JPY and GBP to slip further

January 29, 2013 — Mitul Kotecha

Market gyrations were relatively limited overnight, with a rise in the VIX fear gauge and rise in Chinese equities the most notable market moves overnight. US data was mixed, with enthusiasm over a solid gain in December durable goods orders tempered by a drop in pending home sales. Notably the Baltic Dry Index has extended its decline over recent days, suggesting that the risk rally is losing some steam.

Nonetheless, core debt yields continue to test important psychological levels, with the 2% barrier in sight for 10 year US Treasuries. Data and events today include a US consumer confidence, for which we expect a slight decline in January, and various European Central Bank speakers. Additionally, the ECB’s main refinancing operation (MRO) will be scrutinised to determine bank’s health following last week’s LTRO payback. Overall, direction looks limited ahead of this week’s Fed FOMC decision and US jobs report.

The JPY’s drop has proven to be relentless. Despite being blamed for instigating a currency war Japanese officials are showing little let up in their push for JPY weakness. Although there has been some widening in the US Treasury and German bunds yield advantage over Japanese JGBs it does not fully account for the sharp JPY move. Interestingly speculative JPY short positions have actually lessened, implying that the drop in the JPY is attributable to other investor classes.

Additionally Japan has registered net portfolio inflows over recent weeks and so cannot explain the JPY’s drop. One factor that is weighing on the JPY is the improvement in risk appetite; USD/JPY is the most correlated currency with our risk barometer over the past 3 months. As risk and yield appetite has picked up JPY has effectively regained its mantle as funding currency. USD/JPY will face some tough resistance levels from around the 91.48 level, but so far the currency pair has made short work of breaking through resistance.

In one respect GBP’s drop against the USD and EUR reflects a reversal of safe haven flows similar to JPY. Notably however, GBP has not been correlated with the JPY. Its decline is more associated with renewed UK economic worries and in turn expectations of further Bank of England asset purchases, especially under the helm of a new governor. Moreover, speculation of a credit ratings downgrade has not been helpful to GBP. The net result is a reduction in speculative interest and further selling pressure.

Fortunately for the UK economy a weaker currency is no bad thing unless it provokes growing inflationary pressures. Given the dovish noises from incoming BoE Governor Carney, it looks as though there is little concern on this front. Manufacturing confidence data at the end of this week is unlikely to dispel economic concerns, leaving GBP vulnerable to further slippage.

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Currency frictions

January 28, 2013 — Mitul Kotecha

I would like to apologise for the lack of posts over the last couple of weeks. I have been on a client roadshow presenting our macro and markets outlook for 2013 to clients across Asia. Having returned the mood of the markets is clearly bullish as risk assets rally globally. Recovery hopes are intensifying as tail risk is diminishing while central banks continue to keep their monetary levers fully open.

A heavy slate of US data releases this week will keep markets busy but overall I see little to dent the positive tone to risk assets over coming sessions. The main events this week include the US January jobs report (forecast +160k) and Fed FOMC meeting (no change likely) while consumer and manufacturing confidence, Q4 GDP and December durable goods orders are also on tap.

In the Eurozone attention will focus less on data but more on Eurozone banks’ balance sheets, with further capital inflows likely to be revealed, marking another positive development following last week’s strong payback of LTRO funds. Elsewhere, industrial production in Japan is likely to reveal a healthy gain while an interest rate decision in New Zealand (no change likely) will prove to be a non event.

As fiscal and monetary stimulus measures are largely becoming exhausted or at least delivering diminishing returns the next policy push appears to be coming from the currency front. The issue of ‘currency war’ is once again doing the rounds in the wake of Japan’s more aggressive stance on the JPY leading to growing friction in currency markets.

In contrast the easing of Eurozone peripheral strains have boosted the EUR, in turn resulting in a sharp and politically sensitive move higher in EUR/JPY. Central banks globally are once again resisting unwanted gains in their currencies, a particular problem in emerging markets as yield and risk searching capital flows pick up. Expect the friction over currencies to gather more steam over the coming weeks and months.

In the near term likely positive news in the form of large capital inflows into Eurozone peripheral banks and sovereign bond markets will keep the EUR buoyed. The USD in contrast will be restrained as US politicians engage in battle over the looming budget debate and spending cuts despite the move to extend the debt ceiling until May.

GBP has slid further and was not helped by the bigger than expected drop in Q4 GDP revealed last week which in turn suggests growing prospects of a ‘triple dip’ recession. The lack of room on the fiscal front implies prospects for more aggressive Bank of England monetary policy especially under the helm of a new governor and in turn even greater GBP weakness.

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USD under pressure, except versus JPY

January 14, 2013 — Mitul Kotecha

Following another positive week for risk assets where equities in particular benefitted from substantial capital inflows this week is unlikely to look much different. A host of earnings, especially from financials will help dictate the equity market and in turn risk tone over coming days. There will also be plenty of focus on speeches by various Fed and European Central Bank (ECB) officials including Fed Chairman Bernanke today.

The week will start off in more subdued fashion however, with a Japanese holiday and little fresh news to digest over the weekend. Hope and faith in global economic recovery helped by data releases in the US and China in particular, have helped to calm markets while there is little angst as yet about the looming debt ceiling / spending cut negotiations in the US.

Despite the rush into equities, core bond yields appear to have hit a short term ceiling. Meanwhile, the USD is likely to maintain a weaker tone over the short term except versus JPY where the currency pair has broken through key technical barriers on the top side and is verging on a break of 90.00 helped by more comments over the weekend by Japanese Prime Minister Abe pushing for a 2% inflation target to be implemented.

Data releases this week will maintain the growth recovery story in the US while the Eurozone will continue to show a weaker trajectory. In the US there are plenty of releases to chew on including December retail sales, inflation, industrial production, manufacturing surveys, housing starts, Michigan confidence, and the Fed’s Beige Book. Overall, US releases will help paint a picture of steady and gradual recovery.

In contrast the Eurozone data slate is more limited and what there is (German GDP, Eurozone industrial production) will be less impressive supporting the view of Eurozone economic underperformance over coming months. Admittedly this has yet to affect the EUR which continue to benefit from peripheral bond yield compression and receding crisis fears although EUR/USD will likely run into resistance around 1.3385 which if broken will open the door for a test of 1.3486.

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EUR and GBP slipping, JPY lower

January 10, 2013 — Mitul Kotecha

Slightly better market sentiment allowed equity markets in the US to close higher in the wake of earnings helped too boost sentiment but overall direction remains limited ahead of a plethora of earnings releases over coming days and more immediately the European Central Bank and Bank of England meetings today.

Fed speakers will also be watched closely, while bond auctions in Spain and Italy will be another key influence for Eurozone markets. Meanwhile, the VIX ‘fear gauge’ rebounded slightly but remains at a low level while the USD index continued its ascent and is likely to continue to remain firm.

The ECB and BoE are set to leave policy unchanged today but this will not prevent both EUR and GBP from losing ground against the USD. The principle risk to GBP revolves around the UK economy. Weaker data releases have restrained GBP both against the USD and EUR.

Given the likelihood that growth will not recover quickly this will continue to act as a weight on GBP in the months ahead. Only the fact that the Eurozone economy will look even weaker will allow GBP to appreciate versus EUR while relative US economic outperformance will ensure a relatively softer GBP versus USD.

The breach of GBP/USD’s 100 day moving average level around 1.6061 is a trigger for a steeper decline. Conversely EUR/GBP may register some further short term upside but technical indicators suggest a relatively flat picture for the currency pair over coming weeks.

It is clear that the Japanese authorities have a fresh determinism to weaken the JPY as reflected by the news that Japan purchased bonds issued by the European Stability Mechanism. Additionally pressure on the Bank of Japan to implement a 2% inflation target has not eased, with Prime Minister Abe continuing to highlight the prospects of a joint accord between the government and BoJ.

Reflecting these factors and the higher starting point for USD/JPY I have revised my forecast and now look for the currency pair to end 2013 at 92.00 versus 85.00 previously. It will not be a one way bet for the JPY, however. Its drop against the USD looks excessive especially as it has largely been driven by expectations rather than actual policy change. There is scope for disappointment should policy be less aggressive than hoped for.

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USD firm but running into resistance

January 7, 2013 — Mitul Kotecha

Happy New Year!

The consensus view for 2013 favours equities over bonds helped by expectations of a sustained improvement in risk appetite as tail risk diminishes further. Additionally relative valuations support the consensus. So far equities are on track although it may be a mistake to make a strong judgement based on the first week’s trading.

The US December jobs report provided more evidence that the US economy will trundle along this year at a modest pace of growth. Meanwhile, the US fiscal cliff agreement may have played into a tone of firmer risk appetite but the fact that in less than two months there may be even greater tensions on the debt ceiling and spending cuts suggest that a one way bet of improving risk appetite can by no means be guaranteed.

The USD has begun the year in firm shape appearing to break free from the constraint of improving risk appetite at the turn of the year. In part its strength especially against the JPY can be attributed to higher US bond yields which in turn was pushed higher by less dovish than expected Fed December 11-12 FOMC minutes last week. Given that yields are running into technical resistance the USD may find less support from this source over coming days.

A light data week will give little directional impetus to the USD, with highlights including trade data, consumer credit and small business confidence. Instead the USD will take its cue from various Fed speakers who will likely provide more elaboration on their views on an eventual exit from QE. The USD is likely to remain firm in the short term although we would be wary of extrapolating trends based on early year moves.

In contrast to the limited US data schedule there are plenty of data releases and events in Europe to digest this week including the European Central Bank Council meeting. The ECB is unlikely to ease policy at this meeting, with those in the Council against a cut unlikely to have shifted their stance although a rate cut, possibly in March remains on the cards. Data releases will continue to show weakness although importantly sentiment surveys will stabilise rather than drop further.

Sovereign debt issuance may take more importance for the EUR this week, with Austria, Belgium, Italy, Germany, Italy and Spain all scheduled to issue debt. Given the better risk environment a generally favourable reception to the debt issues will give the EUR some solace, likely preventing the currency from sliding further. Strong EUR/USD technical support is set to come just below 1.3000 at 1.2996.

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