Draghi shakes things up

July 27, 2012 — Mitul Kotecha

European Central Bank President Draghi shook things up overnight providing a major backstop for risk assets. Draghi effectively noted that the ECB “is going to do whatever is necessary to preserve the EUR”. The aggressiveness of his comments left no doubt that the ECB chief means business.

Whether this translates into renewed bond buying by the central bank is debatable but this is what the market is now hoping for at next week’s ECB policy meeting. Anything less would provoke disappointment.

At the least Draghi has helped to put a floor under the EUR ahead of the policy meeting. After dropping to a low around 1.2117 the currency bounced sharply but its gains were exhibited mainly against the USD rather than on the crosses. Further short covering could see EUR/USD move up to around the 1.2350 resistance level but much further gains are expected to be limited.

The biggest beneficiaries of Draghi’s comments were equity volatility which dropped sharply and Spanish stocks, which rallied by over 6% yesterday. Gold also rallied in the hope of central bank action next week. In terms of Asian currencies, those most sensitive to risk gyrations including KRW, MYR, INR and IDR will be the biggest beneficiaries.

Attention today will turn to data releases including July German inflation data and Q2 US GDP. A weak US GDP may put a bit of a dampener on sentiment especially as it will highlight the sharp slowing in growth over the quarter.

Nonetheless, markets are likely to move into consolidation mode ahead of next week’s ECB and Fed meetings, with risk assets generally supported by expectations / hopes of policy actions by both or either central bank. One index which remains on a downward trajectory is the Baltic Dry Index, which dropped further overnight, highlighting the growing risks to the global economy.

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USD bulls restrained

July 26, 2012 — Mitul Kotecha

Two events over recent days have managed to inflict a degree of pain to USD bulls over recent days. Firstly the report in the press this week that the Fed is actively considering further policy stimulus steps, which taken together with softer economic data such as the 8.4% drop in new home sales registered in June but more specifically declines in the June ISM manufacturing survey and weaker jobs data, have sharply increased the speculation that the Fed will deliver new policy steps at its FOMC meeting next week.

Secondly the comments overnight from ECB board member Nowotny putting the prospects of giving the ESM bailout fund a banking licence firmly back on the table, has given a lift to the EUR. A banking licence would allow the ESM to leverage the ECB’s balance sheet, massively increasing its firepower. No wonder the markets reacted positively! The only catch is that there is significant opposition from both within the ECB council and from outside especially from Germany, suggesting that it would not be an easy step to take.

However, in a market that is extremely short EUR any slight positive news will act as a balm on the Eurozone’s wounds. Nowotny’s comments managed to overpower the impact of further drop in the German IFO survey in July which in fairness still remains at a relatively high level. The positive impact on the EUR is set to be short lived especially as a license for the ESM is a long way off while the ESM itself has yet to formally take over from the temporary bailout fund (EFSF).

Nonetheless, downside risks to the EUR will be limited ahead of the FOMC meeting next week and risks that a fresh round of Fed quantitative easing could weigh on the USD. Another complication is that there is also an ECB Council meeting next week, another factor that will play into a tone of consolidation for markets over coming days. EUR/USD is likely to face firm resistance around the 1.2181 level while downside is likely to be capped around 1.2040 in the near term. Assuming no major Fed action next week, EUR/USD remained destined for a drop below 1.2000.

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EUR/USD edging towards 1.20

July 23, 2012 — Mitul Kotecha

There hasn’t been much of a respite before Eurozone concerns have resurfaced. Spain and Greece are once again in the spotlight, with the formal approval of a bank bailout for the former providing little solace as speculation of a full scale sovereign bailout grows. The fact that two Spanish regions have asked for government help, with more likely in the pipeline, has only acted to reinforce such concerns.

As for Greece, the halting of a bailout tranche due to failure to meet targets, the European Central Bank (ECB) decision not to accept Greek debt as collateral and the visit of the Troika (EC, ECB. IMF) will keep markets nervous as default fears intensify. Unsurprisingly Eurozone peripheral bond yield have come under renewed pressure while core Eurozone yields have turned negative in some cases.

Spanish yields have moved above the critical 7% threshold while the EUR has tanked versus USD and on the crosses as it increasingly takes on a funding currency role and makes its way towards the 1.20 level versus USD that I expect it to test soon.

Hopes of further monetary stimulus, especially in the US and China have provided some support to markets recently but the provision of drugs will not cure the patient this time around. Even relatively decent US corporate earnings, with around 2/3 of S&P earnings released beating admittedly lowered expectations so far, have failed to stop the rout.

Big cap defensive and high dividend companies have fared well, giving a degree of resilience to US equities which are up over 8% (S&P 500) this year, but with around 171 companies set to deliver results this week it is not clear that this will continue.

Weakening US data, with a deceleration in US Q2 GDP set to be revealed this week will provide more evidence that US economic momentum is slowing. Nonetheless, as long as US Fed quantitative easing is not an imminent prospect the USD will likely find plenty of support as risk aversion creeps back into the market psyche.

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No respite for the Euro

July 11, 2012 — Mitul Kotecha

Following a relatively positive session for European stocks yesterday, the enthusiasm did not carry through to US markets which registered losses overnight. Commodity prices dropped led by gold while equity volatility rose.

Marginal progress at the meeting of European Finance officials, with the decision to furnish Spain with the first EUR 30 billion of funds for its banks, helped sentiment in Europe. Moreover, officials edged closer to purchasing bonds in the secondary market by agreeing a separate accord to use the European Central Bank (ECB) as a buying agent for bond purchases by the bailout funds.

However, questions such as how Greece would get through next month’s bond redemptions following a delay in a loan tranche for the country were left unanswered while the timing of setting up a single banking supervisor was also unclear. Meanwhile, the German constitutional court hearings on complaints about the ESM bailout fund mean that the ESM’s implementation continues to be delayed.

All-in-all, despite the marginal progress made yesterday there is a long climb ahead before markets can be appeased. Coupled with growing concerns about the US earnings outlook following several profit warnings by US companies market sentiment will remain fragile, with little headway likely for risk assets. Hopes of further Fed stimulus may offer some solace to markets but the reality is that the Fed is unlikely to be close to a further round of quantitative easing.

High beta / risk currencies remain pressured although it is notable that there is at least a little relative resistance from the likes of the AUD as indicated by the drop in EUR/AUD. European officials are doing just enough to prevent the EUR from gapping lower but not enough to enable the currency to rally. Having already dropped by around 3% against the USD since the start of the month EUR/USD looks set to test tech technical support around 1.2193 before next support around 1.2151.

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EUR slides as summit hopes fade

July 9, 2012 — Mitul Kotecha

Any boost to confidence following the recent EU Summit is fading fast. Policy easing from the European Central Bank, Bank of England, and PBoC in China, have done little to turn things around. Moreover, the weaker than expected US June jobs report has added to the calls for the Federal Reserve to inject more monetary stimulus via another round of quantitative easing but this is unlikely anytime soon.

Admittedly the jobs data which reported an 80k increase in payrolls and unemployment rate remaining at 8.2%, was disappointing but it was not weak enough to trigger imminent Fed action. Congressional testimony by Fed Chairman Bernanke on July 17 and 18 will provide the next key clues to whether the Fed is moving closer to more QE.

This leaves markets in a miserable state of being. It was hoped that the recent EU Summit would provide much needed breathing space and relief to Eurozone peripheral bond markets. However, renewed policy implementation doubts, concerns that the Summit did not go far enough and opposition from Finland and the Netherlands who appear to have taken an even tougher stance than Germany, have resulted in Spanish and Italian bonds facing significant pressure once again with yields higher than pre summit levels.

A delay in the ESM permanent bailout fund, timing of the setting up of a banking supervisory authority and doubts about the size of the bailout fund given that the ECB appears to have ruled out a banking license as a means of leveraging up the ESM, are just a few of the concerns afflicting markets. Meanwhile, added to this list is the fact that Greece’s next bailout tranche has been delayed to mid September. Many of these issues as well as the bailout of Spanish banks will be discussed at today’s Ecofin meeting but the chances of much progress remain limited.

The EUR which is of course not uncrorrelated with peripheral bond yields has itself fallen sharply. Thin trading conditions have helped to exacerbate the drop in the EUR while the realisation that the EU summit has been no game changer is increasingly weighing on the currency. I had thought that the Summit may have helped to at least provide a floor under the EUR but this now looks like a case of misplaced optimism.

The only supportive factor for the currency is that it looks heavily oversold, with market positioning extremely short. However, if a break below the 2012 EUR/USD low around 1.2288 can be sustained markets will quickly latch onto 1.20 as the next target. Given the lack of major events or data releases over coming days there looks like little to offer the EUR any support.

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