USD momentum fading, EUR and gold supported

September 10, 2013 — Mitul Kotecha

Although Syria tensions continue to linger in the background risk assets performed well overnight helped in part by Chinese trade and inflation data released over the weekend. Meanwhile the weaker than forecast US jobs report has eased some of the markets fears about tapering, with the Fed looking less likely to pare back asset purchases too aggressively. Even the situation in Syria looks a little less tense as US President Obama opened the door to holding off any air strikes on Syria if the country handed over its stock of chemical weapons as proposed by Russia. A limited data slated today, with only second tier releases on tap suggests there will be some positive follow through to markets today.

The USD has lost momentum in the wake of last Friday’s US employment report and subsequent drop in US yields. The USD may be helped by a relatively firm US retail sales reading expected at the end of the week but tapering uncertainty will likely act to restrain any topside. Additionally, underperformance of US bonds and equities alongside foreign selling of US portfolio assets (especially by reserve managers) highlights the uphill struggle faced by the USD in the short term. Notably aggregate net USD positioning increased again last week, with net long USD positioning around its three month average, highlighting the lack of USD momentum at present. Further USD gains may need to wait for when the Fed finally begins to taper next week.

EUR has been the most resilient major currency against the USD this year. It has easily quashed expectations that it would face a difficult time in the wake of a weaker growth trajectory and ongoing peripheral worries. Admittedly the Eurozone economy remains weak and will contract this year, but there are already signs of improvement, with positive data surprises being revealed. Moreover, the Eurozone external position has strengthened due to strong portfolio inflows and a healthy current account surplus. Although there a number of risks ahead including Italian political tensions and German elections the near term outlook for the EUR looks constructive, with strong technical support seen around 1.3220.

Gold has moved into consolidation mode, with a range of 1360-1400 being observed over recent days. Lower US bond yields, and a weaker USD in the wake of the softer US August jobs report suggests will offer some support to gold prices while speculative positioning has shown a significant improvement over recent weeks, with positioning well above the three month average. Some resolution towards ending South African strikes and improving risk appetite may dampen the upside but we expect gold prices to be relatively resilient over the coming weeks as seasonal demand kicks in (our analysis shows that historically gold has a positive month in September) with a retest of the recent high around USD 1434 set be breached over the coming week.

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Euro resilience

August 27, 2013 — Mitul Kotecha

The disappointing reading for US July durable goods orders released yesterday following on from the surprisingly large drop in new home sales at the end of last week has added further uncertainty about the timing of Fed tapering. Although the next meeting in September remains most likely as reflected in various Fed comments over the weekend it is by no means a done deal.

US Treasury yields slipped in the wake of the data but equities failed to sustain gains as Syria tensions escalated a factor that could cast a shadow over risk assets today, with rhetoric in the US strengthening and expectations of action growing. Further US data disappointment is likely today, with the August consumer confidence survey set to decline in contrast to a likely increase in the German IFO business confidence survey.

EUR resilience has been impressive over recent weeks. Despite all efforts at trying to sell the currency, investors have has their fingers burned. Today is also not a day to sell EUR. Although the growth trajectory looks firmer in the US, the propensity to surprise in a positive direction has come from Eurozone data releases.

Today expect a further positive surprise, with a likely further rise in the IFO German business survey which will contrast sharply with the drop in headline July US durable goods orders. It’s not all bullish for EUR, however. Technical indicators suggest that upside EUR/USD momentum is fading while Greek jitters could return as the Troika returns on September 16. Moreover, speculative market EUR positioning has risen to its highest since early February, leaving no more scope for short covering.

Although USD/JPY has crept higher over recent weeks it is still a long way off the 22 May high of 103.74. JPY bears have not yet given up hope, with JPY short positioning at around its 3-month average. Nonetheless, despite the rise in US Treasury versus Japanese JGB bond yield differential USD/JPY has failed to budge. Although this is likely to be a temporary phenomenon, yield differentials are clearly not impacting USD/JPY at present.

Eventually, the widening yield gap between the US and Japan will see increased capital outflows from Japan. Perhaps more details about Prime Minister Abe’s third arrow of reforms will prompt some downside for the JPY but unless risk appetite improves markedly it is unlikely that the JPY will fall far in the near term.

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The “Great Rotation”

July 22, 2013 — Mitul Kotecha

Evidence that the “Great Rotation” is finally beginning to take place has been established. Capital is finding its way into US equities as reflected in recent flow data while flooding out of Treasuries and other fixed income instruments. However, another rotation of sorts is also taking place, with emerging market assets, both bonds and equities, continuing to register outflows much of which appears to be returning to the US.

Given that the Fed has helped to ease the transition process towards tapering, finally managing to establish effective communication with markets, there is little to suggest that this rotation will reverse. Indeed, the US equity risk premium remains high (ie bonds still look expensive relative to equities) despite the recent correction. Nonetheless, US bond yields pulled back last week (10 year yields have fallen by around 15 bps over the last two weeks) a factor that is also helping to take the wind out of the USD’s sails.

Events and data this week are unlikely to alter the dynamics noted above. US data will remain upbeat, with housing market data remaining positive; existing home sales will edge higher while new home sales will drop but largely due to low inventories, while durable goods orders will register solid gains, and Michigan consumer confidence will be revised higher.

Data in Europe will look less impressive but still encouraging as the German IFO and various purchasing managers’ indices record gains, albeit of an uneven nature. More distressing is the ongoing political travails in Spain, Portugal and Italy, factors that will likely continue to undermine Eurozone markets although EUR/USD will likely remain supported due to the recent softening in US yields.

In Japan, the political picture is now clearer, with an unsurprisingly solid election victory for Prime Minister Abe’s LDP, winning a majority in the Upper House with its partner New Komeito. Ultimately this should play for firmer Japanese assets and a weaker JPY although markets will now look for a clear reform strategy to justify such moves.

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US dollar grinding higher

July 16, 2013 — Mitul Kotecha

As markets await Fed Chairman Bernanke’s semi-annual testimony to Congress over the next couple of days, sentiment has become relatively upbeat. Risk measures have shown improvement over recent weeks as reflected in gains in equity markets and the fall in the VIX ‘fear gauge’. Central banks have done a good job in massaging market fears over higher yields by implementing “forward guidance” and even in the US Treasury yields have fallen although 10 year yields look well supported above 2.5%.

Meanwhile, Q2 GDP data in China yesterday came in as expected revealing less of a slowdown than perhaps feared, while Q2 earnings in the US have for the most part have beaten forecasts so far. There is little to suggest that this tone will change even with a plethora of data releases scheduled for release today. The next trigger for market direction will come from Bernanke’s testimony.

A surprisingly weak reading for US June retail sales failed to take the shine off the USD. A spate of US data releases are on tap today including June CPI inflation, June industrial production and July NAHB housing data as well as the May TIC capital flow data. I do not expect the data to divert the USD’s path.

Given that there has been much talk that capital has been flowing to the US as US yields rise, the TIC data will be quite instructive given that US yields began their heady ascent from early May. Net long term capital flows into US portfolio assets have been negative for the previous three months and Treasuries registered major outflows in April. The USD is likely to continue to grind higher over coming days despite further revelation of capital outflows.

EUR/USD appears to be stuck around the middle of a relatively broad range at present. The build up of negative news including Portuguese political uncertainty, downgrade of France’s credit ratings, and corruption allegations in Spain among other factors, threatens to pressure the EUR lower. However, as has been the case over past months the EUR has managed to reveal an impressive resistance or “Teflon” coating to bad news.

Nonetheless, weak growth and a relatively strong move higher in US Treasury yields relative to German bunds recently suggests that downside risks to the EUR will dominate. A small gain expected in today’s release of the July German ZEW survey will do little to change this perspective.

I retain a bearish JPY stance but the move is not going to be a one way bet. Volatility will remain elevated especially ahead of Japanese Upper House elections. Prime Minister’s Abe’s LDP is likely to win but markets will be more interested in Abe’s reform program.

JPY positioning has become increasingly JPY short over recent weeks but does not look particularly stretched suggesting further scope to build JPY shorts. Fed policy expectations will drive USD/JPY, with a renewed relative increase in US yields required to push USD/JPY sustainably above the psychologically important 100 level.

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US dollar running rampant

June 24, 2013 — Mitul Kotecha

A calmer tone looks like it will settle over markets today after recent sharp volatility. However, little relief to the pain inflicted on markets from tapering fears is likely this week. Weaker growth and funding concerns in China added another layer of uncertainty to the market psyche although comments from China’s central bank the PBoC about “fine tuning” may help to allay fears of a wider credit crunch.

Meanwhile across the pond Fed officials are probably quite frustrated by the market reaction to last week’s FOMC statement. There will be plenty of Fed speakers on tap this week to provide clarification, with markets looking for some soothing comments. Given the varying and diverse views among Fed officials such hopes may be dashed.

Data releases both in the US and Europe will be encouraging in terms of recovery expectations but will do little to ease the angst over tapering. In the US durable goods orders and new homes sales will record gains in May while June consumer sentiment indices will remain at relatively high levels.

In Europe, aside from the European council meeting this week the German IFO business confidence survey today and economic sentiment gauges later in the week are set to rise in June. In Japan the main CPI inflation gauge will stabilize in May although reaching the 2% inflation targets remains as difficult as ever while industrial production is set to decline in May due to still fragile foreign demand.

Most asset markets will continue to track bonds, with equities, and commodities remaining under pressure and the USD supported by higher US yields. Notably 10 year Treasury yields spiked to over 2.5%, a sharp increase over the week. Consequently the USD’s firm tone was expressed across a broad swathe of currencies, with Scandinavian, Latam and commodity currencies among the worst performers.

Emerging market and commodity currencies are set to suffer from continued capital outflows while the USD runs rampant. However, many currencies look oversold and over the near term some stabilisation is likely as they benefit from a slightly better risk tone at the turn of the week. As indicated by the latest CTFC IMM data, the USD long positioning has been cut back, suggesting scope for further gains. EUR positioning has turned net long for the first time in four months implying no further room for short covering.

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