firmer US data and weaker Eurozone data is set to continue, this stability is likely to be short lived. Our quantitative model suggests EUR/USD may rally in the short term but we suggest selling into it.

GBP/USD’s decline has continued unabated and there appear to be little to stand in the way of further weakness apart perhaps from the fact that a lot of bad news is priced in. Sentiment for GBP has clearly deteriorated as reflected in the CFTC IMM data revealing four straight weeks of negative positioning. The deviation with the 3 month average positioning has widened significantly, highlighting the pace of the move but also that the drop is beginning to look excessive.

Nonetheless, the bigger than expected drop in January industrial production data revealed yesterday has helped to compound the negativity towards the currency in the wake of deteriorating economic data and in turn heightened expectations of more BoE quantitative easing. Strong technical support around GBP/USD 1.4767 may hold in the short term but momentum indicators are showing no sign of a slowing in GBP selling pressure.

For GBP bulls (if there any left) there may be more value in looking to eventually re-enter long positions against EUR but we would not rush into this trade. .

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Contrasting Fed and BoE stance

February 21, 2013 — Mitul Kotecha

A contrasting stance in the minutes of the Fed and Bank of England impacted FX markets. Firstly the Fed minutes revealed some unease among officials about maintaining current quantitative easing settings as the economic outlook improved. In contrast the BoE minutes revealed a more dovish than anticipated 6-3 vote in favour of further easing. Consequently GBP/USD dropped sharply while the USD made broad gains. It will take a move higher in US bond yields to reinforce USD strength and notably 10 year Treasury yields have yet to break the 2.0634 high reached on 14 February.

While the JPY is likely to continue to weaken over coming months I maintain the view that the bulk of its cyclical decline has already taken place, with the risks much more balanced. My models continue to show that the magnitude of JPY weakness is not justified by its usual drivers. Risks of a short term JPY correction higher notwithstanding I expect any further weakness to be much more gradual in the months ahead.

Consistent with my model output, the feeling on the ground in Japan is that the currency has indeed fallen too far, too quickly, while there is plenty of scepticism about the fact that so far there has actually been little in terms of actual policy measures to justify the drop in the JPY. In the meantime the new central bank governor will be scrutinised to determine whether he will be sufficiently aggressive to warrant the drop in the JPY. A decision may take place very soon. Whatever the decision USD/JPY looks set to struggle to break above 94.00 in the short term.

Markets will be very data-dependent in terms of determining AUD direction in the weeks ahead. A further batch of soft data will reinforce expectations of further RBA rate cuts and undermine the AUD further. I do not expect this to occur, with some stabilisation in economic data likely, an outcome which ought to restrain AUD bears. My quantitative model suggests that AUD/USD is now looking relatively cheap, with the regression estimate at around 1.07.

AUD’s drop against NZD has been particularly sharp. I do not believe the drop is justified and yesterday’s jump in AUD/NZD based in large part on comments by RBNZ governor Wheeler warning about FX intervention to weaken the kiwi in my view marks a shift in the fortunes of the currency pair. Such comments should not be surprising given the failure of the G20 to chastise Japan on its FX stance. Expect more FX jawboning in the weeks ahead from other central banks.

Posted in Australia, Bank of England, Bank of Japan, Economics, Federal Reserve, New Zealand. Tags: , , , . Leave a Comment »
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