Ratings agencies spoil the party

December 13, 2011 — Mitul Kotecha

Just as I thought that attention may finally switch to the US along comes the ratings agencies to spoil the party once again. Moody’s and Fitch Ratings criticised last week’s European Union Summit outcome for falling short of a comprehensive solution to Eurozone ills. Consequently the risk of further sovereign credit downgrades across Europe remains high over coming weeks especially as economic growth weakens. Moody’s also put 8 Spanish banks and two bank holding companies on review for a possible downgrade.

The EUR and Eurozone bonds came under pressure as a result, with EUR/USD verging on its strong support level around 1.3146. Further pressure is likely into year end although the fact that the speculative market is still very short EUR may limit its downside potential in the short term. Disappointment that the ECB has not stepped up to the plate to support the Eurozone bond market more aggressively is also having a damaging effect on confidence. A test of sentiment will come from today’s EFSF and Spanish bill auctions while on the data front we look for a below consensus outcome for the German December ZEW survey, which will deteriorate further.

The comments from the ratings agencies resulted in risk assets coming under pressure once again, leaving the market open to further selling today given the lack of positives. US data and events will at least garner some attention, with the Federal Reserve FOMC meeting and November retail sales on tap. We do not look for any big surprise from either of these, but at least the Fed may sound a little more positive in light of firmer data over recent weeks. Even so, speculation of more Fed QE early next year will remain in place. In the current environment demand for US Treasuries remains strong with a Treasury auction yesterday receiving the highest bid/cover ratio since 1993.

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The Devil is in the details

December 12, 2011 — Mitul Kotecha

The “partial solution” delivered by European Union (EU) leaders last week has failed to match the high hopes ahead of the EU Summit. Nonetheless, the deliverance of a “fiscal compact”, acceleration of the European Stability Mechanism (ESM) to July 2012 , no forced private sector participation in debt restructuring (outside Greece), and possible boost to the International Monetary Fund (IMF) of up to EUR 200 billion, are steps in the right direction. The fact that UK Prime Minister Cameron threw a spanner in the works to veto a joint proposal to revise the EU Treaty should not detract from the progress made.

Nonetheless, the measures may not be sufficient to allay market concerns, with disappointment at the lack of European Central Bank (ECB) action in terms of stepping up to the plate as lender of the last resort still weighing on sentiment. Data will add to the disappointment this week as “flash” Eurozone purchasing managers indices (PMI) drop further in December.

This week events in the US will garner more attention, including the Federal Reserve FOMC meeting, November inflation and retail sales data plus manufacturing confidence gauges as well as November industrial production on tap. The Fed will not shift its policy stance at this meeting but may sound a little more upbeat on the economy following recent firmer data. Inflation will likely remain subdued while the other data will continue to show gradual recovery.

Overall, the market is likely to thin further as the week progresses and holidays approach, with ranges likely to dominate against the background of little directional impetus. Our call to sell risk assets on rallies remains in place, however. The EUR will likely struggle to make much headway in the current environment, especially given that many details of the EU agreement still need to be ironed out and once again the risk to market confidence lies in implementation or lack of it. A range of EUR/USD 1.3260-1.3550 is likely to hold over the short term.

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All Eyes On Europe

December 8, 2011 — Mitul Kotecha

EUR looks range bound ahead of key events including the European Central Bank (ECB) meeting, European Union Summit and release of bank stress test results. A senior German official poured cold water over expectations of a concrete outcome from the EU Summit, dampening EUR sentiment as a result.

There will be plenty of attention on the ECB to determine whether they will give a little more ground and provide further assistance to the Eurozone periphery. While a refi policy rate cut is highly likely as well as additional liquidity measures I do not expect any move in the direction of more aggressive action to support peripheral bonds in terms of becoming “lender of the last resort’.

If however, the ECB hints at intensifying its securities market purchases of Eurozone bonds this will likely bode well for the EUR. Indeed, reports overnight suggest that the ECB will announce a set of measures to stimulate bank lending including easing collateral requirements for banks.

More weak UK data in the form a bigger than consensus drop in manufacturing and industrial production in October add to the soft BRC retail sales and house price data, in putting pressure on the Bank of England (BoE) to increase its quantitative easing at today’s policy meeting. While the BoE is set to keep policy unchanged it is only a matter of time before additional asset purchases are announced.

Despite the weaker IP data GBP has held up relatively well against the USD although downside risks appear to be intensifying. If I am correct in the view of no change by the BoE today we expect little change in GBP although there could be a risk of a push higher in EUR/GBP if the ECB delivers some positive news, with resistance seen around 0.8665.

The RBNZ unsurprisingly left policy rates unchanged at 2.5%, sounded less hawkish than the previous meeting and also lowered growth forecasts. The NZD was left unmoved by the rate decision and looks well supported at current levels perhaps due to relief that the statement was not more dovish. The kiwi has been an underperformer over the year but unlike the AUD it has not been particularly influenced by gyrations in risk aversion.

Interest rate futures differentials have seen a renewed widening versus the US over recent weeks. This is significant given that the NZ-US interest rate differentials have a very strong correlation with the performance of NZD/USD. If this widening is sustained it will point to upside potential for the Kiwi.

Posted in Currencies, ECB, Economics, Economy, Europe, eurozone, Fiscal/Budget, FX, Interest rates, Monetary Policy, New Zealand, UK. Tags: , , , , , , , , , , , , , , , . Leave a Comment »

Risk Appetite Buoyed by Central Banks

December 1, 2011 — Mitul Kotecha

Co-ordinated central bank action led by the Federal Reserve to lower the rate on USD liquidity by 50bps was accompanied by a cut in China’s reserve requirements and an easing by Brazil of its benchmark Selic rate. Unsurprisingly risk assets have rallied strongly overnight but once the announcement effect wares off the reality that the underlying tensions in the Eurozone remain in place will see any boost to sentiment wane. The move by the Fed will be a boon to the banking sector but should actually not have been too surprising as this tool was an easy one to use and one that should have been expected given the ample room to cut pricing on USD liquidity swap arrangements.

The other boost to markets overnight was the strong November ADP jobs report, which came in at 206k in November, and will lead to upward revisions to Friday’s payrolls data. Indeed, we now look for a 175k increase in non-farm payrolls from 120k previously. The trend of better than expected US data continued with a stronger than forecast reading for November Chicago PMI at 62.6. We expect this to be echoed by an increase in the ISM manufacturing survey today and the Fed’s Beige Book, all of which will at least allay concerns of a renewed US recession.

What will be important is whether the Fed move will be followed up by other measures from governments and central banks over coming days. Although European Union (EU) leaders have agreed to enhance their bailout fund attention is centred on French and German leaders, with hints that there could be a strong announcement over coming days. At the least, the upcoming EU Summit on 8/9 December will be expected to deliver concrete results otherwise the market rout will continue.

The USD will remain under pressure following the moves by central banks in line with the improvement in risk appetite. High beta risk currencies ie those with the highest correlation to risk over the past 3-months will benefit the most. These include RUB, AUD, TRY, CNH, KRW, GBP and CAD in respective order of correlation. All of these currencies are likely to register gains over the short term, especially given anticipation of further announcements from European officials and a reasonable US jobs report tomorrow.

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Extreme Uncertainty

November 20, 2011 — Mitul Kotecha

The level of uncertainty enveloping global markets has reached an extreme level. Who would have thought that close to 13 years after its introduction at a time when it has become the second largest reserve currency globally (26.7% of global reserves) as well as the second most traded currency in the world, European leaders would be openly talking about allowing countries to exit the EUR? No less an issue for currency markets is the sustainability of the USD’s role as the foremost reserve currency (60.2% of global reserves). The US debt ceiling debacle and the dramatic expansion of the Fed’s balance sheet have led to many official reserve holders to question their use of the USD. Perhaps unsurprisingly the JPY has been the main beneficiary of such concerns especially as global risk aversion has increased but to the Japanese much of this attention is unwanted and unwelcome.

The immediate focus is the travails of the eurozone periphery. Against the background of severe debt tensions and political uncertainties it is perhaps surprising that the EUR has held up reasonably well. However, this resilience is related more to concerns about the long term viability of the USD rather than a positive view of the EUR, as many official investors continue to diversify away from the USD. I question whether the EUR’s resilience can be sustained given that it may be a long while before the situation in the eurozone stabilises. Moreover, given the now not insignificant risk of one or more countries leaving the eurozone the long term viability of the EUR may also come into question. I believe a break up of the eurozone remains unlikely but such speculation will not be quelled until markets are satisfied that a safety net / firewall for the eurozone periphery is safely in place.

In this environment fundamentals count for little and risk counts for all. If anything, market tensions have intensified and worries about the eurozone have increased since last month. Politics remain at the forefront of market turmoil, and arguably this has led to the worsening in the crisis as lack of agreement between eurozone leaders has led to watered down solutions. Recent changes in leadership in Italy and Greece follow on from government changes in Portugal and Ireland while Spain is widely expected to emerge with a new government following elections. Meanwhile Chancellor Merkel has had to tread a fine line given opposition from within her own coalition in Germany while in France President Sarkozy is expected to have a tough time in elections in April next year. The likelihood of persistent political tensions for months ahead suggests that the EUR and risk currencies will suffer for a while longer.

Posted in Bond markets, Currencies, ECB, Economics, Economy, Europe, eurozone, Financial crisis, Fiscal/Budget, France, FX, Germany, Greece, Italy, UK, US, US administration. Tags: , , , , , , , , , , , , . Leave a Comment »
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