What To Watch This Week

March 13, 2010 — Mitul Kotecha

A “crisis over” mode is being adopted across markets as worries about Greece wane and economic data provides support to recovery hopes, whilst importantly allaying fears of a “double-dip”. Equities, bonds and currencies are reacting accordingly; equities are close to year highs, bond yields have risen and spreads have narrowed, whilst the USD and JPY are weaker, and conversely risk currencies are stronger. Even EUR/USD pushed higher on its way to 1.3800 as a number of stops were cleared and shorts were squeezed.

The coming weeks will be important to determine whether there is any staying power in the upward move in risk assets. A lot of the February data in the US will likely be obscured by bad weather however, including industrial production figures this week, leaving markets with little to go on. In Europe, the key release is the March German ZEW investor confidence survey, and better news in Greece, will likely prevent a sharper decline in confidence.

After both the Swish National Bank (SNB) and Reserve Bank of New Zealand (RBNZ) unsurprisingly left policy unchanged last week this week sees the turn of the US Federal Reserve and Bank of Japan (BoJ). Neither central bank is likely to shift policy but the Fed statement will be looked upon for guidance on the timing of rate hikes. The comment in the FOMC statement that the Fed Funds rate is expected to remain low for an “extended period” is set to be retained, even if some FOMC members are itching to remove it soon.

The BoJ meeting will be particularly interesting. I have just returned from a week long trip in Japan and on the ground there is plenty of speculation that the BoJ will take extra action to combat deflation and weaken the JPY. Additionally comments by Japan’s Prime Minister and Deputy PM have highlighted the potential for action to weaken the JPY although the usual market hesitation to sell JPY into fiscal year end and repatriation talk may mean a weaker JPY path is not straightforward.

Greece will not move too far from the spotlight, with EU officials likely to give the official stamp of approval on Greece’s deficit cutting measures and plenty of discussion at the Eurogroup Finance Minister’s meeting and Ecofin meeting early in the week. Moreover, weekend press reports suggest that a bailout up to EUR 25 billion is close to being agreed. Other topics of conversation will include the possible formation of a European Monetary Fund, though this looks like it will be a non-starter given the many objections to it.

Overall, risk appetite is set to continue its upward trajectory, likely keeping the USD on the back foot. Some deterioration in USD sentiment was reflected in the fact that net long aggregate USD speculation positioning has turned negative again according to the latest CFTC Commitment of Traders (IMM) report. Much in terms of FX direction will depend on what the FOMC says rather than does tomorrow.

EUR/USD may take a crack at resistance around 1.3840 on improving Greek news but it is difficult to see much upside from current levels. The one to watch will be the JPY, especially if the BoJ embarks on aggressive actions at this week’s meeting, leaving USD/JPY plenty of scope to test resistance around 92.16.

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Risk Appetite Puts Dollar On The Back Foot

February 22, 2010 — Mitul Kotecha

Markets look somewhat calmer going into this week helped by comments by Fed members who noted that the discount rate hike did not signal a shift in monetary policy, something which is likely to be repeated by Fed Chairman Bernanke in his testimony to Congress on Wednesday and Thursday.  A tame US January CPI report last Friday helped too, giving further support to the view that the Fed will not hike the Fed Funds rate for some time yet; a rate hike this year seems highly unlikely in my view.  

Data this week will be conducive to a further improvement in risk appetite and despite the lingering concerns about Greece the EUR may find itself in a position to extend gains.  In Europe all eyes will be on the February German IFO survey and eurozone sentiment indicators, which following the surprising strength in the manufacturing Purchasing Managers Indices (PMIs), are likely to reveal solid gains. 

The main highlights in Japan this week includes January trade data and industrial production. The trade numbers will be particularly important to determine whether the rebound in exports due in large part to robust Asian demand, has continued whilst the bounce back in exports will be a key factor in fuelling a further gain in industrial output. 

In the US aside from the testimonies by Fed Chairman Bernanke there are plenty of releases on tap including consumer confidence, new and existing home sales, durable goods orders and a likely upward revision to Q4 GDP.  For the most part the data will show improvement and play for a further improvement in risk appetite. 

FX direction will depend on whether markets focus on the potentially positive USD impact of a reduction in USD liquidity or on the likely firmer tone to risk appetite this week.  Given expectations of firmer data and the soothing tone of the Fed, risk currencies will likely perform better, with crosses such as AUD/JPY favoured.  The USD will likely be placed on the back foot, especially given the very long market positioning in the currency.

The EUR will be helped by the fact that speculative market, according to the CFTC IMM data, holds record short positions in the EUR (as of the week ended 16 February) giving plenty of potential for short-covering.   The more timely Tokyo Financial Exchange (TFX) data also reveals that positioning in EUR/JPY has continued to be scaled back.  

CFTC Commitment of Traders (IMM) data – Net EUR speculative positioning

EUR/USD bounced smartly from its lows around 1.3444 on Friday, partly reflecting some short covering and the drop in FX volatility suggests the market is more comfortable with EUR/USD around these levels.  A positive IFO survey and improved risk appetite could see EUR/USD test resistance around 1.3774, its 20 day moving average, over coming days.  Ongoing Greek concerns suggest that any EUR bounce will be limited, however. 

USD/JPY looks well supported and although data this week will suggest that exports are improving despite JPY strength, the relatively more aggressive stance of the Fed compared to the BoJ, long JPY positioning, and improved risk appetite, give plenty of scope for the JPY to extend losses, with technical USD/JPY support seen around 91.28.

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Fed discount rate move boosts dollar

February 19, 2010 — Mitul Kotecha

The Fed’s move to hike the discount rate by 25bps has set the cat amongst the pigeons.   Although the move was signalled in the FOMC minutes yesterday a hike in the discount rate was not expected to happen so soon.  The Fed sees the modifications which also include reducing the typical maximum maturity for primary credit loans to overnight, as technical adjustments, rather than a signal of any change in monetary policy. 

Nonetheless, the market reaction has been sharp, with the USD strengthening across the board and short term interest rate and stock futures falling.  Although the reaction looks overdone and will likely be followed by some consolidation over the short term, the move will be interpreted as the beginning of a move towards monetary policy normalisation despite the Fed’s insistence that this is not the case.  The firm USD tone is set to remain in place for now but the bulk of the strengthening has likely already occurred following the announcement.  

The Fed’s desire to reduce the size of its burgeoning balance sheet, which at $2.3 trillion is roughly around three times its size before the financial crisis began, will imply further measures to reduce USD liquidity over the coming months.   A withdrawal of liquidity could have positive implications for the USD but given that the Fed is still some months away from hiking the Fed Funds rate, interest rate differentials will not turn positive for the USD for a while yet. 

The move has however, changed the complexity of the FX market and likely shifted currencies into new lower ranges against the USD.  There were plenty of reasons to sell EUR even before the Fed move and the discount rate hike inflicted further damage on EUR/USD which dropped below the key psychological level of 1.35.  GBP and commodity currencies were also big losers, with GBP/USD below 1.55.  Key technical support levels to watch will be EUR/USD 1.3422, GBP/USD 1.5374 and AUD/USD 0.884.

US Federal Reserve Balance Sheet ($trillion)

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Euro Still Vulnerable

February 18, 2010 — Mitul Kotecha

Markets have become rather skittish, with attention gyrating between sovereign deficit/debt concerns on the one hand and better news on the corporate and economic front on the other.  This week the latter appears to be gaining the upper hand helped by an easing of concerns about Greece. Although the Greek saga is by no means close to an end, especially given the new deadlines set by the EU Commission on adherence to budget cuts, the chances of the worst case scenario of default or pull out from the EU looks to have diminished. 

Renewed attention on other EU members, especially in light of the derivatives transactions carried out by Greece and potentially by other European countries to disguise the extent of their budget problems suggests that there is still more pain ahead. Nonetheless, it is increasingly clear that investors are differentiating between Europe and the rest of the world much to the chagrin of the EUR.  

Differentiation between the eurozone and the US was particularly apparent in the wake of stronger than forecast earnings and data in the US. Two more companies joined the three-quarters of S&P 500 companies beating earnings forecasts whilst economic reports including US January industrial production and housing starts came in ahead of forecasts.  This pattern is set to continue today, with the US Philly Fed manufacturing index set to increase to around 17 in February from 15.2 in January. 

In contrast, data in Europe has been much less impressive, with for example, the February ZEW survey of investor confidence recording its 5th consecutive decline in February.  The eurozone economic news may look a little better in the form of likely increases in manufacturing Purchasing Managers Indices (PMIs) but unless the data reveals particularly strong readings the growing perception that Europe is falling behind in the recovery process will remain in place.

Despite the improvement in risk appetite the USD has taken a firmer tone, appearing to react more to positive data and implications for a reduction in policy accommodation by the Fed.  In particular, the USD was spurred by the FOMC minutes of the January 26-27 meeting, in which the Fed debated its exit strategy from quantitative easing.  Some officials even went as far as pushing for asset sales in the “near future” to reduce the size of the Fed’s balance sheet.

Even though the USD has taken a firmer tone it will continue to be buffeted by the conflicting forces of improved risk appetite and shifting interest rate expectations.  Correlations reveal that risk is still the dominant FX factor suggesting that there may still be some further downside left for the USD as risk appetite improves. 

Although commodity currencies have also come under pressure due to the generally firmer USD tone overnight, the downside in these currencies is likely to prove limited especially given strong data releases.  For example, data overnight revealed that business confidence rose to its highest level in 15 years in Australia.  Added to upbeat comments from RBA deputy governor Lowe and strong labour market data, it highlights the growing probability of a March rate hike by the RBA.

The EUR remains the weak link and although it may benefit from easing Greek concerns the growing evidence of a relatively slower economic recovery in the eurozone suggests any upside in the EUR will be limited.  Having dropped below technical support around 1.3580, EUR/USD looks vulnerable to a further push lower in the short-term.

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Calming the Tiger

February 17, 2010 — Mitul Kotecha

As markets enter the year of the Tiger a somewhat calmer tone appears to be ensuing, with risk appetite edging higher helping equities and the beleaguered EUR to recover some lost ground.  US stocks were helped by a firmer than expected reading for the Empire manufacturing survey (to 24.91 in Feb) and a slight uptick in the US NAHB (National Association of Home Builders) index (to 17 in Feb) but consumer confidence remained weak as indicated by the decline in the weekly reading of ABC Consumer Confidence (-49).  

On the other side of the pond the better than expected February ZEW survey (a survey of investor confidence) in Germany (45.1) helped sentiment although it still recorded a decline from the previous month as Greek fiscal/debt concerns weighed on financial market participants’ confidence.  The bigger impetus came from comments by Greek Finance Minister Papaconstantinou who said there would be no need to for a bailout of the country.

Tensions over Greece eased further following news that tax collectors in the country called off a planned strike, helping to allay some concerns that unions will block planned spending cuts.   On the policy front, the EU Council ratified Greece’s plans but with strings attached, giving the country one month to present a report on the timetable for implementing budget cuts for 2010 and three months to outline policy measures required to cut the deficit below 3% by 2012.

Meanwhile, commodity prices have pushed higher helping currencies such as the AUD and NZD to strengthen.  Moreover, the AUD was boosted by more hawkish interest rate expectations following the release of the minutes of the latest RBA policy meeting which indicated that the Reserve Bank was merely pausing in its rate cycle.  Expectations of a rate hike in March increased as a result.

Overall, the recent rally in the USD is looking increasingly overdone and some reversal is likely over coming weeks.  The fact that market positioning has reached extreme levels in particular in the case of the EUR highlights scope for some recovery in the currency, especially now that the worst case scenario of a Greek default has passed.  The outlook for commodity currencies is even more bullish as risk appetite improves further.     

If anything, data today is likely to give further support to the recovery story, with US industrial production and housing starts expected to post healthy gains.  The Fed FOMC minutes may offer some additional insight into the debate over the implementation of exit strategies but there is unlikely to be much elaboration from the recent comments by Fed Chairman Bernanke in his speech to the US Senate in which he hinted that a rise in the discount rate is not far off.  

Risk currencies including many Asian currencies are likely to benefit from the improvement in risk appetite over the short term.  EUR/USD will likely strengthen as more short positions are covered but will face strong technical resistance around 1.3839.   Asian currencies have been resilient to the recent rise in risk aversion and this is likely to continue over the coming weeks.  As risk appetite recovers currency plays including long AUD/JPY , and even some further upside in EUR/USD look favourable.

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