US dollar buoyed by higher yields, Asian currencies hit

July 8, 2013 — Mitul Kotecha

Efforts by the European Central Bank and Bank of England to disassociate themselves from Fed policy actions were overwhelmed by the US June jobs report which revealed a bigger than consensus 195k increase in payrolls and upward revisions to previous months. The data reinforced expectations that the Federal Reserve would begin tapering in September while the data also pushed US yields sharply higher (close to 23 basis points increase in US 10 year yields following the data) and fuelling further USD strength.

In fairness attempts by the ECB and BoE to introduce ‘forward guidance” may eventually garner some success but US yields will continue to dictate market direction, at least until the markets successfully transition to the reality of Fed tapering, which could take several weeks. During the interim expect transitional volatility to continue, with risk assets globally remaining under pressure.

Further detail on Fed policy will be looked for from within the minutes of the June FOMC meeting to be released on Wednesday although it is unlikely that there will be any real divergence from the message delivered by Fed Chairman Bernanke and a host of other Fed officials over recent weeks. Consequently the USD is likely to retain a broadly firm tone as it reacts to the sharp move higher in US yields at the end of last week.

The Bank of Japan will likely be emboldened in its ultra easy monetary policy stance following last week’s ECB and BoE announcements although no further policy action is likely at this week’s meeting as attention shifts to Japan’s Upper House elections on 21 July. The JPY in particular will remain susceptible to USD strength and widening yield differentials, with potential to test USD/JPY resistance around 102.45 this week.

European attention will centre on Greece and Portugal as the former will be the focus of discussions at the Eurogroup / Ecofin meetings today and tomorrow, with officials set to deliberate Greece’s bailout. Attempts in Portugal to resolve political differences between the main coalition parties appears to have garnered some success in a deal which could stave off fresh elections. None of this will help the EUR which is set to remain under pressure as it edges towards support levels at 1.2744 versus USD.

USD strength will also continue to be exhibited versus Asian currencies this week. Equity fund outflows continue to damage regional currencies lower. Since the end of May Asia has recorded around USD 15.4 billion in equity outflows. Total inflows this year have dropped to only around USD 3.6 billion. A renewed fall in the JPY will added pressure to more JPY sensitive currencies such as TWD and KRW but the overwhelming influence is higher US yields and capital outflows which will continue to have particularly negative impact on currencies with external funding needs, especially the INR and IDR.

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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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Risks to US payrolls / Japan disappointment

June 6, 2013 — Mitul Kotecha

US service sector confidence improved, with the ISM non manufacturing index revealing a stronger than forecast rise to 53.7 while the Fed’s Beige Book recorded “modest to moderate” growth across most Fed districts. However, any positive reaction was fully negated by a drop in the employment component of the ISM report and a weaker than expected ADP private sectro jobs report which revealed only a 135k increase in jobs. Consequently there will be a scramble to revise down forecasts for May US non farm payrolls released tomorrow.

Risk assets and in particular equities didn’t like what they saw even though on balance the data suggests less risk of the Fed beginning to taper its asset purchases this year. Added to the uncertainty revolving the around the Fed was disappointment on Japanese policy in the wake of Prime Minister Abe’s policy speech yesterday which failed to reveal details about his growth strategy or third arrow to reform business and deregulate parts of the economy. Central banks will remain in focus today although both are likely to be less volatile, with both the European Central Bank and Bank of England set to deliver unchanged policy outcomes.

USD/JPY’s pull back has continued unabated as disappointment over Japanese prime minister Abe’s ‘third arrow’ speech of structural reforms and a pull back in US Treasury yields taken together with firming risk aversion have all contributed to a firmer JPY. Clearly pressure will grow to limit the JPY’s bounce back but as long as Japanese equities continue to slide it will be difficult to do so.

Given that this is coinciding or perhaps spurring more Japanese selling of foreign assets as revealed in recent data, it is difficult to prevent a further drop in USD/JPY unless and until such flows reverse. Having dropped below its 50 day moving average level around 99.28 USD/JPY is vulnerable to more short term slippage.

EUR/USD is likely to struggle to make further headway and there will be plenty of caution around the ECB meeting today. While there is very little chance of a further easing in policy President Draghi is likely to keep the door open for further action which ought to take the wind out of the EUR’s sails.

While the EUR may be taking advantage of a softer USD tone as well as a narrowing in the US Treasury yield advantage over bunds (2 year) I don’t believe this will continue. It is only a matter of time before US yields renew their widening trend, with Friday’s US jobs data a possible trigger.

GBP is another currency taking advantage of a generally softer USD tone having made a solid recovery from its lows around 1.5008 at the end of last month. EUR/GBP has been more stable but we expect GBP outperformance here too.

While the BoE will offer little help given the likelihood of an unchanged policy decision firmer UK data in the form of better than expected manufacturing, construction and services purchasing managers’ indices revealed this week has provided a solid backstop for the currency. Given that positioning in GBP has been around record low levels it would appear that the potential for short covering remains significant.

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Firmer JPY and CNY fixings to support Asian FX

May 28, 2013 — Mitul Kotecha

The USD has lost steam as US yields appear to have temporarily topped out. The fact that aggregate (minus MXN) USD speculative positioning is marginally below its all time high also points to the risk of position squaring / profit taking on USD longs. However, any downside risks to the USD will be limited.

Consumer confidence data today will highlight the ongoing improvement in sentiment driven by both equity and housing wealth gains. In the debate about early Fed tapering the confidence data will err on the side reducing Fed asset purchases sooner rather than later. Consequently, it seems unlikely that the yields and the USD will drop much further.

Hopes of a calm start to the week were dashed as Japanese equity markets extended their slide and the JPY strengthened. Heightened volatility is frustrating policymaker’s efforts to contain the rise in Japanese bond yields. Although Bank of Japan governor Kuroda noted that Japan could cope with rising interest rates, higher yields could dampen growth at a time when the economy is finally showing signs of life.

Higher JGB yields have led to a narrowing in the US Treasury yield advantage over JGBs, which in turn has helped to push the JPY higher versus USD. Unless the BoJ succeeds in curtailing the rise in yield, USD/JPY is at risk of breaking back below 100.

Like the JPY, the CHF has strengthened in part due to increasing risk aversion. For a change the CHF may garner some direction from domestic news this week, with Q1 GDP, April trade data and the May KoF Swiss Leading Indicator scheduled for release later in the week. The data will likely show that Switzerland is escaping the downdraft from weak Eurozone activity, helped to some extent by the CHF cap.

Encouraging economic news will not imply any change in the CHF cap, however especially given the benign inflation outlook. Higher risk aversion will keep the CHF supported in the near term but any move in EUR/CHF back to 1.24 should be bought into.

The rebound in the JPY and strong CNY fixings have given Asian currencies some support although sideways trading is expected in the near term. Equity capital outflows over recent days in the wake of higher risk aversion suggest some caution, however. South Korea in particular has been a major casualty of equity portfolio outflows this year although a factor that prevented the KRW from strengthening. Our models show PHP and THB as likely outperformers over coming weeks.

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