Interest Rate Decisions Galore

March 10, 2011 — Mitul Kotecha

The Reserve Bank of New Zealand (RBNZ) decision to cut policy rates by a bigger than expected 50bps does not necessarily mark the onset of a new wave of NZD selling. Indeed, whilst the NZD was hit by the rate cut it recovered quickly.

The NZD was aided by comments from the RBNZ Governor Bollard that short term inflation may spike due to the earthquake but this tempered by another RBNZ official who stated that the central bank may hold rates at 2.5% at least until January 2012. The post meeting statement indicated that the RBNZ will not embark on a series of rate cuts, a fact that will provide some relief to the Kiwi. Moreover, the currency looks increasingly oversold especially relative to the AUD as indicated by relative positioning.

Weaker than expected employment data in Australia will also help to stem AUD strength versus NZD. After many months of positive surprises the labour market is showing signs of cracking. Admittedly full time employment rose but this was outweighed by an even bigger drop in part time employment, resulting in a 10.1k fall in overall employment.

Although the AUD is unlikely to face too much downside markets the data will likely dampen expectations of possible rate hikes in the months ahead. My preferred way of playing possible AUD underperformance is via the NZD. AUD/NZD is likely to face plenty of resistance around the 1.3800 level and eventually as indicated by our quantitative models the currency pair is likely to move lower over coming weeks.

In sharp contrast to the RBNZ, the Bank of Korea hiked interest rates by 25bps in a further move to normalize policy. The decision was not much of a surprise and the statement indicated that more rate hikes should be expected. The KRW remains rangebound but the currency remains on path for further appreciation over coming months. The surprise trade deficit in China has weighed on Asian currencies in general but weakness is likely to be limited.

The Bank of England is the next central bank on tap today but is unlikely to hike rates despite the hawkish shift within the Monetary Policy Committee. A rate hike is moving closer but the Bank will likely wait until at least May before moving. Further details about today’s decision will as usual wait for the minutes in two weeks time. GBP looks vulnerable and whilst a rate move today is not expected the currency may lose ground over coming days against the background of a firmer USD.

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USD Pressured As Yields Dip

February 18, 2011 — Mitul Kotecha

The USD came under pressure despite a higher than forecast reading for January US CPI and a strong jump in the February Philly Fed manufacturing survey. On the flip side, an increase in weekly jobless claims dented sentiment. The overnight rally in US Treasury yields was a factor likely weighing on the USD. The US calendar is light today leaving markets to focus on the G20 meeting and to ponder next week’s releases including durable goods orders, existing and new home sales.

The jump in the European Central Bank (ECB) marginal facility borrowing to EUR 15 billion, its highest since June 2009, provoked some jitters about potential problems in one or more eurozone banks. At a time when there are already plenty of nerves surrounding the fate of WestLB and news that Moody’s is reviewing another German bank for possible downgrade, this adds to an already nervous environment for the EUR.

Nonetheless, EUR/USD appears to be fighting off such concerns, with strong buying interest on dips around 1.3550. The G20 meeting under France’s presidency is unlikely to have any direct impact on the EUR or other currencies for that matter, with a G20 source stating that the usual statement about “excess volatility and disorderly movements in FX” will be omitted.

Although USD/JPY has been a highly sensitive currency pair to differentials between 2-year US and Japanese bonds (JGBs), this sensitivity has all but collapsed over recent weeks. USD/JPY failed to break the 84.00 level, coming close this week. There appears to be little scope to break the current range ahead of next week’s trade data and CPI.

Given the recent loss in momentum of Japan’s exports the data will be instructive on how damaging the strength of the JPY on the economy. In the near term, escalating tensions in the Middle East will likely keep the JPY supported, with support around USD/JPY 83.09 on the cards.

It seems that the jump in UK CPI this week (to 4.0%) provoked even more hawkish comments than usual from the Bank of England BoE’s Sentance, with the MPC member stating that the Quarterly Inflation Report understates the upside risks to inflation indicating that interest rates need to rise more quickly and by more than expected. Specifically on GBP he warned that the Bank should not be relaxed about its value.

Although these comments should not be particularly surprising from a known hawk, they may just help to underpin GBP ahead of the January retail sales report. Expectations for a rebound in sales following a weather related drop in the previous month will likely help prop up GBP, with GBP/USD resistance seen around 1.6279.

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GBP troubles, KRW too weak

February 17, 2011 — Mitul Kotecha

The Fed FOMC minutes for the January meeting revealed that behind the unanimous vote to leave policy settings unchanged there was some unease about the completion of QE2. Nonetheless, the USD was left weaker given the Fed’s sanguine view on inflation and worries about unemployment. Inflation data will garner most market attention today but the fact that the core rate of CPI inflation is expected to remain well below the Fed’s preferred level could undermine the USD and add a further barrier to the USD’s recovery so far in February. Jobless claims data will also be of interest given the sharp drop last week. Another firm outcome will help to dispel worries about job market recovery.

As warned in my last post, downside risks to GBP were high given the long GBP speculative positioning overhang and hawkish expectations for the BoE Quarterly Inflation Report. In the event the Report revealed a downward growth forecast revision and an upward inflation forecast revision but importantly showed some reluctance to play into market expectations of an early UK policy rate hike. Following on from a weaker than expected UK January jobs report in which unemployment increased, GBP was hit on both counts. GBP/USD is unlikely to veer far from the 1.6000 level, but with markets reassessing interest rate expectations downside risks are beginning to open up.

News yesterday that Moody’s ratings agency has placed Australia and New Zealand’s major banks on review for possible downgrades went down like a lead balloon but once again AUD and NZD showed their usual resilience and acted as if little has happened. AUD and NZD have weakened since the turn of the year. Weaker data and a paring back in policy tightening expectations have contributed to the weaker performance of the AUD and NZD, but markets have gone too far in scaling back the timing and magnitude of interest rate hikes, suggesting that both currencies may bounce back as interest rate expectations become more hawkish.

Asian currencies continue to register mixed performances largely influenced by capital flows. Most equity markets in the region have registered outflows so far in 2011, with the exception of Taiwan and Vietnam. This has been reflected in Asian FX performance, with the strongest performer being the IDR, but its gains have only been around 0.72% versus USD, coinciding with the fact that it has registered some of the least capital outflows this year. Interestingly the worst performing currency has been the THB, one of last year’s star performers. Korea has also registered strong equity capital outflows but this will not persist and a resumption of inflows taken together with positive fundamentals and higher interest rates will boost the KRW this year.

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Global Themes

February 11, 2011 — Mitul Kotecha

It’s definitely been a strange start to the year, with markets taking plenty of time to get their bearings. Some general themes have developed but none have provided clear direction. As a result, the path over coming weeks and months is likely to remain highly volatile and in this respect, currencies, equities and bonds will continue to see strong gyrations.

One theme that has been evident since the start of the year is an improvement in sentiment towards the eurozone periphery as hopes of an enlargement/extension of the European Union bailout fund (EFSF) have increased. This is a key reason why the EUR has strengthened this year although nervousness on this front appears to have returned over recent days (note the recent widening in peripheral bond spreads, drop in EUR and European Central Bank purchases of Portuguese debt). It seems that a lot of good news has already been discounted in relation to the eurozone periphery and now markets are in wait and see mode for the EU Council meeting on 24/25 March. There is a strong chance that eventually market expectations will prove overly optimistic and the EUR will drop but more on that later.

The second theme is global inflation concerns, driven by higher food and energy prices. Certainly this has had an impact on interest rate expectations and in some cases resulted in a hawkish shift in central bank language, notably in the eurozone and UK. Although European Central Bank (ECB) President Trichet has toned down his comments on tighter monetary policy compared to the more hawkish rhetoric following the last ECB council meeting, expectations for monetary tightening in the eurozone still look overly hawkish, with a policy rate hike currently being priced in for August/September this year, which looks way too early. The EUR has benefitted from the relative tightening in eurozone interest rate expectations compare to the US but will suffer if and when such expectations are wound down.

Elsewhere in many emerging markets the impact of higher food prices is finding its way even more quickly into higher inflation, forcing central banks to tighten policy. In Asia, the urgency for higher rates is even more significant given that real interest rates (taking into account inflation) are negative in many countries. China has accelerated the pace of its rate hikes over recent months and looks set to continue to tighten policy much further to combat inflation. In India, worries about inflation and the need for further monetary tightening have clearly weighed on equity markets, with more pain to come. Although not the sole cause by any means, in the Middle East and Africa higher food prices are feeding social tensions such as in Egypt.

Another clear theme that has developed is the improvement in US economic conditions. The run of US data over recent months has been encouraging, confirming that the economy is gaining momentum. Even the disappointing January non-farm payrolls report has not dashed hopes of recovery, with many other job market indicators pointing to strengthening job conditions such as the declining trend in weekly US jobless claims. Manufacturing, business and consumer confidence measures have strengthened whilst credit conditions are easing, albeit gradually. The US economy is set to outperform many other major economies this year, especially the eurozone, which will be beset with a diverging growth outlook between northern and southern Europe.

Although the US dollar has not yet benefitted from stronger US growth given the still dovish tone of the Fed and ongoing asset purchases in the form of quantitative easing, the rise in US bond yields relative to other countries, will likely propel the dollar higher over 2011 after a rocky start over Q1 2011. In contrast, the EUR at current levels looks too strong and as noted above, hopes of a resolution of eurozone peripheral problems look overdone. EUR/USD levels above 1.3500 provide attractive levels to short the currency. Other growth currencies that will likely continue to do well are commodity currencies such as AUD, NZD and CAD, whilst the outlook for Asian currencies remains positive even despite recent large scale capital outflows. The JPY however, will be one currency that suffers from an adverse yield differential with the US as US bond yields rise relative to Japan.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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China Hikes Rates, More On the Cards

February 9, 2011 — Mitul Kotecha

In an otherwise unexciting day China livened things up by raising its 1 year deposit and lending rates by 25 basis points. The hike, the third in the last four months, should not have come as a surprise, given the growing emphasis by China’s central bank PBoC, to dampen inflation pressures. Indeed, more hikes are on the cards, with at least another two more in prospect over H1. The other tool to combat inflation is CNY appreciation further gains in the currency over coming months should be expected to around 6.3 by year-end versus USD.

Global markets largely shrugged of China’s move, with generally positive market sentiment continuing. Even in the eurozone, where there was some disappointment at the surprise drop in German December industrial production, market sentiment continued to improve as Egypt and local debt worries eased further. EUR was particularly resilient despite calls from a Belgian think tank that Greece needs to restructure its debt to avoid a long and painful path ahead. Commodity currencies also showed impressive resilience to China’s rate hike, with both the AUD and NZD holding up well.

The overall positive risk background is supportive for Asian currencies and other risk trades. Currencies in Asia remain highly correlated with portfolio capital inflows and so far this year the weakness in the INR and THB has matched the strong equity outflows from India and Thailand. However, this appears to be reversing, especially in the case of India registering positive equity flows this month, helping the INR to reverse some of its losses.

In the absence of key data releases markets will turn their attention to the testimony by Fed Chairman Bernanke to the House budget committee where he will give comments on the economy, jobs and the budget. Dallas Fed’s Fisher stated overnight that whilst he expects the Fed to complete QE2 he would not support another round of quantitative easing. Fisher’s comments on QE were similar to Atlanta Fed’s Lockhart who notes there is a “high bar” for more QE. Bernanke is unlikely to deviate from this tone in his speech today whilst also maintaining his view that there should be a long term commitment to fiscal retrenchment.

Against the background of improving risk appetite the USD is likely to stay under mild pressure although it is difficult to see a break of recent ranges for most currency pairs. EUR/USD ought to find strong support around its 100-day moving average 1.3535 whilst USD/JPY will be supported around 81.10. Equity sentiment is being supported by US data which remains encouraging. On cue the NFIB Small Business Optimism index duly rose in January to 94.1 as sentiment in this sector continued its improving trend.

Taken together with firmer equities, encouraging data is taking its toll on US bond markets, resulting in a back up in yields. Bond market sentiment wasn’t helped by a relatively poor 3-year auction. For example, US 2-year bond yields have backed up by over 30bps since 28 January. Bad news for bond is good news for the USD however, as higher relative US bond yields will likely help prevent a deeper USD sell-off, with EUR/USD in particular most reactive to relative eurozone / US bond yield differentials.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

Posted in Asia, Australia, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Fiscal/Budget, FX, Greece, India, Interest rates, Japan, Monetary Policy, South Korea, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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