Sell into the USD/JPY rally, EUR bottoming out, GBP vulnerable

November 19, 2012 — Mitul Kotecha

Following a week when risk measures continued to worsen there may not be much respite over coming days. The usual suspects will continue to direct sentiment including US fiscal cliff discussions, Greece’s next loan tranche and debt sustainability, the timing of any possible Spanish bailout request, and the conflict between Israel and Hamas in the Gaza strip. Added to this list are worries about economic growth.

Data releases this week are expected to be soft in general, with US existing home sales set to slip in October, weak readings for Eurozone flash purchasing managers’ indices and an eight consecutive drop in the German IFO business climate survey in November. Trading conditions will likely thin over coming days as the US Thanksgiving holiday on Thursday approaches.

Events over coming days will at least give further clues on the monetary policy front, with Fed Chairman Bernanke scheduled to give a speech at the Economics Club of New York, an event which may shed some light on Fed policy once Operation Twist ends. In the UK Bank of England minutes will also be scrutinised for clues on more QE, with a likely split decision set to be revealed. GBP continues to suffer from a bad combination of weak activity and higher inflation, leaving the currency vulnerable to further selling, especially against EUR.

Additionally, the Bank of Japan will decide on policy although a pause is expected this week given that easing measures were only announced at the last meeting at the end of October. The general election on December 16 may also complicate BoJ policy. USD/JPY’s upside potential looks limited from current levels and a lack of action from the BoJ tomorrow will likely undermine the current pair further. USD/JPY will find strong resistance around 81.78.

In Europe policy decisions will focus on developments in Greece, with the next loan tranche for the country to be decided and discussions on the 2014-2015 EU budget set to take place. The loan Greek aid discussions tomorrow ought to lead to an agreement to distribute EUR 31.5 billion in aid to Greece. The decision may help the EUR to edge higher, although EUR/USD will need to break above its 200 day moving average around 1.2807 before it can register more concrete signs of recovery.

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Peering over the cliff

November 16, 2012 — Mitul Kotecha

As the US edges closer to falling off the fiscal cliff budget discussions between US President Obama and Congressional leaders commencing today will garner most attention. Conciliatory signs from both sides suggest some attempt at compromise but tough starting points mean that it will not be easy to match rhetoric with reality.

Markets are clearly in nervous mood, with US stocks closing lower as risk aversion edged higher. Disappointing earnings from Wal-Mart Stores taken together with a weaker than anticipated Philly Fed survey in November and weekly jobless claims added another layer of negativity to the market. Despite the US-centric fiscal cliff risks the USD remains firm although notably its pace of appreciation has slowed, with the currency likely to make little headway in the near term.

Although unsurprising, data in Europe confirmed that the region fell back into recession, an outcome that will do little to ease tensions. Hopes of a final agreement on Greece’s loan tranche at next week’s Eurogroup meeting may however, limit any damage to Eurozone markets. The EUR has shown signs of bottoming out and may take further advantage of the respite from a more restrained USD. There is little of interest on the data front today, with Eurozone current account data, US industrial production and TICS flows the main highlights.

On the political front the dissolution of parliament in Japan is the highlight, with markets continuing to push the JPY lower as expectations of more aggressive action after elections to the weaken the currency grow. The fourth consecutive downgrade of Japan’s economic assessment by the government highlights the urgency for such action.

Asian currencies are finding a little more resistance to further gains as the appreciation of the CNY has stalled over recent days. The most sensitive currencies to the CNY including KRW and TWD will likely face most resistance to further gains. In contrast those currencies that are more USD sensitive including INR and MYR could take advantage of any pause in USD index gains.

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JPY hit by politics, AUD losing ground

November 15, 2012 — Mitul Kotecha

A total solar eclipse as seen in Australia yesterday portends to a shift in market trends. Whether this is borne out by actual market movements is debatable as the major themes underlying investor psyche continue to dominate. First and foremost is the US fiscal cliff and the potential lack of resolution to this issue. Notably US and European equities slipped overnight as hopes/expectations of a solution by the end of the year continue to fade ahead of discussions between US politicians tomorrow.

In Europe, lack of progress in Spain and Greece are resulting in Eurozone peripheral bond yields creeping higher while safe haven demand continues to support core bonds. Geopolitical tensions increased following Israeli air strikes in the Gaza strip, helping to prop up oil prices. The USD remains supported against this background, but notably has failed to make much progress over recent days. All of this is not conducive to a positive environment for risks assets and as fiscal cliff talks are awaited a cautious tone is likely to permeate trading today.

The JPY took a hit following news that Japan’s Prime Minister Noda may dissolve parliament on November 16, paving the way for fresh elections. The JPY’s drop was not attributable to political uncertainty but rather the prospects that a likely opposition led LDP victory in any new election would likely lead to a more aggressive stance on policy, putting more pressure on the BoJ to ease.

USD/JPY has broken back above the 80.00 level but is susceptible to a renewed drop given the decline in US bond yields relative to Japanese bond yields. Moreover, risk aversion has intensified over recent weeks, providing another prop to the JPY. However, worsening economic news means that official pressure for JPY weakness will be maintained and regardless of the elections the BoJ has a lot further to act over coming months.

AUD extended its rally since the RBA kept policy on hold last week helped by better domestic and external data (especially in China). However, the currency has looked more vulnerable this week and my quantitative model estimates for AUD/USD and AUD/NZD highlight that AUD is looking increasingly overbought in the short term. While the models do not yet have a high conviction sell signal I suggest beginning to offload long positions around the 1.0400 level versus USD, playing for a short term pull back in the currency.

Any pull back will likely be short lived, but nonetheless, it will in my view provide better entry levels for investors looking to build medium term long positioning in AUD. Supporting my assessment is the fact that long AUD speculative positioning (IMM) is back at multi week highs, leaving the currency vulnerable to profit taking.

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JPY, GBP and CHF outlook

October 18, 2012 — Mitul Kotecha

USD/JPY blipped above 79.00 in the wake of a report in the Japanese press that states that the Bank of Japan (BoJ) is considering more easing measures at its board meeting on October 30 in order to achieve their 1% inflation goal. Higher US bond yields in the wake of the better than expected US data releases this week are also acting to support USD/JPY.

Given that Japan has effectively been less aggressive than other central bank yet has a fairly ambitious inflation goal, pressure for more aggressive BoJ action should not be surprising. However, in the past the BoJ has underwhelmed and unless US yields continue to push higher, USD/JPY may end up back in its recent ranges. USDJPY 79.23 is a strong initial barrier for the currency pair to cross to establish any move higher.

GBP/USD has edged higher since hitting a low just under 1.60 late last week benefitting in large part from general USD weakness. This is unsurprising given the strong correlation between GBP/USD and the index. However, the true reading of GBP is evident on the crosses and here the picture is far less positive. GBP has lost ground against the EUR and looks set to weaken further.

GBP losses may be limited to around 0.8198 given that interest rate differentials have turned more GBP positive recently. UK retail sales and public finances data today will give further direction and although a bounce back is likely in September sales any positive impact on GBP is likely to be short lived as the currency continues to be restrained by expectations of more BoE QE.

The expectations of a request for Spanish aid and ensuing European Central Bank (ECB) action has managed to alleviate inflows into CHF assets, helping the SNB’s task of protecting its 1.2000 line in the sand for EUR/CHF. Consequently FX reserves growth is likely to slow which in turn will reduce diversification flows from the SNB into other currencies. My forecasts continue to show both EUR/CHF and USD/CHF moving higher by year end.

However, in the short term USD/CHF will edge lower amid general pressure on the USD. Upcoming data releases including trade data today will help give some indication as to whether the SNB’s policy stance is having a positive economic impact. The sharp drop in the CHF nominal effective exchange rate since the implementation of the CHF ceiling will help but there are still many domestic companies calling for a weaker currency.

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Reality Check

September 24, 2012 — Mitul Kotecha

Markets face a reality check going into this week. The euphoria emanating from recent Fed, ECB and BoJ actions is fading quickly. The reality of weak growth and underlying structural tensions is coming back to haunt markets, suggesting much more limited upside for risk assets over coming weeks.

While there are some positive indications that the growth outlook may not have much further to deteriorate, such as the bounce in the Baltic Dry Index, scepticism about the ability of central banks to reflate economies is growing. In this respect, its worth highlighting that the rally in gold prices failed to extent much further last week although in part this may be due to an options expiry tomorrow.

Renewed tensions are creeping back into the market psyche, especially with regard to Europe. Procrastination from Spain about a formal bailout threatens to weigh on markets in the days ahead as some officials suggest that the EUR 100 billion received for Spanish banks will be sufficient for the country to avoid needing further aid. Bank stress test results, a Moody’s review on Spanish ratings and the country’s 2013 budget will all be scrutinised over coming days.

Meanwhile, disagreement between Germany and France over the timing of introducing banking union and supervision is accentuating tensions in the region. Greece remains in the limelight too, as the government continued to find further budget cuts in order to receive the next tranche of loans. The only good news appeared to come from a German press report that the ESM permanent bailout fund’s firepower will be leveraged up to EUR 2 trillion.

The EUR has lost momentum following its initial surge higher and looks constrained on any move above 1.3000. While EUR short positions have continued to be pared back according to IMM data the scope for short covering is becoming more limited. Developments in Spain and Greece will provide further guidance for the currency, but any upside in EUR/USD will be limited to resistance around 1.3180. It seems more likely that having failed to sustain gains, the EUR will continue to drift lower.

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