Fed’s status quo fuels caution

June 23, 2011 — Mitul Kotecha

The Fed’s status quo did little to stir markets overnight although there was a decidedly negative tone to equities and commodities, perhaps spurred by the downgrading of US growth forecasts. The fact that the Fed did not indicate that it is considering further asset purchases but instead will keep its balance sheet at around $,2800 billion also acted as a drag on markets.

The major concern for markets remains the depth and length of the current ‘soft patch’. The Fed believes it will be temporary and we concur, but clearly the slide in equity markets over recent weeks, suggests that there has been a divergence between stock market expectations and reality. The USD however, may actually be finding a medium term bottom, with the fact that the Fed is not considering QE3,

The downbeat Fed stance combined with a cautious reaction to the Greek government’s passage of a confidence motion indicates that markets will remain cautious over the near term. Indeed, comments by the Greek opposition that they will not support further austerity measures dashed any hopes of unity and will add another obstacle towards an easing in Greek tensions.

As it is the continued wrangling between European officials over private sector participation in any debt rollover as well as uncertainty over how ratings agencies will react, threatens to keep sentiment under pressure. The EUR has remained surprisingly resilient but its muted reaction to the passage of the confidence motion has given way to some weakness and the currency remains a sell on rallies.

GBP was a major underperformer weighed down by the relatively dovish Bank of England MPC minutes in which some members were even discussing further asset purchases. The currency faces further risks from a the CBI reported sales data for June where a decline in sales is likely to be reported. GBP/USD looks vulnerable to a drop below its 200 day moving average around 1.6027.

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US Economic Data Disappointments

June 2, 2011 — Mitul Kotecha

Risk gyrations continue, with a sharp shift back into risk off mood for markets driven in large part by yet more disappointing US economic data as the May ADP jobs report came in far weaker than expected at 38k whilst the ISM manufacturing index dropped to 53.5 in May, its lowest reading since September 2009. This was echoed globally as manufacturing purchasing managers indices (PMI) softened, raising concerns that the global ‘soft patch’ will extend deeper and longer than predicted.

The market mood was further darkened by news that Moodys downgraded Greece’s sovereign credit ratings to Caa1 from B1, putting the country on par with Cuba and effectively predicting a 50% probability of default.

The resultant jump in risk aversion was pretty extensive, with US Treasury yields dipping further, commodity prices dropping led by soft commodities, and equity volatility spiking although notably implied currency volatility has remained relatively well behaved.

Global growth worries led by the US have now surpassed Greek and eurozone peripheral country concerns as the main driver of risk aversion, especially as it increasingly looks as though agreement on a further bailout package for Greece is moving closer to being achieved. Moreover, it seems as though a ‘Vienna initiative’ type of plan is moving towards fruition involving a voluntary rollover of debt.

The lack of first tier economic data releases today suggests that it will be a case of further digestion or perhaps indigestion of the weak run of US data releases over recent weeks and the implications for policy. For instance, it is no coincidence that QE3 is now being talked about again following the end of QE2 although it still seems very unlikely.

Bonds may see some respite from the recent rally given the lack of data today although this may prove short-lived as expectations for the May US jobs report tomorrow are likely to have been revised sharply lower in the wake of the weak ADP jobs data and ISM survey yesterday, with an outcome sub 100k now likely for May US non-farm payrolls.

Meanwhile, FX markets are caught between the conflicting forces of higher risk aversion and weaker US data, leaving ranges to dominate. On balance, risk currencies will likely remain under pressure today and the USD may get a semblance of support in the current environment.

This may be sufficient to prevent EUR/USD from retesting its 1 June high around 1.4459 as markets wait for further developments on the Greek front. Once again the likes of the CHF and to a lesser extent JPY will do well in a risk off environment whilst the likes of the AUD and NZD will suffer.

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Position Unwinding Boosts USD

May 9, 2011 — Mitul Kotecha

The USD’s multi-month fall has come to an abrupt halt, with the currency registering gains in reaction to what appears to be a major position unwinding across asset markets, led by a drop in commodity prices.

Will it continue? Whilst I am amongst the more bullish forecasters on the USD over the medium term, the current rally could prove to be short-lived in the absence of a shift in Federal Reserve rhetoric or end to quantitative easing (QE2). Nonetheless, the market had got itself very short USDs (as reflected in the CFTC IMM data as of early last week which showed an increase in net short positions) and the rally in the USD last week was likely spurred by major short-covering which could extend further into this week.

The move in the USD gained momentum as European Central Bank (ECB) President Trichet proved to be less hawkish than many expected in the press conference following last Thursday’s ECB meeting. Moreover, renewed worries about Greece at the end of last week, with a report in the German Der Spiegel, later denied by Greek officials, that the country was planning to leave the Eurozone dented the EUR,

Taken together with the improving trend in US April non-farm payrolls (April registered +244k increase, with private payrolls 268k), these factors colluded to provide further positive stimulus to the USD and negative fallout on the EUR. The room for EUR downside is evident in the net long EUR speculative position, which rose to its highest since December 2007 as of 3rd May.

This week’s batch of US releases including March trade data, April retail sales and CPI, are unlikely to result in a reversal in last week’s trend though a trend like reading for core CPI, with the annual rate below the Fed’s comfort zone will reinforce expectations of dovish Fed policy being maintained, which could inject a dose of caution into the USD’s rally.

Against the background of a likely widening in the US trade deficit in March there will plenty of attention on the annual strategic and economic dialogue beginning today, with markets interested in discussions on Chinese worries about the gaping US fiscal deficit and US concerns about China’s exchange rate policy.

Greece’s denial of plans to leave the eurozone and discussions over a further adjustment to Greece’s bail out package, may help limit any drop in the EUR this week though it will by no means mark the end of such speculation about the periphery especially with this weeks’ Q1 GDP data releases across the eurozone likely to further highlight the divergence between the core and the periphery even if the headline eurozone reading rebounds strongly as we expect.

In the UK the Bank of England Quarterly Inflation Report will be the main influence on GBP. Downward growth revisions will play into the view that inflation will eventually moderate, capping expectation of higher interest rates over the coming months. However, the likely upward revision to near term inflation forecasts will help limit any damage to GBP.

GBP has lost ground to the USD but it should be noted that it has outperformed the EUR over recent days, reversing some of the recent run up in EUR/GBP. Given that EUR sentiment is likely to remain fragile this week, GBP may continue to capitalise, with a test of EUR/GBP 0.8672 on the cards.

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Risk Aversion Creeps Higher

May 4, 2011 — Mitul Kotecha

The USD index has dropped by around 17% since June 2010 high and despite a slight bounce this week it is unlikely to mark the beginning of a sustained turnaround. Nonetheless, I would caution about getting carried away with positioning for USD weakness. Whilst an imminent recovery looks unlikely the risk/reward of shorting the USD is becoming increasingly unfavourable.

Until then Federal Reserve comments will be watched closely for clues on policy and there are plenty of Fed speakers this week including a speech by Boston Fed’s Rosengren today and Fed Chairman Bernanke tomorrow. The USD will also gain some direction from jobs data and markets will be able to gauge more clues for Friday’s non-farm payrolls data , with the release of the April ADP employment report today.

The EUR is one currency that has suffered this week. News that Portugal’s caretaker government has reached an agreement with the European Union / International Monetary Fund on a bailout of as much as EUR 78 billion has so far been greeted with a muted response. EUR attention is still very much focussed on the ECB meeting tomorrow and prospects of a hawkish press statement suggest that EUR/USD downside will be limited, with support seen around 1.4755.

The JPY has strengthened by around 5% versus USD since its 6th April USD/JPY high around 85.53, confounding expectations that Japan’s FX intervention following the county’s devastating earthquake marked a major turning point in the currency. A combination of narrowing interest rate differentials with the US (2 year US/Japan yield differentials have narrowed by around 20bps in the past month), strong capital inflows to Japan (net bond and equity flows in the last four weeks have increased to their highest this year), and rising risk aversion have all played their part in driving the JPY higher.

As a result USD/JPY is fast approaching the psychologically important level of 80, a level that if breached will likely lead to FX intervention. Although Golden Week holidays in Japan this week suggest that JPY liquidity may be quite thin, Japanese authorities are likely to remain resistant to further gains in the JPY, likely using thinning liquidity to their advantage.

Despite the JPY’s recent strength speculative positioning over the past four weeks has remained net short JPY, whilst Japanese margin traders have also increased their long USD/JPY bets, suggesting that these classes of investors are not to blame for the JPY’s appreciation. This suggests that FX intervention may not be as successful given that the market is already short JPY.

Given the risk of intervention on USD/JPY, the CHF appears to be an easier choice for safe haven demand against the background of rising risk aversion. The currency has risen to a record high against the USD, gaining around 8.3% so far this year. Given the hints of higher interest rates by the Swiss National Bank (SNB) and resilience economic performance, downside risks for CHF are limited at present unless risk appetite improves sharply. Further gains are likely with USD/CHF likely to test the 0.8570 support level over the short-term.

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Central bank decisions and US payrolls in focus

May 1, 2011 — Mitul Kotecha

The USD’s troubles are far from over. Data and events this week will do little to stop the rot. As US Federal Reserve Chairman Bernanke made clear last week the Fed is committed to completing its asset purchase programme by the end of June though there is plenty of debate about what comes after. Reduced growth forecasts and the Fed’s view that price pressures are “transitory” have been sufficient to keep the USD on its knees.

The weaker than expected reading for Q1 US GDP growth at 1.8% QoQ clearly did nothing to alleviate pressure on the USD even though it is widely believed that the soft growth outcome will prove fleeting, with recovery set to pick up pace over the coming months. In truth much will depend on the trajectory for oil prices, especially as petrol prices in the US verge on the psychologically important $4 per gallon mark. Even higher energy prices could dent growth further but lower or stable prices will keep the recovery on track.

The highlight in this holiday shortened week for many countries this week is the US April jobs report at the tail end of the week. Estimates centre on around a 200k gain in payrolls but forecasts will be refined with the release of the ADP private sector jobs report and ISM manufacturing survey earlier in the week. The unemployment rate may prove sticky and will likely remain at 8.8%, a disappointment to those looking for a quicker recovery. The elevated unemployment rate will only reinforce expectations that the Fed will not be quick to reverse policy, with the USD continuing to suffer as a result.

Central bank meetings will be plentiful this week, with the European Central Bank (ECB) and Bank of England (BoE) likely to garner most attention. Recent data in the Eurozone has provided further evidence of growth divergence between North and South, but the EUR has remained resilient to this as well as to increased concerns about the periphery. This make the ECB’s job even tougher than usual when it meets this week and it is unlikely that the Bank will hike rates again so soon, especially given the strength of the EUR. Nonetheless, Trichet will continue to sound hawkish, limiting any damage to the EUR (if any) of no move in policy rates.

Similarly the Bank of England will also remain on the sidelines though this should come as little surprise in the wake of disappointing data recently and a surprise drop in inflation, albeit to still well above the BoE’s target. GBP has made up ground against a generally weak USD but judged against other currencies it has been an underperformer as expectations of monetary tightening have been pared back. Finally, the Reserve Bank of Australia (RBA) is set to remain on hold, but a hike over coming months remains likely even with the AUD at such a high level. Quite frankly although the USD is looking increasingly oversold there is nothing this week that would suggest it will recover quickly.

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