Australian and NZ Dollar Outperform

January 27, 2012 — Mitul Kotecha

The boost to EUR following the dovish tone of the Fed FOMC statement on Wednesday has faded although the EUR looks well supported against the USD, JPY and GBP. Further gains against the USD will however, be limited to around 1.3201 (21 December 2011 high and 61.8% retracement from its 1.3553 high).

Reports overnight that Greek private lenders were willing to accept a coupon rate below 4% helped to boost confidence of an imminent deal with regard to Greek debt restructruing. Ahead of next week’s EU Summit the EUR will consolidate its gains, with attention focussing on a meeting between German Chancellor Merkel, Italian Prime Minister Monti, and French President Sarkozy on Monday.

USD/JPY has become insensitive to moves in most of its usual drivers. Bond yield differentials have lost influence over recent months despite a very strong relationship in the past. Similarly USD/JPY is also not particularly sensitive to moves in the USD index or risk aversion, with these relationships also breaking down lately according to my correlation calculations. Net foreign portfolio flows should in theory be playing negative for the JPY with outflows from bond and equity flows recorded in 8 of the last 10 weeks.

However, the reality is that USD/JPY remains stubbornly entrenched in a narrow 77-78 range. While a base appears to have been formed around the 77.00 level the upside momentum for the currency pair is weak. I stand by my view of USD/JPY ending the quarter around current levels given the loss of influence of its usual drivers but still look for an eventual move higher.

AUD and NZD have performed extremely well over recent weeks recording the biggest gains among major currencies so far this year. Both currencies have been boosted by improving risk appetite and receding growth worries in China. AUD in particular looks attractive in the wake of the dovish Fed and relative high AUD yield. I continue to believe markets are too dovish on Australian policy rate expectations, with markets pricing in more rate cuts this year beginning in February. Any reversal in easing expectations will support AUD.

AUD is also benefiting from diversification flows, with Russia’s central bank noting that it may begin to buy AUD in February. Nonetheless, AUD/USD gains look overly aggressive in a short space of time, with positioning turning increasingly long. AUD/USD will face strong resistance around 1.0753 over coming days.

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Fed weighs on the dollar

January 26, 2012 — Mitul Kotecha

The USD was already losing ground over the last couple of weeks against the background of firming risk appetite but the currency was dealt another blow from the Fed when it announced in the FOMC statement new guidance for monetary policy, stating that interest rates would remain “exceptionally low until at least late 2014” while keeping the door open to further quantitative easing. The statement helped to counter the pressure on the EUR from rising Portuguese bond yields, with EUR/USD breaking above 1.3100.

The prospect of prolonged low US interest rates means that the USD could remain a funding a currency for longer than anticipated. My forecasts of only a gradual appreciation of the USD over coming months take this into account to a large extent. I remain positive on the prospects for the USD against the EUR, JPY and CHF but predict further weakness against high beta commodity currencies and emerging market currencies over coming months. However, should US bond yields continue to remain suppressed even expectations of USD gains against the EUR, JPY and CHF may be dashed.

Although the Fed downgraded its growth expectations over coming quarters US data releases are looking more encouraging and in this respect the US is beginning to outperform other major economies. In contrast Europe’s growth outlook looks even gloomier while there is a long way to go before the problems in the region are resolved. Portugal has moved increasingly into the spotlight as markets increasingly anticipate some form of debt restructuring while in Greece debt talks have so far failed to reach any agreement on the extent of debt writedowns.

As the end of the week approaches risk is definitely on the front foot and the EUR has confounded many expectations by strengthening against all odds. I have highlighted the fact that the market was extremely short EUR over recent weeks as well as the EUR’s increasing resilience to bad news. I also noted that the Eurozone external position is still very healthy providing underling support for the currency. While I still look for the EUR to weaken over coming months expectations of a one way will not be fulfilled. EUR/USD will face strong resistance around 1.3201 (the 21 December high and 61.8% retracement from its 1.3553 high).

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Euro edging towards year highs, GBP lagging

January 20, 2012 — Mitul Kotecha

Contrary to most expectations at the beginning of this week EUR has managed to claw back its losses and more, with the currency edging towards its year-to-date highs around 1.3069. The resilience of the currency to bad news in Europe has been impressive and its gains have reflected a speculative market that has been extremely short. The end of the week sees no key data of note so markets will have to contend with digesting the outcome of the relatively positive Spanish and French debt auctions while keeping one eye on Greek debt talks with private investors.

Unless there is yet another breakdown of talks in Greece the EUR will end the week on a positive note. I suspect it won’t last further out especially given the pitfalls ahead but at a time when investors have become increasingly bearish on the EUR it may just extend its bounce over the short term. One country to watch is Portugal whose bonds have underperformed recently as markets speculate that it could be the next contender for any debt writedown.

Retail sales data in the UK will capture local market attention today. Sales are set to have bounced back in December but the improvement is likely to be short-lived, suggesting any support to GBP will be fleeting. GBP has underperformed even against the firmer EUR recently but this is providing better levels for investors to take long positions versus EUR. In part this reflects the move in relative European/US interest rate differentials, which has been correlated with the move in EUR/GBP.

I expect GBP to outperform EUR over coming months to around 0.80, with the former continuing to benefit from the simple fact that it is not in the Eurozone and has therefore acquired a quasi safe haven status. Nonetheless, as reflected in the drop in Nationwide consumer confidence in December, this year will be particularly difficult for the UK economy. GBP will be restrained by the prospects of more quantitative easing by the Bank of England as inflation eases further

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Resilient Markets

January 19, 2012 — Mitul Kotecha

Risk assets have registered a good start to the year despite ongoing tensions in the Eurozone. US stocks rose overnight, with the S&P 500 extending its rally to 4% year to date. Evidence that markets are becoming increasingly resilient to bad news emerged from the muted reaction to sharp downgrades in growth forecasts by the World Bank, with the world economy expected to grow by 2.5% this year compared to a June forecast of 3.6%.

US markets also reacted positively to news that the US NAHB Homebuilders index rose to its highest level in more than 4 years and while industrial output expanded, albeit less than expected. Markets will continue to keep one eye on earnings to ascertain whether the equity rally can be sustained, with at least 48 S&P 500 companies reporting earnings this week including Morgan Stanley Bank of America, Intel and Google today. So far, relatively more companies have fallen short of expectations than have beaten expectations.

Even in the Eurozone the news has been slightly more encouraging than of late, with reports that a deal between Greece and private creditors on the extent of debt writedowns could be reached by the end of this week. Moreover, the International Monetary Fund (IMF) is reported to be raising $500 billion in new funds for bail out funds, another factor that has helped to shore up market sentiment. The net result has been to see peripheral bond yields ease further and the EUR to strengthen, helped by the fact that the market is extremely short.

There is still plenty of event risk on the horizon, however, including debt auctions in Spain and France today although these ought to pass relatively smoothly. US data are likely to be mixed today, with benign inflation keeping the door open to more Fed quantitative easing (QE) while a gain in the Philly Fed manufacturing survey will continue to reveal signs of economic recovery. In the short term risk assets look supported but given the risks ahead any bounce still looks to be short-lived.

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More Bad News In Europe

January 16, 2012 — Mitul Kotecha

Several pieces of bad news soured sentiment at the end of last week undoing much of the good news since the beginning of the year and dashing hopes of a relatively swift resolution to Eurozone’s ills. S&P ratings agency downgraded nine Eurozone countries’ credit ratings leaving 14 on negative outlook. In particular France and Austria, which lost their triple AAA status while not particularly surprising, comes as a major blow to efforts to resolve the crisis. The downgrade puts at risk the EUR 180 billion in credit guarantees underpinning the EUR 440 EFSF bailout fund.

Separately the breakdown of talks on Greek debt restructuring and criticism by the Euuropean Central Bank (ECB) on a new draft of a treaty to ensure fiscal discipline added to the malaise, with the ECB noting that proposed revisions amount to a “a substantial watering down”. Such criticism will likely be an obstacle to the ECB stepping up its peripheral debt buying potentially threatening any decline in bond yields. It is difficult to see sentiment improving this week, with risk aversion set to remain elevated as Eurozone leaders attempt to restore confidence. In contrast, US data continues to support evidence of economic recovery, albeit gradual and this week’s releases including industrial production and manufacturing surveys will likely add to this.

The EUR slid further at the end of last week reversing earlier gains, as the bad news mounted in the Eurozone. Ratings downgrades, breakdown of Greek debt talks and ECB criticism over watered down fiscal rules, combined to make a dangerous concoction of negative headlines. The news put an end to the EUR’s short covering rally, leaving the currency vulnerable too further declines this week. Speculative sentiment according to IMM data reached another all time low last week (-155k net positions), suggesting that any good news could lead to a strong bounce as short positions are covered.

However, it is difficult to see where such news will come from and even a small expected bounce in the German January ZEW investor confidence survey this week will do little to detract from the negative news on the policy front. A meeting between Merkel, Monti and Sarkozy will be eyed closely as they prepare for a meeting of European Union (EU) Finance Ministers and markets will be looking for aggressive action to turn confidence around. Debt sales in In the meantime EUR/USD will continue to languish but strong technical support is seen around 1.2588.

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