Speculators still short Euro

January 30, 2012 — Mitul Kotecha

Since I wrote “Beware of EUR short covering” EUR/USD has gained around 4%. EUR/USD is trying to gain a foothold above 1.3200 but failed overnight. Further gains will be more gradual. Helping the EUR is the fact that short positions hit an all time high according to IMM data for last week. However, data releases are unlikely to provide much impetus to the EUR, with most attention on the monthly series of PMI manufacturing confidence indices as consumer confidence readings.

At best the data will show some stabilisation but market will focus instead on the EU Summit beginning today and ongoing Greek debt talks as well as Italian debt auctions today. Greek debt talks are expected to be finalised this week including writedowns of around 70% but tensions over a German proposal to create a “budget commissioner” could yet hit the EUR.

The major release of the week in the UK is the January PMI manufacturing survey although there will also be attention on housing data including mortgage approvals and house price surveys from the Nationwide and Halifax. Overall the data will do little to dispel fears about the UK economy following the contraction in Q4 GDP revealed last week.

GBP will likely remain resilient to any bad economic news however, but its gains look limited especially given the revelation in the BoE MPC minutes that some members thought that more quantitative easing will be required. Having strengthened against the USD but weakened against the EUR over recent days, GBP continues to trade in a middle of the road manner. GBP/USD sellers will likely emerge around the 1.5870 resistance level while EUR/GBP is set to consolidate around 0.8350.

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Australian and NZ Dollar Outperform

January 27, 2012 — Mitul Kotecha

The boost to EUR following the dovish tone of the Fed FOMC statement on Wednesday has faded although the EUR looks well supported against the USD, JPY and GBP. Further gains against the USD will however, be limited to around 1.3201 (21 December 2011 high and 61.8% retracement from its 1.3553 high).

Reports overnight that Greek private lenders were willing to accept a coupon rate below 4% helped to boost confidence of an imminent deal with regard to Greek debt restructruing. Ahead of next week’s EU Summit the EUR will consolidate its gains, with attention focussing on a meeting between German Chancellor Merkel, Italian Prime Minister Monti, and French President Sarkozy on Monday.

USD/JPY has become insensitive to moves in most of its usual drivers. Bond yield differentials have lost influence over recent months despite a very strong relationship in the past. Similarly USD/JPY is also not particularly sensitive to moves in the USD index or risk aversion, with these relationships also breaking down lately according to my correlation calculations. Net foreign portfolio flows should in theory be playing negative for the JPY with outflows from bond and equity flows recorded in 8 of the last 10 weeks.

However, the reality is that USD/JPY remains stubbornly entrenched in a narrow 77-78 range. While a base appears to have been formed around the 77.00 level the upside momentum for the currency pair is weak. I stand by my view of USD/JPY ending the quarter around current levels given the loss of influence of its usual drivers but still look for an eventual move higher.

AUD and NZD have performed extremely well over recent weeks recording the biggest gains among major currencies so far this year. Both currencies have been boosted by improving risk appetite and receding growth worries in China. AUD in particular looks attractive in the wake of the dovish Fed and relative high AUD yield. I continue to believe markets are too dovish on Australian policy rate expectations, with markets pricing in more rate cuts this year beginning in February. Any reversal in easing expectations will support AUD.

AUD is also benefiting from diversification flows, with Russia’s central bank noting that it may begin to buy AUD in February. Nonetheless, AUD/USD gains look overly aggressive in a short space of time, with positioning turning increasingly long. AUD/USD will face strong resistance around 1.0753 over coming days.

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Fed weighs on the dollar

January 26, 2012 — Mitul Kotecha

The USD was already losing ground over the last couple of weeks against the background of firming risk appetite but the currency was dealt another blow from the Fed when it announced in the FOMC statement new guidance for monetary policy, stating that interest rates would remain “exceptionally low until at least late 2014” while keeping the door open to further quantitative easing. The statement helped to counter the pressure on the EUR from rising Portuguese bond yields, with EUR/USD breaking above 1.3100.

The prospect of prolonged low US interest rates means that the USD could remain a funding a currency for longer than anticipated. My forecasts of only a gradual appreciation of the USD over coming months take this into account to a large extent. I remain positive on the prospects for the USD against the EUR, JPY and CHF but predict further weakness against high beta commodity currencies and emerging market currencies over coming months. However, should US bond yields continue to remain suppressed even expectations of USD gains against the EUR, JPY and CHF may be dashed.

Although the Fed downgraded its growth expectations over coming quarters US data releases are looking more encouraging and in this respect the US is beginning to outperform other major economies. In contrast Europe’s growth outlook looks even gloomier while there is a long way to go before the problems in the region are resolved. Portugal has moved increasingly into the spotlight as markets increasingly anticipate some form of debt restructuring while in Greece debt talks have so far failed to reach any agreement on the extent of debt writedowns.

As the end of the week approaches risk is definitely on the front foot and the EUR has confounded many expectations by strengthening against all odds. I have highlighted the fact that the market was extremely short EUR over recent weeks as well as the EUR’s increasing resilience to bad news. I also noted that the Eurozone external position is still very healthy providing underling support for the currency. While I still look for the EUR to weaken over coming months expectations of a one way will not be fulfilled. EUR/USD will face strong resistance around 1.3201 (the 21 December high and 61.8% retracement from its 1.3553 high).

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More Bad News In Europe

January 16, 2012 — Mitul Kotecha

Several pieces of bad news soured sentiment at the end of last week undoing much of the good news since the beginning of the year and dashing hopes of a relatively swift resolution to Eurozone’s ills. S&P ratings agency downgraded nine Eurozone countries’ credit ratings leaving 14 on negative outlook. In particular France and Austria, which lost their triple AAA status while not particularly surprising, comes as a major blow to efforts to resolve the crisis. The downgrade puts at risk the EUR 180 billion in credit guarantees underpinning the EUR 440 EFSF bailout fund.

Separately the breakdown of talks on Greek debt restructuring and criticism by the Euuropean Central Bank (ECB) on a new draft of a treaty to ensure fiscal discipline added to the malaise, with the ECB noting that proposed revisions amount to a “a substantial watering down”. Such criticism will likely be an obstacle to the ECB stepping up its peripheral debt buying potentially threatening any decline in bond yields. It is difficult to see sentiment improving this week, with risk aversion set to remain elevated as Eurozone leaders attempt to restore confidence. In contrast, US data continues to support evidence of economic recovery, albeit gradual and this week’s releases including industrial production and manufacturing surveys will likely add to this.

The EUR slid further at the end of last week reversing earlier gains, as the bad news mounted in the Eurozone. Ratings downgrades, breakdown of Greek debt talks and ECB criticism over watered down fiscal rules, combined to make a dangerous concoction of negative headlines. The news put an end to the EUR’s short covering rally, leaving the currency vulnerable too further declines this week. Speculative sentiment according to IMM data reached another all time low last week (-155k net positions), suggesting that any good news could lead to a strong bounce as short positions are covered.

However, it is difficult to see where such news will come from and even a small expected bounce in the German January ZEW investor confidence survey this week will do little to detract from the negative news on the policy front. A meeting between Merkel, Monti and Sarkozy will be eyed closely as they prepare for a meeting of European Union (EU) Finance Ministers and markets will be looking for aggressive action to turn confidence around. Debt sales in In the meantime EUR/USD will continue to languish but strong technical support is seen around 1.2588.

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Beware of EUR short covering

January 11, 2012 — Mitul Kotecha

Europe has plenty of events to focus on over the next couple of days including the European Central Bank (ECB) Council meeting, and debt auctions in Spain and Italy. While I am by no means a EUR bull the risk is skewed towards some short term recovery or at least stabilization around EUR/USD 1.28. The speculative market is extremely short EUR while policy makers, specifically German Chancellor Merkel and French President Sarkozy are making the right noises. it appears to have finally dawned on Eurozone officials that its not just about austerity but also about growth and reform.

News that Fitch ratings is unlikely to downgrade France’s ratings this year has provided a boost to Eurozone confidence. Greece could yet spoil the party given the ongoing discussion with the Troika (Euuropean Commission, International Monetary Fund and ECB) to finalise the second bailout package for the country. Opposition resistance within Greece suggests that more austerity may not be easy to implement. Meanwhile there are ongoing questions about the extent of writedowns that Greek debt will undergo. Despite these issues it appears that markets are becoming somewhat more immune to events in the Eurozone. While still high bond yields for Italy and other debt still point to ongoing trouble, risk appetite has firmed.

One factor that is helping to boost sentiment is the encouraging news out of the US. Although the Q4 earnings season has not began particularly well data releases look somewhat more positive. Not only has positive impact of last week’s US December jobs report continued to filter through the market but so has other news such as a pick up in small business confidence and a rise in consumer credit. These lesser watched data highlight the gradual recovery process underway in the US and the growing divergence with the Eurozone economy and support the view of medium term USD outperformance versus EUR.

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