Markets in limbo ahead of policy rate decisions

April 6, 2011 — Mitul Kotecha

Markets are generally range-bound ahead of tomorrow’s Japan, Eurozone and UK interest rate decisions, as reflected in the flat performance of equity markets overnight. Risk appetite remains positive though still lower than the high levels seen during most of March. China’s interest rate hike did not change the market’s perspective, with markets reacting well.

Overnight the Fed FOMC minutes reflected a range of opinions on the timing of the end of QE2 and the Fed’s exit strategy but the majority view was to end QE2 as planned at the end of June leaving markets, with little new to digest. The USD was a little undermined by a weaker than expected US March ISM non-manufacturing survey but losses are likely to be limited.

Meanwhile there was more negative peripheral news in Europe, with Moody’s cutting Portugal’s sovereign credit ratings by one notch, with Moody’s highlighting the urgent need for financial support from the EU. Portuguese debt took a hit but eurozone markets in general including the EUR continue to take such news in their stride, with EUR/USD holding above 1.4200. Firm readings for the eurozone final services purchasing managers index (PMI) in March helped to support sentiment, outweighing the negative impact of a drop in eurozone retail sales.

GBP was a key outperformer, helped by a much stronger than expected services PMI, which helped GBP/USD breach 1.63 overnight. Today’s industrial and manufacturing production data will likely reveal firm readings too, helping GBP to consolidate its gains but the currency looks rather rich around current levels, with risks skewed to the downside.

JPY was another mover, having breached 85.00 versus the USD, with USD/JPY now some 6 big figures higher from its post earthquake lows. Japanese authorities will undoubtedly see a measure of success from their joint intervention but the reality is that the shift in bond yields (2-year US / Japan yield differentials have widened by close to 30 basis points since mid March, are finally having some impact on USD/JPY as reflected in the strengthening in short-term correlations.

EUR/USD remains resilient to negative peripheral news such as the Portugal credit ratings downgrade, with further direction from tomorrow’s European Central Bank (ECB) meeting and accompanying statement. The risk that the ECB is not as hawkish as the market has priced in holds some downside risks to EUR.

Asian currencies are holding up well though it looks as though the ADXY (Bloomberg-JP Morgan Asian currency index) may have hit a short term barrier. Range trading for EUR/USD suggests little directional influence for Asian currencies in the short-term. Nonetheless, portfolio capital inflows continue to support Asian FX with all Asian equity markets recording foreign inflows so far this month. In particular, KRW continues to outperform. Note that Korea has recorded a whopping inflow of $1.1bn in equity inflows month-to-date.

Posted in Asia, Bond markets, central banks, China, Currencies, ECB, Economics, Economy, emerging markets, Europe, eurozone, Federal Reserve, FX, Interest rates, Japan, Portugal, South Korea, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

FX sensitivities to yield differentials

April 1, 2011 — Mitul Kotecha

A lot has been made about the hawkish language from a few Federal Reserve FOMC members over recent days and growing speculation about whether quantitative easing (QE2) will end earlier than initially planned. In turn, this has been noted as a positive factor for the USD. Undoubtedly there are a few in the Fed who are becoming more nervous about current policy settings but it is highly unlikely that the Fed will not complete its $600 billion in planned asset purchases by the end of June.

The biggest imponderable is how and when the Fed begins its exit policy and how effectively/efficiently it can be done. Whilst it is likely to be over a year before the Fed Funds rate is hiked, the USD will be sensitive to balance sheet reduction. Moreover, the way in which the Fed reduces the size of the balance will also be important given the likely active approach to liquidity withdrawal required.

For the present, it should be noted that even with the hawkish Fed rhetoric and increase in US bond yields (2 year yields have risen by close to 25bps over the last couple of weeks) the USD is actually lower versus EUR than where it was two weeks ago. The reality is that German bund yields have risen by even more than US yields ahead of the anticipated European Central Bank (ECB) rate hike on 7 April (the case for which appears to have been sealed by the above consensus 2.6% YoY reading for March eurozone CPI).

However, I would be cautious about ascribing general FX moves at present to yield / interest rate differentials given that it is only EUR crosses (including EUR/JPY, EUR/GBP, EUR/CAD, and EUR/USD) that hold a statistically significant relationship with yields. All of this implies EUR crosses look supported ahead of the upcoming ECB meeting, with EUR/USD unlikely to sustain a drop below 1.4000 ahead of the rate decision. What happens after depends on the press conference. Bearing in mind that markets have already priced in 75bps of rate hikes by the ECB it would take an even stronger tone from the ECB to push the EUR higher, something that looks unlikely

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Germany, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »

Risk on, US dollar pressure

March 22, 2011 — Mitul Kotecha

FX markets have plenty of different factors to digest these days and after a harrowing couple of weeks markets began this week on a firmer footing. The overall tone into this week is to load up on risk assets. News that the nuclear situation in Japan may closer to stabilising has helped, whilst markets easily shook off another hike in China’s reserve ratio and ongoing conflict in Libya as Allied forces step up their campaign in the face of continuing resistance from Gaddafi’s forces.

Improved risk appetite has helped to keep the JPY on the defensive along with the continued threat of FX intervention, with further official JPY selling likely in the days ahead. Interestingly the intervention last Friday was estimated at only JPY 530 billion ($6.2 billion), much lower than previously thought. USD/JPY 80 remains a major line in the sand and any sign of another breach of this level will likely be met with official JPY selling. I suspect that the Japanese authorities will not be content until USD/JPY is far higher. In this respect its worth noting an official report released earlier in March highlighting that Japanese companies are not profitable at a USD/JPY rate below 86.

The EUR looks overbought around the 1.42 level but seems to be a beneficiary of Japanese FX intervention (perhaps a recycling of USDs into EUR) as well as comments by European Central Bank (ECB) Council members reiterating their intention to hike the refi policy rate, likely at the April ECB meeting. In a similar vein to the recycling of intervention USDs into EUR, Middle East entities may also be recycling petrodollars into EUR whilst news that Russia has permitted one of its oil related funds to buy Spanish debt has given a lift to sentiment for the EUR. Over the near term EUR/USD may struggle to make much headway above 1.42, with further direction coming from the EU leaders meeting on 24/25 March.

GBP is also doing well, having jumped close to the 1.6400 level versus USD, with UK February CPI giving the currency a further lift. The outcome at 4.4% YoY, which was not as bad as rumoured but in any case worse than consensus will give the hawks in the Bank of England MPC further ammunition to push for a policy rate hike. The fact that core inflation also increased suggests that the jump in headline inflation cannot merely be brushed under the table. A BoE rate hike is increasingly looking like a done deal. Renewed inflation worries in the UK and the hawkish rhetoric from ECB officials is sufficient to keep the USD under pressure.

Posted in central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, FX, Interest rates, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

G7 Intervention Hits Japanese Yen

March 18, 2011 — Mitul Kotecha

One could imagine that it was not difficult for Japan to garner G7 support for joint intervention in currency markets given the terrible disaster that has hit the country. Given expectations of huge repatriation flows into Japan and a possible surge in the JPY Japanese and G7 officials want to ensure currency stability and lower volatility. Moreover, as noted in the G7 statement today officials wanted to show their solidarity with Japan, with intervention just one means of showing such support.

Although Japanese Finance Minister Noda stated that officials are not targeting specific levels, the psychologically important level of 80.00 will likely stick out as a key level to defend. Note that the last intervention took place on 15 September 2010 around 83.00 and USD/JPY was trading below this level even before the earthquake struck. The amount of intervention then was around JPY 2.1 trillion and at least this amount was utilised today. The last joint G7 intervention took place in September 2000.

Unlike the one off FX intervention in September 2010, further intervention is likely over coming days and weeks by Japan and the Federal Reserve, Bank of France, Bundesbank, Bank of England, Bank of Canada and other G7 nations. The timing of the move today clearly was aimed at avoiding a further dramatic drop in USD/JPY, with Thursday’s illiquid and stop loss driven drop to around 76.25 adding to the urgency for intervention. USD/JPY will find some resistance around the March high of 83.30, with a break above this level likely to help maintain the upside momentum.

The JPY has become increasingly overvalued over recent years as reflected in a variety of valuation measures. Prior to today’s intervention the JPY was over 40% overvalued against the USD according to the Purchasing Power Parity measure, a much bigger overvaluation than any other Asian and many major currencies. The trade weighted JPY exchange rate has appreciated by around 56% since June 2007. In other words there was plenty of justification for intervention even before the recent post earthquake surge in JPY

Although Japanese exporters had become comfortable with USD/JPY just above the 80 level over recent months, whilst many have significant overseas operations, the reality is that a sustained drop in USD/JPY inflicts significant pain on an economy and many Japanese exporters at a time when export momentum is slowing. Japan’s Cabinet office’s annual survey in March revealed that Japanese companies would remain profitable if USD/JPY is above 86.30. Even at current levels it implies many Japanese companies profits are suffering.

Upward pressure on the JPY will remain in place, suggesting a battle in prospect for the authorities to weaken the currency going forward. Round 1 has gone to the Japanese Ministry of Finance and G7, but there is still a long way to go, with prospects of huge repatriation flows likely to make the task of weakening the JPY a difficult one. The fact that there is joint intervention will ensure some success, however and expect more follow up by other G7 countries today to push the JPY even weaker over the short-term.

Posted in Asia, central banks, Currencies, ECB, Federal Reserve, France, FX, Germany, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

Japanese yen spikes higher

March 17, 2011 — Mitul Kotecha

Events in Japan continue to dominate market action in this respect the situation is highly fluid. Markets will continue to gyrate on various pieces of news concerning the nuclear situation in Japan. As a result, risk aversion remains highly elevated and safe haven assets including US Treasuries, German bunds and the CHF are the main beneficiaries. In contrast, risk assets including global equity markets and risk currencies have come under growing pressure.

Prior to Japan’s earthquake risk aversion was already elevated amidst renewed eurozone peripheral bond tensions but the aftermath of the earthquake has seen our risk barometer rise to its highest level since the end of August last year. Any decline in risk aversion will depend on the nuclear situation coming under some form of control but until then the general “risk off” market tone will continue. Similarly currency and equity volatility will also remain relatively high.

Risk had been losing its influence on currencies over recent months but the spike in risk aversion over recent weeks has seen short-term correlations increase. The most highly impacted (highest correlations over the past month) currencies from higher risk aversion USD/JPY, USD/CHF, NZD/USD, NOK/SEK, EUR/CHF, EUR/HUF, EUR/PLN, USD/KRW. Over a three-month period all of the correlations are much lower and insignificant for the most part. JPY and CHF will likely remain the key beneficiaries in the current environment.

USD/JPY hit a low of 76.25 amidst volatile trading conditions but Japanese authorities noted that rumours of Japanese life and non life insurance companies repatriating funds back to Japan are “groundless”. USD/JPY bounced from its lows but there appears to be no sign of intervention although there may have been Bank of Japan rate checking, which helped to provoke some fears about imminent intervention. There is a high risk of FX intervention as long as USD/JPY remains below the 80.00 level.

Posted in Asia, central banks, Currencies, equity markets, Europe, eurozone, FX, Hungary, Japan, South Korea, Switzerland, US. Tags: , , , , , , , , , , , , , . Leave a Comment »
« Older posts
Newer posts »