Modest growth in the G3 economies

January 14, 2010 — Mitul Kotecha

A few themes are already becoming evident into 2010. Firstly, the dominance of China and any news on the Chinese economy is becoming increasingly apparent as reflected in the market reaction to trade data and hike in reserve requirements this week. Despite the odd setback the second theme that is developing this year is the “risk on” environment for asset markets. Another theme is the problems and concerns about sovereign debt and ratings, which will likely intensify further.

I could add one more to the list; the underperformance of the Eurozone economy, a theme that is likely to become more apparent as the year progresses. As markets become increasingly bullish about the prospects for China’s economy the opposite is true for the eurozone. Growth over Q4 2009 appears to have lost momentum according to recent data. There is however, expected to be a rebound in November industrial production but this will follow a weak October reading, leaving overall output in Q4 looking lacklustre.

Economic conditions in Japan do not seem to be improving any more quickly, especially in the manufacturing sector as reflected in the surprisingly sharp 11.3% MoM drop in machinery orders in November. Orders have dropped by a whopping 20.5% annually sending a very negative signal for capital spending in the months ahead. Uncertainty over demand conditions has likely restrained capital spending plans whilst the strong JPY has not helped.

The US economy is showing more signs of life but even here the improvements are “modest” as reflected in the Fed’s Beige Book. Consumer spending showed some, limited improvement, whilst manufacturing performance was said to be mixed. In particular, the Beige Book noted that labour market conditions remained soft, with wage pressures subdued. Overall, the report highlighted the likely lack of urgency in a prospective Fed reversal of monetary policy.

In contrast to the modest growth improvements seen in the G3 economies, Australia seems to be powering ahead. Australian jobs data revealed a bigger than expected 35.2k increase in employment and surprise drop in the unemployment rate to 5.5% in December. The only slight negative about the jobs data was that many of the jobs (27.9k) were due to temporary hiring. Nonetheless, the report will give a boost to the AUD aiming for a test of resistance around 0.9326, and solidify expectations for a rate hike next month, when the RBA is set to hike by 25bps.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, FX, Interest rates, Japan, US. Tags: , , , , , , , , , , , , , , , , , , . Leave a Comment »

China tightens policy

January 13, 2010 — Mitul Kotecha

Risk appetite has soured due to a combination of the rise in China’s reserve requirements, disappointing earnings including Alcoa and a profit warning by Chevron, setting the scene for a day in the red for Asian markets.  The turn in sentiment has hit commodities and commodity currencies particularly hard whilst the JPY has outperformed.  As would be expected against the background of higher risk aversion the US dollar made up some ground.

All eyes are on China and markets will now look to the implications for CNY policy.  Increasingly it seems that data and policy in China is driving global markets and aside from the hike in reserve requirements this was also evident in the fact that stronger trade data over the weekend helped to counter the impact of the soft US December payrolls report.  Further increases in the reserve ratio are likely over coming months followed by actual hikes in interest rates (likely the 1 year rate).  China’s move to tighten policy further over coming months will likely be accompanied by allowing greater appreciation of the CNY too.

The news worsened overnight as the ABC Consumer Confidence index dropped by 6 points to -47, the biggest one-week drop in the last 25 years.  US trade data also came in worse than expected, with the deficit widening to $36.4bn in November.  There is little on the data front today to keep markets occupied today, suggesting that direction will come from equity markets and with more earnings this week including Intel Corp and JPMorgan Chase & Co. there will be plenty to digest.  In the near term the tone of risk aversion is set to continue to dominate but any pull back in risk currencies is likely to prove short-lived.   

There will be more Fed speakers as well as the Fed’s Beige Book today to provide clues ahead of the January 26-27 FOMC meeting.   Aside from noting some improvements in the economy, weak labour market conditions as well as a lack of inflationary pressures will help support expectations that the Fed will hold off from raising interest rates this year.   Fed speakers include Fisher and Plosser both of whom give speeches on the US economy though neither are current voters on the FOMC.   Plosser’s comments so far have highlighted the need for a timely “exit strategy”.

Posted in Asia, central banks, China, Currencies, Economics, Economy, emerging markets, equity markets, FX, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , . 2 Comments »

“Risk On”- Which Currencies Will Benefit?

January 5, 2010 — Mitul Kotecha

It was a “risk on” beginning of the week as equity markets rallied, commodities prices rose, and G10 bonds and USD came under pressure. Stronger manufacturing PMIs helped to boost confidence in the global economic recovery, with solid PMIs revealed in China, and across the rest of Asia, UK, and the US. The US ISM manufacturing which rose to its highest since April 2006 also revealed a rise in the unemployment component, consistent with view of an unchanged reading for December payrolls.

In the Eurozone the PMI matched the flash release and remained in expansion territory though there was some slippage in Germany, Spain, and Italy, underscoring the likely underperformance of the Eurozone economy relative to expectations of faster recovery in the US. Nonetheless, the PMIs continued to show a picture of expansion, with the Eurozone PMI at its highest in 21-months.

The USD lost ground against the background of improved risk appetite and looks set to fall further abruptly ending its short covering rally. The USD appears to be finding little support from interest rate expectations, with the correlation between most currencies and relative interest rate differentials remaining relatively low for the most part (just -0.04 over the past 3-months between the USD index and US rate futures).  The correlation between the USD and US 10-year bond yields looks somewhat stronger however, and could offer some relief to the USD if yields continue to push higher.

Speculative (CFTC Commitment of Traders) data reveals just how massive the shift in USD positioning has been over recent weeks, with net aggregate USD positioning (vs EUR, JPY, GBP, AUD, NZD, CAD, CHF) registering its first net long USD position since May 2008. The swing in positioning has been dramatic, from -167k contracts on 15 September 2009 to +8.7k in the week ending 29th December 2009. The data also reveals the sharp deterioration in sentiment for the EUR to its lowest since September 2008. Likewise net JPY positions have shifted to their biggest net short since August 2008.

What does this imply? The market is very short EUR and JPY but the JPY has much further to go on the downside as it increasingly retakes the mantle of funding currency.  In any case compared to historical positioning JPY shorts are not so big suggesting more room to increase short positions.   

The EUR has moved into a short term uptrend, with the MACD (12,26,9) having crossed its signal line and positioning supports further upside. EUR/USD will need to take out strong resistance at 1.4459 (December 29) before it can embark on a more significant move higher. Asian currencies also look set to take more advantage of a resumption of USD weakness, especially in the wake of strong risk seeking capital flows into the region. KRW, TWD, IDR and PHP look bullish technically.

Posted in Asia, Commodities, Currencies, Economics, Economy, equity markets, FX, Interest rates, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »

All eyes on US payrolls

January 4, 2010 — Mitul Kotecha

Happy New Year.  Markets are likely to struggle for direction ahead of the key US December non-farm payrolls data though the end of the year ended on a softer note for equity markets in the US, whilst Asian stocks were somewhat firmer.  The USD has taken a firmer tone at the start of this week but is likely to face renewed pressure into the new-year.  The fact that USD/Asian FX has failed to build any momentum on the upside also highlights risks to the USD from current levels. 

Ahead of payrolls look for EUR/USD technical support around 1.4177, with strong resistance around 1.4459 whilst USD/JPY will find support at 91.00 and resistance around 94.08.   I favour a firmer bias for the USD at the beginning of the week but this may not last too long and would look to take profits on long USD / short risk currency positions into next week. 

2010 is set to be a year of two halves for currency markets and whilst the USD is to eventually recover, the rally seen at the end of last year is likely to prove unsustainable, especially now that a lot of short USD positions have been covered.   If anything the pull back in various risk currencies provide better levels to take long positions, especially in the AUD and NZD as well as many Asian currencies where renewed appreciation in the months ahead is likely.  I particularly like the IDR and KRW, two of last year’s winners. 

The US jobs report will provide some evidence of a normalisation in economic conditions, with December likely to have marked the best month in two years for payrolls (Bloomberg consensus forecasts a 1k drop in payrolls). Although hiring is unlikely to pick up quickly and wage pressures are set to remain subdued, the data will mark an encouraging shift in job market conditions following the loss of 7.2 million jobs since the US recession began.  The unemployment rate is likely to remain stubbornly high, however.

Ahead of the jobs data markets will be able to garner some clues to the data from the jobs component in today’s release of the December ISM data.  The ISM is likely to remain in expansion territory though is unlikely to register much of a gain from last month’s 53.6 reading.   The eurozone and UK also release their manufacturing PMIs today and although both will remain above the 50 boom/bust mark, neither are set to register much improvement from November’s reading. 

There will also be some attention on central bank thinking this week, with the release of the December 16 meeting FOMC minutes as well as the BoE rate decision to digest.  The minutes will likely acknowledge some signs of improvement in the economy but there will be no indication that the Fed is shifting its “extended period” thinking even if the Fed wants to reassure markets that it has an exit strategy in place.   The BoE meeting will be a non-event for markets, with more interest on the outcome of the February meeting.

Posted in Asia, central banks, Currencies, Economics, Economy, equity markets, FX, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , . 2 Comments »

FX Prospects for 2010

December 23, 2009 — Mitul Kotecha

There can be no doubt that for the most part 2009 has been a year for risk trades, not withstanding the sell off into year end. The policy successes in preventing a systemic crisis and the massive flood of USD liquidity injected globally kept the USD under pressure for most of the year and the currency became a victim of this success. Risk appetite is likely to improve only gradually over coming months given the still significant obstacles to recovery in the months ahead.  This will coincide with the declining influence of risk on FX markets. 

2010 will not be as straightforward and whilst risk will dominate early in the year interest rate differentials will gain influence in driving currencies as the year progresses. The problem for the USD is that market expectations for the timing of the beginning of US interest rate hikes is likely to prove premature as the Fed is set to hold off until at least late 2010/early 2011 before raising interest rates. The liquidity tap will stay open for some time, and risk trades will still find further support at least in the early part of 2010, whilst the USD will come under renewed pressure.    

The ECB will be much quicker in closing its liquidity tap than the Fed and arguably an earlier reduction in credit easing and interest rate hikes compared to the Fed would favour a stronger EUR.  However, the EUR is already very overvalued and a relatively aggressive ECB policy is unwarranted. Consequently rather than benefiting from more favourable relative interest rate expectations, the EUR could be punished and the EUR is set to decline over much of 2010 following a brief rally in Q1 2010, with EUR/USD set to fall over the year. 

Japan is moving in the opposite direction to the ECB.  FX intervention is firmly on the table though the risk is limited unless USD/JPY drops back to around 85.00. Even at current levels the JPY is overvalued but for it to resume weakness it will need to regain the role of funding currency of choice, a title that the USD has assumed. Efforts by the BoJ to combat deflation will likely help result in fuelling some depreciation of the JPY and it is likely to be the worst performing major currency over 2010, with a move back up to around USD/JPY in prospect.

The issue of global rebalancing will need to involve currencies but the currency adjustments necessary will not be forthcoming in 2010.  USD weakness early in the year will be mostly exhibited against freely floating major currencies which will bear the brunt of USD weakness.  However, the bulk of adjustment is needed in Asian currencies and there is little sign that central banks in the region will allow a rapid appreciation.  China holds the key and a gradual appreciation in the CNY over 2010 suggests little incentive to allow other Asian currencies to appreciate strongly. 

So in many ways 2010 will be one of two halves for currency markets and this has the potential to reignite some volatility in FX markets.  High beta risk trades including the AUD, NZD, NOK and many emerging currencies will see further upside in H1 as the USD falls further.  Gains in risk currencies will look even more impressive when played against the JPY and/or CHF than vs. USD given that they will succumb to growing pressure in the months ahead as their usage as funding currencies increases.

Ongoing rate hikes in Australia and Norway and the likely beginning of the process to raise rates in New Zealand early next year will mean that these currencies will also have the additional support of yield to drive them higher unlike the JPY.  There is a limit to most things however, and eventually the USD will recover some of its lost ground against risk currencies, as it undergoes a cyclical recovery over H2 2010.

Posted in central banks, Currencies, Economics, Economy, Europe, FX, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . 2 Comments »
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