Double-dip fears pressure USD

July 2, 2010 — Mitul Kotecha

Markets have found it hard to decide whether to sell the USD due to weaker economic data or buy it on higher risk aversion, but the moves overnight were clear; the USD sold off sharply in the wake of a run of soft data releases. Four separate US releases came in below consensus yesterday, with the June ISM, jobless claims, pending home sales and domestic vehicle sales, all disappointed to varying degrees, especially pending home sales, which dropped an astonishing 30% in June.

The news could have been much worse today, with the release of the US June jobs report. Following the 13k increase in the June ADP employment count the consensus forecast for nonfarm payrolls looked way too optimistic; consensus expectations were for a 130k drop in payrolls according to Bloomberg, with estimates ranging from 0 to -250k. In the event payrolls dropped by 125k and the unemployment dropped to 9.5%, an outcome that was not as bad as feared.

It was not just the US ISM that slipped, but a host of global purchasing managers indices (PMIs) weakened in June including China and India, supporting the view that economic activity will lose momentum in H2 2010. Before we all get too carried away it is worth noting that most manufacturing surveys are coming off a high level.

Nonetheless, for once it wasn’t European concerns that sparked an increase in risk aversion as eurozone banks borrowed less than feared from the ECB, and the Spanish bond tender passed off relatively well, factors that helped EUR/USD jump above 1.25000. Although I remain bearish on the prospects for the EUR over coming months, there may be some further near term upside, with EUR/USD 1.2675, the next resistance level in focus.

As a consequence of US double-dip fears, risk aversion remains at a high level, with US bond yields and commodity prices dropping sharply, leaving commodity currencies sharply lower. In the current environment the USD is likely to be sold on rallies.

On the commodity currency front, AUD/USD may find some relief from the news of a compromise on a proposed mining tax, but the weight of risk aversion will limit any rebound, with my preference to play AUD upside versus NZD. The main concession from Australian Prime Minister Gillard reduce was to reduce the tax to 30% for iron and coal, whilst retaining the 40% tax for oil and gas projects. The agreement likely increases the chance of an election in Australia in the next couple of months as Gillard capitalises on a popularity bounce. Fresh elections could be another factor that limits AUD upside over coming weeks.

Posted in Asia, Australia, Bond markets, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Fiscal/Budget, FX, India, Spain, US. Tags: , , , , , , , , , , , , , , , , , , . 3 Comments »

Double Whammy

June 30, 2010 — Mitul Kotecha

Markets were dealt a double whammy resulting in a broad global equity and commodities sell off, and a jump in equity and FX volatility. The risk asset selling began following the news that the Conference Board revised its leading economic indicator for China to reveal a 0.3% gain in April compared to 1.7% increase initially reported earlier.

Given that this indicator has not been a market mover in the past it is difficult to see how it had such a big impact on the market but the fact that the release came at a time when the mood was already downbeat gave a further excuse to sell.

The damage to markets was exacerbated by a much steeper drop than forecast in US consumer confidence, with the index falling to 52.9 in June, almost 10 points lower than the consensus expectation. Consumer confidence remains at a relatively low level in the US, another reason to believe that the US economy will grow at a sub-par pace.

Renewed economic and job market worries were attributable for the fall in confidence, with an in increase in those reporting jobs as “hard to get” supporting the view of a below consensus outcome for June non-farm payrolls on Friday. Further clues will be derived from the June ADP jobs report today for which the consensus is looking for a 60k increase.

A run of weaker than forecast US data releases over recent weeks have resulted in a softening in the Fed’s tone as revealed in the last FOMC statement as well as a fears of a double-dip recession. There will not be any good news today either, with the June Chicago PMI index set to have recorded a slight decline in June, albeit from a high level.

There will also be attention on the release of the US Congressional Budget Office (CBO) 10-year budget outlook, which will put some focus back on burgeoning US fiscal deficit and relative (to Europe) lack of action to rectify it.

European worries remain a key contributor to the market’s angst, with plenty of nervousness about the repayment of EUR 442 billion in 12-month borrowing to the ECB. Demand for 3-month money today will give clues to the extent of funding issues in European banks given that the 12-month cash will not be rolled over.

Elevated risk aversion will keep most risk currencies under pressure, with the likes of the AUD, NZD and CAD also suffering on the back of lower commodity prices. The AUD has failed to gain much traction from a purported deal being offered to miners including various concessions to the mining industry. Much will depend on the reaction of mining companies, and despite the concessions there is importantly no reduction in the 40% rate of the tax.

Equity markets, especially the performance of Chinese stocks will give direction today but a weak performance for Asian equities points to more risk being taken off the table in the European trading session. EUR/USD will now set its sights on a drop to support around 1.2110 ahead of a likely drop towards 1.2045. Having dropped below support around 88.95 USD/JPY will see support coming in around 87.95.

Asian currencies also remain vulnerable to more selling pressure today, with the highly risk sensitive KRW looking most at risk in the short-term, with markets likely to ignore the upbeat economic data released this morning. USD/KRW looks set to target the 11 June high around 1247.80. Other risk sensitive currencies including MYR and IDR also face pressure in the short-term. TWD will be slightly more resilient in the wake of the China/Taiwan trade deal but much of the good news has been priced in, suggesting the currency will not escape the downturn in risk appetite.

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The Week Ahead

June 27, 2010 — Mitul Kotecha

As last week progressed there was a clear deterioration in sentiment as growth worries crept back into the market psyche. It all started well enough, with a positive reaction to China’s de-pegging of the CNY but the euphoria faded as it became evident that there was still plenty of two-way risk on the CNY. A change in Prime Minister in Australia, which fuelled hopes of a resolution to a controversial mining tax, and an austere budget in the UK, were also key events. However, sentiment took a hit as the Fed sounded more cautious on the US economy in its FOMC statement.

The US Congress finalised a major regulatory reform bill towards the end of the week and markets, especially financial stocks, reacted positively as the bill appeared to give some concessions to banks and was not as severe as feared. However, equity market momentum has clearly faded against the background of renewed growth concerns including sprouting evidence of a double-dip in the US housing market as well as fresh worries about the European banking sector. As if to demonstrate this US Q1 GDP was duly revised lower once again, to a 2.7% annualised rate of growth.

The US Independence Day holiday and World Cup football tournament will likely keep liquidity thin in the run up to month and half year end. However, there is still plenty to digest this week including the all important employment report and consumer confidence data in the US. In Europe economic sentiment gauges, purchasing managers indices and the flash CPI estimate will be in focus. Elsewhere, Japan’s Tankan survey and usual slate of month end Japanese releases, Switzerland’s KoF leading indicator and Australian retail sales will be of interest.

On balance, economic data this week is unlikely to relieve growth concerns, with Eurozone, US and UK consumer and manufacturing confidence indicators likely to post broad based declines due to a host of factors. The data will further indicate a slowing in growth momentum following Q2 2010, with forward looking surveys turning lower, albeit gradually. Whilst a double-dip scenario still seems unlikely there can be no doubt that austerity measures and the waning of fiscal stimulus measures are beginning to weigh on growth prospects even if there is still plenty of optimism for emerging market and particularly Asian growth prospects.

This suggests that Q3 could turn into a period of heightened uncertainty in which equity markets and risk assets will struggle to gain traction. In addition to growth worries, some tensions in money markets remain in place whilst banking sector concerns seem to be coming back to the fore, especially in Europe and these factors will prevent a sustained improvement in risk appetite from taking place over the coming quarter. Some more clarity may come from the results of European stress tests but much will depend on just how stressful the tests are.

In the near term, the main focus of attention will be on the US June jobs report released at the end of the week. Non-farm payrolls are set to record a decline over the month due to a reversal in census hiring, with a consensus expectation of a 110k fall. Private sector hiring is likely to record a positive reading, however, suggesting some improvement in the underlying trend in jobs growth, albeit a very gradual one. Downside risks to consensus suggest plenty of scope for disappointment.

Interestingly, weaker US data of late, has managed to restrain the USD, suggesting that cyclical factors and not just risk aversion are beginning to play into FX movements. Notably the USD was on the back foot against a number of currencies as last week progressed. Even the beleaguered EUR managed to end the week well off its weekly low and close to where it closed the previous week whilst risk currencies such as the AUD and NZD as well as GBP also posted firm performances.

Perhaps some reversal of the optimism towards US recovery prospects give USD bulls some cause for concern, but pressure is likely to prove temporary, especially given that the US economy is still on course to outperform many other major economies. Over the short-term, especially ahead of the US jobs report markets are set to remain cautious with range trading likely to dominate in the week ahead, suggesting that EUR/USD is unlikely to breach the key level of 1.2500. GBP performance has been robust but even this currency is likely to make much headway above GBP/USD 1.5000, where there are likely to be plenty of sellers.

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Risk trade rally fizzles out

June 23, 2010 — Mitul Kotecha

The risk trade rally spurred by China’s decision to de-peg the CNY fizzled out. The realization that China will only move very gradually on the CNY brought a dose of reality back to markets after the initial euphoria. The fact that unlike in July 2005 China ruled out a one off revaluation adds support to the view that China will move cautiously ahead with CNY reform. In addition, renewed economic worries have crept back in, with particular attention on a potential double dip in the US housing market following a surprise 2% drop in existing home sales in May.

European banking sector woes have not disappeared either with S&P raising the estimate of writedowns on Spanish bank losses, whilst Fitch ratings agency noted that there is an increased chance of the eurozone suffering a double-dip recession. The net impact of all of these factors is to dampen risk appetite and the EUR in particular.

The UK’s announcement of strong belt tightening measures in its emergency budget did not fall far outside of market expectations. The budget outlined a 5-year plan of deficit reduction, from 11% of GDP in 2009-10 to 2.1% of GDP in 2014-15. The main imponderable was the response of ratings agency and so far it appears to have been sufficient not to warrant a downgrade of the UK’s credit ratings. Fitch noted that the “ambitious” plan ensured that the UK would keep its AAA credit rating. The emergency budget and reaction to it has been mildly positive for GBP, which has shown some resilience despite the pull back in risk currencies.

The recent rally in Asian currencies is looking somewhat overdone but direction will come from gyrations in risk appetite and the CNY rather than domestic data or events. Encouragingly equity capital flows into Asia have picked up again over recent weeks, with most countries with the exception of the Philippines registering capital inflows so far this month, led by India and South Korea.

China’s CNY move may attract more capital inflows into the region, suggesting that equity capital flows will continue to strengthen unless there is a relapse in terms of sovereign debt/fiscal concerns in Europe. Nonetheless, central banks in the region will continue to resist strong FX gains via FX interventions, preventing a rapid strengthening in local currencies.

Although India and Korea have registered the most equity inflows this month, both the INR and KRW have had a low correlation with local equity market performance over recent weeks. In fact the most highly sensitive currencies to their respective equity market performance have been the MYR and IDR both of which have reversed some of their gains from yesterday. USD/MYR will likely struggle to break below its 26th April low around 3.1825 whilst USD/IDR will find a break below 9000 a tough nut to crack.

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China’s gradual renminbi move

June 21, 2010 — Mitul Kotecha

China’s decision to “proceed further with reform” of the CNY exchange rate regime will dictate market activity at the turn of the week. The decision to act now reflects the fact that China is no longer in crisis mode policy. Although the eurozone sovereign crisis may have delayed China’s move, the authorities in China clearly felt that conditions had improved sufficiently enough to act. The decision will pre-empt some of the criticism that China would have faced at the G20 meeting next weekend, leaving attention firmly on Europe.

Before we all get too excited it should be noted that it is unlikely that China’s announcement presages aggressive action on the CNY. Stability appears to be the name of the game, a fact that has already drawn criticism from some in the US Senate who may still push for legislation over China’s exchange rate.

China will likely allow some, albeit gradual appreciation of the CNY. In this respect, it’s worth noting that the CNY appreciated by around 6.6% against the USD during 2007 and around the same amount in 2008 prior to the formal peg with the USD. Appreciation at a similar pace of coming months is unlikely.

The initial impact on the USD was an echo of the July 2005 move but to a far smaller degree. The USD was sold off across the board as market players reacted to the likelihood of the USD playing a less important role in China’s exchange rate mechanism. The USD rallied when China maintained its CNY fixing but lost ground as the CNY appreciated against the fixing.

The fact that net USD speculative positions halved over the past week according to the CFTC IMM data, suggest that the USD is far less vulnerable this week to selling pressure from a positioning perspective. In other words there will be no repeat of the sharp FX moves that were seen post the July 2005 CNY revaluation. Whilst the major currency impact is likely to prove muted, Asian currencies are set to benefit more significantly, with further strengthening likely this week.

China’s announcement will play into the tone of firmer risk appetite at the beginning of the week but the move in some risk currencies, especially the EUR is looking increasingly stretched. The EUR and risk appetite may have benefited from recent positive news flow including the announcement of European bank stress tests and the relatively positive reception to Spain’s bond auction, but speculative positioning (IMM) data reveals that there was already a strong short-covering rally over the past week, which saw net EUR short positions almost halve.

Further EUR/USD gains will be harder to come by, with an immediate obstacle around 1.2500. Perhaps another reason for China to be cautious about the pace of CNY appreciation is the likelihood of further EUR weakness and the impact that this would have on China’s trade with Europe. As it is EUR/CNY has already dropped by over 13% so far this year and China will not want to enact measures that will accelerate the pace of the move in the currency pair.

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