When things are just not right

November 20, 2009 — Mitul Kotecha

One knows when things aren’t quite right when a football team wins a game by using a hand to help score a goal rather than a foot.  In this case it was French striker Thierry Henry who helped France to qualify for the world cup at the expense of Ireland.  To English soccer fans this looks like decidedly similar situation to the “hand of god” goal scored by Diego Maradona during the 1986 World Cup. 

Similarly things don’t look quite right with markets at present and what began as a loss of momentum turned into a bit of a rout for US (Thursday) and Asian stocks (Friday).  In turn risk appetite has taken a turn for the worse whilst the USD is on a firmer footing.  Profit taking or simply repatriation at year end may explain some of the market moves but doubts about the pace and magnitude of economic recovery are playing a key role.

Ireland has called for a replay of the soccer game but markets may not get such an opportunity as sentiment sours into year end.  Markets chose to ignore some relatively positive news in the form a  stronger than forecast increase in the Philly Fed manufacturing survey and the improving trend in US jobless claims leaving little else to support confidence. 

The only event of note today was the Bank of Japan policy decision.   Interest rates were kept unchanged at 0.1%.  Given that official concerns about deflation are intensifying interest rates are unlikely to go up for a long while and we only look for the first rate hike to take place in Q2 2011.  The BoJ may however, be tempted to buy more government bonds in the future if deflation concerns increase further.   USD/JPY was unmoved on the decision, with the currency pair continuing to gyrate around the 89.00 level though higher risk aversion suggests a firmer JPY bias. 

In the short term increased risk aversion will play positively for the USD against most currencies, especially against high beta currencies such as the AUD, NZD and GBP.   Asian currencies will also be on the back foot due to profit taking on the multi-month gains in these currencies.

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Fed keeps the risk trade party going

November 17, 2009 — Mitul Kotecha

Risk is back on and the liquidity taps are flowing. Fed Chairman Bernanke noted that it is “not obvious” that US asset prices are out of line with underlying values, comments that were echoed by Fed Vice Chairman Kohn, effectively giving the green light to a further run up in risk trades. The last thing the Fed wants to do is ruin a good party and the comments indicate that the surge in equities over recent months will not be hit by a reversal in monetary policy any time soon.  

Aside from comments by Fed officials risk appetite was also boosted by a stronger than forecast rise in US October retail sales, with US markets choosing to ignore the sharp downward revision to the previous month’s sales, the weaker than forecast ex-autos reading and a surprisingly large drop in the Empire manufacturing survey in November.

Fed comments were not just focussed on the economy and equity markets as Bernanke also tried to boost confidence in the beleaguered USD, highlighting that the Fed is “attentive” to developments in the currency.  He added that the Fed will help ensure that the USD is “strong and a source of global financial stability”.  The comments had a brief impact on the USD and may have given it some support but this is likely to prove short lived. 

The reality is that the Fed is probably quite comfortable with a weak USD given the positive impact on the economy and lack of associated inflation pressures and markets are unlikely to take the Fed’s USD comments too seriously unless there is a real threat of the US authorities doing something to arrest the decline in the USD, a threat which has an extremely low probability.

It is perhaps no coincidence that the Fed is attempting to talk up the USD at the same time that US President Obama meets with Chinese officials.  The comments pre-empt a likely push by China for the US not to implement policies that will undermine the value of the USD but comments by Obama appear to be fairly benign, with the President noting that the US welcomes China’s move to a “more market based currency over time”. The relatively soft tone of these comments will further dampen expectations of an imminent revaluation of the CNY.

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Lots of event risk in the days ahead

November 3, 2009 — Mitul Kotecha

Fears about yet another market crash in October proved unfounded but there were severe bouts of nervousness during parts of the month.  This was hard to tie in with the strength of earnings and continued good news on the economic front but perhaps markets had already priced in a lot of good news.   This was evident in the fact that economic surprises were becoming increasingly negative.

Nervousness is good for the dollar and has at least given the currency a semblance of support.   However, not all the economic news is coming in below forecast as demonstrated by the stronger than consensus reading for the US ISM index for October whilst even the eurozone PMI moved back into expansion territory following 17 months of contraction.

The tone over the rest of the week will depend on the outcome of several central bank meetings the main ones being the Fed, ECB and BoE as well as the US non-farm payrolls report.  None of the central banks are likely to hike rates but in an FX market that is becoming increasingly reactive to interest rate differentials whichever bank sounds relatively more hawkish will see their respective currency strengthen the most.

Unless the Fed sounds particularly dovish the dollar is likely to consolidate further over the short term and given the still significant size of dollar short positioning there is still some scope for some further relief for the dollar.   However, don’t expect much movement out of current ranges until after the payrolls report and even then markets may be hesitant ahead of this weekend’s G20 meeting.

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Contemplating Rate Hikes

October 28, 2009 — Mitul Kotecha

The market mood has definitely soured and risk appetite has faltered.  This is good for the USD but bad for relatively high yielding/commodity risk trades. The USD is set to retain a firm tone over the near term even if is temporary, which I believe it is.  

Whether it’s profit taking on crowded risk trades, a lot of good news having already been priced in, fears that other countries will follow Brazil’s example of taxing capital inflows to dampen currency strength, or a reaction to weaker economic data, it is clear that there are many reasons to be cautious. 

It is also unlikely to be coincidental that the rise in risk aversion and drop in equity markets is happening at a time when many central banks are contemplating exit strategies and when many investors are pondering the timing of interest rates hikes globally following the moves by Australia and Israel. 

One of the reasons for the worsening in market mood is that some parts of the global economy may not be ready for rate hikes.  Certainly there is little chance of a US rate hike on the horizon and perhaps not until 2011 given the prospects of a sub par economic recovery.  This projection was given support by the surprise drop in US consumer confidence in October.

It is not just the US that is unlikely to see a quick reversal in monetary policy.  As indicated by the bigger than expected decline in annual M3 money supply growth in the eurozone, which hit its lowest level since the series began in 1980, as well as the drop in bank loans to the private sector, the ECB will be in no hurry to wind down its non-standard monetary policy measures. 

The chances of any shift in policy at next week’s ECB meeting are minimal, with the ECB’s cautious stance emboldened by the subdued money supply and credit data.  As long as EUR/USD remains below 1.50 ECB President Trichet is also unlikely to step up his rhetoric on the strength of the EUR.  

Although the major economies of US, Eurozone, Japan and UK are likely to maintain current policies for a long while yet, the stance is not shared elsewhere.  The Reserve Bank of India did not raise interest rates following its meeting this week but edged in this direction by requiring banks to buy more T-bills. Other central banks in the region are set to move in this direction.

In terms of developed economies, Norway was the latest to join the club hiking rates by 25bps and adding to the growing list of countries starting the process of policy normalisation.   Australia is set to hike rates again at next week’s meeting although a 50bps hike looks unlikely, with a 25bps move more likely. 

Posted in Asia, Bond markets, central banks, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, India, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Respite for the dollar

October 27, 2009 — Mitul Kotecha

Markets are increasingly discounting stronger than expected Q3 earnings.  Further gains in equities and risk appetite may be harder to achieve even if profits continue to be beat expectations, which so far around 80% of Q3 earnings have managed to do. Measures of risk such as the VIX “fear gauge” have highlighted an increasingly risk averse environment into this week.  The negative market tone could continue in the short term.

The USD has found some tentative relief, helped by the drop in equities and profit taking on risk trades.  The fact that the market had become increasingly short USDs as reflected in the latest CFTC Commitment of Traders’ (IMM) report in which aggregate short USD positions increased in the latest week (short USD positions numbered roughly twice the number of long positions), has given plenty of scope for some short covering this week.

The USD has even managed quite convincingly to shake off yet another article on the diversification of USD reserves in China.  The USD index looks set to consolidate its gains over the short term against the background of an up tick in risk aversion.  The USD index will likely remain supported ahead of the main US release this week, Q3 GDP on Thursday, but any rally in the USD is unlikely to be sustainable and will only provide better levels to short the currency.

Given the broad based nature of the reversal in risk sentiment with not only equities dropping but commodities sliding too, it suggests that high beta currencies, those with the highest sensitivity to risk will suffer in the short term.  These include in order of correlation with the VIX index over the past month, from the most to the least sensitive, MXN, AUD, MYR, SGD, NOK, EUR, CAD, INR, ZAR, BRL, TRY and NZD. The main beneficiary according to recent correlation is the USD.

EUR sentiment in particular appears to be weakening at least on the margin as reflected in the latest IMM report which revealed that net long EUR speculative positions have fallen to their lowest level in 6-weeks.  Whether this is due to profit taking as EUR/USD hit 1.50 or realisation that the currency appeared to have gone too far too quickly, the EUR stands on shakier ground this week.  EUR/USD may pull back to near term technical support around 1.4840 and then 1.4725 before long positions are re-established.

Posted in Commodities, Currencies, emerging markets, equity markets, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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