Euro firmer, AUD vulnerable to risk gyrations

August 29, 2012 — Mitul Kotecha

A surprise drop in US August consumer confidence which dropped to its lowest since November last year put a dampener on markets and notably the VIX index edged higher. Consequently treasuries rose and equities slipped despite a firmer than expected increase in US house prices in June. The confidence data adds the pressure on Fed Chairman Bernanke to give some indication of a further round of quantitative easing during his speech at Jackson Hole on Friday.

An upward revision to US Q2 GDP and a bounce in July pending home sales today are unlikely to change this perspective although the Fed’s Beige Book will likely show some moderate improvement providing the Fed with useful information.

Separately decent debt auctions in Spain and Italy helped to calm Eurozone market nerves further amid hopes of European Central Bank (ECB) action next week despite the news that Spanish region Catalonia formally asked for EUR 5 billion in funding. As a result the EUR retained a firmer tone.

Contrary to expectations, EUR/USD continued to push higher. Just why the currency is strengthening given the significant event risk in the days and weeks ahead is questionable although in part the move is attributable to an ongoing short squeeze. Hopes of constructive ECB action next week taken together with Fed quantitative easing expectations have helped to put the USD on the back foot, allowing the EUR to take advantage.

Admittedly the drop in Eurozone peripheral bond yields is certainly helpful for the EUR, while my short term quantitative ‘fair value’ estimate for EUR/USD suggests more upside too. Nonetheless, given the risk that so much could go wrong in the weeks ahead I am loathe to get on the bullish EUR bandwagon. While EUR/USD and EUR on the crosses will likely remain firm ahead of Jackson Hole I expect the EUR to struggle to hold onto gains into next week.

AUD has lost ground since around 10 August. This has roughly coincided with a rise in risk aversion over recent weeks. Indeed, AUD maintains a strong correlation with risk aversion and is therefore highly susceptible to swings in risk appetite. Additionally renewed China worries have also dampened the attraction of the AUD given the increasing dependency of Australia’s economy to China both directly through trade and indirectly via commodity prices.

While I remain positive on the AUD over the medium term, the high level of speculative positioning in the currency suggests some vulnerability to profit taking over the short term, with AUD/USD vulnerable to a drop to technical support around 1.0282. Much will depend on news out of China in terms of AUD direction, with Chinese stock market gyrations also providing some influence.

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EUR to drift lower, AUD supported, JPY flatlines

August 7, 2012 — Mitul Kotecha

EUR/USD has failed to retake the 1.2400 handle and as noted yesterday looks set to gradually make its way lower again. News that the German government lent its support to the European Central Bank (ECB) bond buying plan helped to limit losses overnight, but there is likely to be little news on the policy front over coming weeks as Europe moves into full blown summer holiday mode.

No news is perhaps good news, but market patience continues to run thin and the EUR will eventually be punished should policy makers fail to deliver which has been so often the case. With only German factory orders in terms of data releases of note today, EUR/USD is set to settle into a range, but with a downside bias.

The RBA meeting today is likely to prove relatively uneventful. Almost all analysts polled expect a no change outcome from the Reserve Bank. As this is the largely priced in, the main influence on AUD will be the accompanying statement. The market is overly aggressive in pricing in 75 basis points of policy rate cuts over the coming months and in this respect it will require a particularly dovish statement to validate these expectations.

More likely, the RBA will sound neutral reflecting on relatively firm data (except the June jobs report) releases since the last meeting and a better global environment. Combined with strong attraction to ‘carry’ trades and a firmer tone to risk appetite, AUD looks well supported, with technical support seen around 1.0437.

USD/JPY continues to flat line just above the 78.00 level ahead of this week’s Bank of Japan meeting. There is unlikely to be much excitement from the BoJ meeting but the pressure to take more aggressive steps to reach their 1% inflation goal as well as to weaken the JPY remains strong. The 78.00 level appears to be an uncomfortable equilibrium for markets and Japanese policymakers.

Although low implied FX volatility suggests that there is little expectation of a move in either direction Japanese officials continue to remain concerned about the strength of the JPY. Similarly, the US Treasury bond versus Japanese JGB yield differential (2 year) remains relatively steady, suggesting little directional impetus in the short term. Given hopes / expectations of more Fed quantitative easing it seems unlikely that USD/JPY will make much traction on the upside over coming weeks.

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Fed passes the baton to the ECB. EUR and GBP downside risks

August 2, 2012 — Mitul Kotecha

Although the Fed’s inaction overnight was perhaps a little disappointing for markets the FOMC did note that it “will” provide further stimulus to the economy if needed. The USD rallied but risk currencies came under pressure. However, any sell off in risk assets will be limited as markets look to the FOMC meeting on September 13 for more action. This will also coincide with updates of the Fed’s economic forecasts. The below consensus reading for the ISM manufacturing index in July which came in at 49.8 added to the slight disappointment, with the data consistent with flat growth in manufacturing.

Attention now turns to the European Central Bank (ECB). Warnings by the Bundesbank President Weidmann for the ECB not to overstep its remit sets the scene for a stressful policy meeting today. Although markets have pared back their overly bullish expectations from the end of last week a lack of action by the ECB to reduce peripheral bond yields will disappoint and lead to a sell of in risk assets and EUR/USD but support around 1.2150 is likely to hold. Even a restart of Securities Market Purchases on its own would not be a game changer.

The Bank of England also decides on policy today but unlike the ECB there is little expectation of any action from the MPC. Inaction by the BoE today will highlight that after a GBP 375 billion in asset purchases there is limited room in the tool kit aside from lowering interest rates further. A weaker than expected reading for UK July manufacturing confidence weighed on GBP, with the data following a rash of disappointing data releases over recent weeks. I continue to see downside risks to GBP both against the EUR and USD, however. Indeed, my quantitative models reveal that GBP/USD should be trading around 1.5144 while EUR/GBP should be around 0.8242.

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USD under pressure, AUD well supported

August 1, 2012 — Mitul Kotecha

Despite comments by the German Finance Ministry that it sees no need to give the ESM bail out fund a banking license, market hopes of European Central Bank (ECB) action tomorrow remain in place, helping to give some support to markets and the EUR. However, the Fed is unlikely to deliver fresh stimulus measures following the conclusion of its two day meeting today.

Sentiment slipped slightly overnight although any weakness was limited by stronger than expected data releases in the US in the form of July consumer confidence and Chicago PMI. US and European equities ended lower but overall its appears to be a case of treading water until the policy decisions over coming days as well as Friday’s US jobs report.

There is perhaps less expectation of Fed action than the ECB but nonetheless, recent press reports suggest that the Fed is shifting closer to pulling the trigger for more balance sheet expansion. This in turn has put some restraint on the USD.

Although it is more likely that the Fed will want to wait to assess more economic data (the Fed will not be privy to the July jobs report before its release on Friday) there is a chance that the Fed could extend its guidance tonight. This will be less important from a USD perspective but if the Fed opens the door even wider to a third round of quantitative easing the USD will find little solace from a lack of QE today as the Fed will merely be seen to delay such a move until September.

Combined with the impact of firmer risk appetite over recent days and consequently reduced safe haven demand the USD will struggle to make any headway in the near term, with the USD index to find it difficult to break above 83.000.

AUD has been the best performing major currency in July. Yield attraction has increased and the AUD has been a key beneficiary. While my forecasts remain among the most bullish this year (1.08 by year end) I am cognisant of the risks of a pull back in the interim.

AUD has benefited to some extent from expectations of further policy stimulus in China as well as a generally more favourable tone to risk appetite. Reports that China is interested in buying Australian regional government bonds will also help buoy AUD.

While external conditions hold various risks to the AUD the domestic picture does not look too adverse and various domestic economic indicators have beaten expectations. Consequently I believe that market expectations for a bigger 75bp of Reserve Bank of Australia (RBA) policy easing are overdone and an eventual correction in the markets’ overly dovish stance will help to support the AUD.

Meanwhile, speculative AUD positioning is well below the all time high reached in April 2011, suggesting scope for more gains. AUD/USD looks well supported around 1.0374.

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Hopes run high ahead of major central bank decisions

July 30, 2012 — Mitul Kotecha

Expectations are running high that central bankers will deliver on further policy steps at the Federal Reserve, European Central Bank and Bank of England meetings this week. Indeed, following strong hints by ECB President Draghi last week, which provoked a rally in global markets, there are high hopes that the ECB restarts its bond buying programme.

Opposition by Germany’s Bundesbank could result in disappointment, however. A meeting today between Draghi and Bundesbank president Weidmann will shed further light on the issue. Also on the table is the potential for the ESM bailout fund to be given a banking licence though this seems unlikely any time soon. Given the rally in risk assets at the end of last week, any lack of action by policy makers this week will provoke significant disappointment.

Similarly a run of weaker US and UK data has led to growing hopes that the Fed and BoE will also ease policy further on Wednesday and Thursday, respectively. While recent press speculation suggests that the Fed is edging closer to further balance sheet expansion the Fed FOMC may want to wait for further news on the economic front before embarking on more quantitative easing.

Meanwhile, the BoE appears to be edging towards further easing too, but rather than more QE a rate cut is looking like the preferred option. I suspect that such action at this week’s monetary policy committee (MPC) meeting is unlikely, however. Adding to the drama of this week’s events is the US July jobs report at the end of this week and yet another lacklustre report is expected, with consensus forecasts for a 100k increase in jobs.

Currency markets are likely to settle into ranges ahead of the key events above. The USD lost a fair bit of ground over recent sessions but further direction will await the ECB and Fed meetings. EUR/USD looks firmly settled above support around 1.2241 but upside traction will be limited until there is further clarification from the ECB. I suspect that last week’s short squeeze has run its course, with a further drop in peripheral Eurozone bond yields required to drive the EUR higher.

Asian currencies look well supported in the near term ahead of the major policy decisions. The SGD and KRW have led gains over the past week and their high degree of sensitivity to risk suggests that they should continue to outperform. The INR has also edged higher on the back of firming risk appetite but much will depend on the outcome of the RBI meeting tomorrow. According to my quantitative models the PHP and TWD will underperform.

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