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.

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

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.

Posted in Asia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Fiscal/Budget, FX, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , . 1 Comment »

Stressing About European Stress Tests

June 18, 2010 — Mitul Kotecha

Equities and risk appetite were bolstered by the relative success of the Spanish bond auction on Thursday. The results of the auction in which Spain sold EUR 3 billion in 10 year notes helped to stem some of the pressure on eurozone bond spreads, which despite the generalized improvement in market sentiment over recent days, had been continuing to widen.

Another key indicator that has been suggested that all is not well moving in the opposite direction to the improvement in many risk indicators is the Baltic Dry Index which has dropped by around a third since 26th May 2010.

Perhaps more significant in terms of providing sustainable support for markets was the news that the European Union agreed to publish the results of bank stress tests, slated for the second half of July. This could turn out to be a key stepping stone towards increasing the transparency of the eurozone banking sector.

However, doubts will remain until there is some clarity on the terms of the tests such as whether they include details of sovereign debt exposure. Also, if the stress tests reveal shortcomings in the banks in question it is unclear if government funding will be provided for them. Although the publishing of stress test results is a step in the right direction until these and other questions are answered it is difficult to see markets getting too excited.

It’s not all plain sailing for equity markets despite the relatively positive news in Europe as disappointing US data in the form of a surprise jump in weekly jobless claims and a bigger than expected drop in the June Philly Fed survey weighed in on the side of those expecting both a slow and jobless recovery in the US.

The CHF has been a key mover following the Swiss National Bank policy decision. The decision to leave interest rates unchanged was no surprise, but the change in rhetoric towards a less aggressive stance towards CHF strength opens up the floodgates for CHF buyers. will look to test its all time low around 1.3720.

Another central bank that has shown concern about a strengthening currency is the Bank of Japan but unlike the SNB Japan’s central bank has not intervened for several years. The BoJ in the minutes of its May meeting noted that it will “watch if Europe’s crisis strengthens JPY”, indicating some concern about JPY strength.

This sentiment that was echoed by the Japanese government in the release of Economic Growth Strategy aimed at avoiding an excessive rise in the JPY via fiscal and monetary steps to beat deflation. The JPY barely reacted to both the minutes and the growth strategy, with market players likely sceptical until concrete measures are actually implemented.

It still look like an environment of sell on rallies for the EUR and other risk currencies, with their gains likely to run out of steam over coming days. The next key technical level for EUR/USD is around 1.2454, a level that will prove a tough nut to crack.

Posted in bank rescue, Bond markets, central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Interest rates, Monetary Policy, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Euro Rally To Fade

June 17, 2010 — Mitul Kotecha

It is not an easy time to forecast currencies. Just as many forecasters fought for the accolade of being the most bearish on the EUR and many others were forced to capitulate or risk falling behind the curve, EUR/USD has started to perk up. Similarly, commodity currencies and many emerging market currencies have bounced.

Perhaps the explanation of these moves is merely position adjustments as traders and investors square positions as they keep one eye on the World Cup or maybe its just fatigue after weeks of selling pressure. Either way, the fact that speculative USD market positioning is at a very high level, suggests there is plenty of scope to take profits on long USD positions.

There are various reasons to expect the calm to give way to renewed tensions, however. Public opposition to austerity plans in Europe, added to the prospects for slowing growth as the plans are implemented, in addition to banking sector concerns, suggest that the outlook for the EUR remains downbeat. These factors also point to the prospects of risk aversion rising over the coming weeks, reversing the recent rally in risk currencies.

Further out, the EUR’s travails will not be over quickly and in the wake of the implementation of austerity plans the EUR will struggle from the impact of relatively slower growth in the eurozone compared to the US and other countries. The EUR will continue to remain under pressure even as risk appetite improves and many risk currencies appreciate.

The interruption of risk as an FX determinant is likely to fade towards the end of the year and investors will then go back to differentiating on the basis of relative growth and interest rate dynamics, which will play well for the USD as US growth strengthens.

Relative growth differentials will also bode well for commodity currencies and there will be scope for plenty of upside in the AUD and NZD as growth strengthens. Both countries have benefited from firm demand in Asia and China in particular and this source of support will likely continue to be beneficial.

Funding currencies including JPY and CHF will likely weaken this year against the USD based on the likely improvement in risk appetite later this year. The outlook for the JPY will be particularly interesting in the wake of the change in Prime Minister in Japan, especially given the new PM’s preference for a weaker JPY and reflationary policies. USD/JPY will likely reach 100 by the end of the year.

GBP should not be seen in the same context as the EUR. Although the UK has got its own share of fiscal problems the new government appears to be moving quickly to mollify both investor and ratings agency concerns. The test will come with the reaction of the emergency budget on June 22nd but I suspect that the downside risk to GBP will be limited.

Unlike the EUR which is trading around “fair value”, GBP is highly undervalued. Arguably past GBP weakness puts the UK economy on a stronger recovery footing. Moreover, problems that Europe will face in implementing multi country austerity plans and widening growth divergence, will not be repeated in the UK. Overall, there is likely to be significant outperformance of GBP versus EUR over coming months

Posted in China, Commodities, Currencies, Economics, Economy, emerging markets, Europe, eurozone, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

World Cup FX Positioning/Data Highlights

June 14, 2010 — Mitul Kotecha

The market tone felt decidedly better over the course of the last week although it was difficult to tell if this was due to position squaring ahead of the World Cup football or a genuine improvement in sentiment. There was no particular event or data release that acted as a catalyst either, with the European Central Bank (ECB) and Bank of England (BoE) meetings passing with little fanfare.

US data ended the week mixed, with retail sales disappointing in May but in contrast June consumer confidence beating expectations. Although questions about the pace of recovery remain, other data such as the Fed’s Beige Book suggest that recovery remains on track, sentiment echoed, albeit cautiously by Fed Chairman Bernanke last week.

Attention this week will centre on inflation data. Expected benign CPI readings will support the view that the Fed will take its time to raise interest rates. Speeches by the Fed’s Bullard, Plosser and Bernanke this week will be eyed for further clues on Fed thinking.

Central banks in Brazil and New Zealand hiked rates last week but this is not likely to be echoed this week. No change is likely from both the Bank of Japan and Swiss National Bank although there will be plenty of attention on the SNB’s comments on the CHF following recent data showing a surge in FX reserves due to currency intervention. The BoJ is unlikely to announce anything new but perhaps some further detail on the loan support plan could be forthcoming.

Manufacturing data will also garner some attention, with the US June Empire and Philly Fed surveys and May industrial production on tap. All three reports will confirm the improving trend in manufacturing activity in the US. Housing data will look weaker, with starts set to pull back in starts in May following the expiry of government tax incentive programmes though permits are set to rise.

In Europe, the June German ZEW (econ sentiment) investor sentiment survey will likely slip slightly due to ongoing fiscal/debt worries but this will be countered by stronger domestic data. In any case the index remains at a high level and a slight drop is unlikely to derail markets.

GBP may find some support form upgrade of UK growth forecasts by the CBI to 1.3% for 2010 and relatively hawkish comments from the BoE’s Sentance in the weekend press warning that inflation is higher than expected, indicating that the Bank may need to hike rates sooner than expected.

Further GBP/USD direction will come from CPI and retail sales data this week as well as public borrowing figures and a report by the new Office of Budget Responsibility on the UK’s fiscal position ahead of the June 22 budget. A break above GBP/USD resistance around 1.4760 is unlikely to materialise.

Despite the many data releases this week, the overall tone is likely to be one of consolidation and reduced volatility in the days ahead. This may allow EUR/USD to gain some ground due to short covering, with the CFTC commitment of traders (IMM) report revealing a further increase in net short speculative positions last week, close to the record set a few weeks back, though we suspect that there will be strong resistance around 1.2227.

The fact that the IMM data revealed that net aggregate net USD long positions reached an all time high last week, highlights the potential for profit taking this week. USD/JPY will look to take out resistance around 92.55 but this looks unlikely unless the BoJ dishes up anything particularly dovish from its meeting.

Posted in central banks, Currencies, Economics, Economy, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Interest rates, Japan, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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