A more constructive start to the week

February 10, 2014 — Mitul Kotecha

Following a period of heightened volatility markets ended last week on a more positive note. Despite another soft reading for US non farm payrolls in January which revealed jobs growth of 142k following a gain of 74k in the previous month, markets took some comfort from a drop in the unemployment rate to 6.6% which for a change was not related to a drop in the participation rate. The participation rate rose to 63.0% in January.

Against this backdrop Fed Chairman Yellen will be giving her first testimony to Congress this week and while there is likely to be little change to the Fed’s policy outlook there will need to be some reassessment of the Fed’s forward guidance, especially given the surprisingly quick drop in the unemployment rate. The USD index slipped last week but we expect a slightly firmer tone to ensue over coming days in line with higher US yields.

Markets will kick off the week much as they left off last week, with a calmer and more constructive tone likely. Aside from Yellen’s speeches, US data will be soft on the whole, with January retail sales likely to post a small decline, while industrial production will record a gain and Michigan sentiment will fall, with consumer confidence weighed down by weaker equity markets.

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Some respite for emerging market assets

January 29, 2014 — Mitul Kotecha

Large gains in many emerging market currencies have been registered in the wake of policy rate hikes in Turkey and to a lesser extent in India. Also some encouraging data in Asia in particular a widening in South Korea’s current account surplus helped to shore up confidence in regional currencies. Not wanting to throw cold water on the move but while everyone is lauding Turkey for its bold move the reality is that its aggressive rate hike will hit growth at a time when its economy is fragile.

The massive rate hike in Turkey (repo rate hiked from 4.5% to 10%) fuelled a bounce in risk appetite nonetheless, although most risk measures have only reversed part of the move registered over recent days. It is way too early to suggest that everything is returning back to normal and the rally in risk assets looks vulnerable to fading out over coming days.

While I am not a proponent of the nervousness in emerging markets turning into a renewed crisis, uncertainty about country specific issues such as slowing growth and deleveraging in China, fundamental and political uncertainties / elections in Thailand, India, Indonesia. Ukraine and countries in the “fragile 5” against the background of Fed tapering, suggest rocky times ahead.

Moreover, the market may have priced in another $10 billion of Fed tapering today but the reality is that the global liquidity injections provided by the Fed will be reduced over coming months. Additionally a likely renewed rise in US Treasury yields will add another layer of pressure on emerging market assets.

Although emerging market currencies have strengthened most G10 currencies remain in a tight range. G10 FX gains were led by the AUD and NZD while JPY came under renewed pressure. This pattern is likely to continue in the near term. Aside from the Fed FOMC there will be some attention on the Reserve Bank of New Zealand too. The RBNZ is expected to keep policy rates unchanged but there is a small chance of rate hike or at the least a hawkish accompanying statement which ought to keep the NZD supported.

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Shaky start to the year for equities

January 14, 2014 — Mitul Kotecha

Equity markets and risk assets in general are having a decidedly shaky start to the year. Following a 30% increase in the US S&P 500 last year markets are finally looking at whether earnings expectations and economic growth will justify further gains in equities.

Worries ahead of Q4 earnings releases and perhaps concerns about the economy in the wake of the disappointing US December jobs report weighed on US equities overnight. These concerns also fuelled a further drop in US Treasury yields and undermined the USD. In contrast gold prices were buoyed.

The sharp drop in Treasury yields over recent days highlights both the previous extent of bearishness in bonds but also some hope / expectation that the Fed may slow the pace of tapering in the wake of the jobs data. This seems unlikely however, and as indicated by the Fed’s Lockhart overnight the data is highly unlikely to alter Fed policy.

Q4 earnings releases from JP Morgan and Wells Fargo as well as speeches by Dallas Fed President Fisher and Philly Fed President Plosser will be in focus today to provide further direction to markets. On the data front US December retail sales is the main release of note for which a drop in headline sales will be more than compensated by a gain in sales ex autos.

Overall a cautious tone is likely to continue until further clarity on the earnings outlook is revealed but economic data at least should look more encouraging over coming days. Clearly lower US Treasury yields are weighing on the USD but this is likely to prove to be a correction rather than a sustained USD decline.

It is interesting that the EUR has not managed to capitalize on the weakness in the USD. Lingering expectations that the European Central Bank may need to become more aggressive in terms of policy in the wake of soft inflation could be restraining the EUR. A solid reading for November Eurozone industrial production expected to be revealed today is unlikely to help the currency.

GBP was a major loser overnight although there does not seem to be much of a fundamental reason to sell the currency aside from soft November industrial production data released at the end of last week. Perhaps some profit taking on long GBP positioning may be attributable for the drop in the currency but the CFTC IMM data shows that speculative positioning was not overly long. Inflation data today will provide further direction, with GBP likely to remain under short term pressure.

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US dollar pull back to prove short lived

January 13, 2014 — Mitul Kotecha

Having spent the tail end of last week in Singapore and Phnom Penh presenting the Global outlook for 2014 to clients as part of our Asian roadshow it struck me that there is a strong consensus view about a number of market movements this year. In particular, most expect the USD to strengthen over 2014. Indeed just as it looked as though the USD was going to surge into the new year, along comes the US jobs report to spoil the party. Clearly, it’s not going to be a one way bet in 2014.

The surprisingly weak US December payrolls data in which only 74k jobs were added compared to consensus expectations of close to 200k helped to support expectations that Fed tapering would take place only gradually, lending a helping hand to risk assets at the turn of this week.

I don’t believe the jobs data materially changes the picture for the Fed. Adverse weather may have played a role in the weakness in jobs while complicating matters was the drop in the unemployment rate to 6.7% largely due to around 350,000 people leaving the labour force. The data resulted in a drop in US bond yields and a weaker USD although equity market reaction was more mixed. Meanwhile gold and other commodity prices rose.

While risk assets may find some support in the wake of the jobs report this week much of the US data slate will if anything highlight that economic growth is strengthening, suggesting a reversal of some of the price action in US Treasuries, USD and gold. Data releases include a likely healthy increase in core US retail sales in December together with gains in manufacturing confidence surveys (Empire and Philly Fed) and industrial output as well as a further increase in consumer confidence (Michigan sentiment survey).

Additionally several Fed speakers are on tap over coming days, which may give more colour on Fed thinking in the wake of the jobs report. However, it is doubtful that they will indicate that the Fed will not taper as expected in January.

Clearly markets were caught overly long USDs last week as reflected in CFTC IMM speculative positioning data as of 7th January which showed that net USD long positions had reached their highest since September 2013. The pull back in the USD is set to be short lived, however, especially if US data over coming days reveals further improvement as expected.

USD/JPY in particular bore the brunt of the pull back in US yields, as long positions were unwound. A Japanese holiday today may limit activity but much will depend on the propensity for US yields to bounce back, with 10 year US Treasury yields currently around 2.85% compared to around 2.97% on Friday.

Asian currencies have been the most sensitive to US Treasury yields gyrations over the past three months. In order of sensitivity to US 10 year Treasury yields the highest is the JPY, followed by MYR, THB, PHP and SGD. These currencies would be expected to benefit the most in the wake of the drop in yields at the end of last week although as noted any pull back in US yields is likely to prove temporary. While the THB may suffer from political concerns in the near term the other currencies are likely to see some short term gains.

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On track for a positive end to the year

December 23, 2013 — Mitul Kotecha

A solid revision higher to US Q3 GDP at the end of last week sets up a positive tone for risk assets into year end even as they digest the imminent onset of Fed tapering. The data revealed a revision higher to a 4.1% QoQ annualised pace of growth and if anything lent credence to the Fed’s decision to begin tapering. The GDP data will be followed by a series of positive data releases in the US this week including November personal income and spending and a likely upward revision to December Michigan consumer confidence both on tap today.

Tomorrow, November durable goods orders and next week December Conference Board consumer confidence will also paint a picture of broadening improvement in economic conditions, providing further validation to Fed tapering. Against this background US yields should be well supported along with the USD. Into next year US economic outperformance will continue, leading to both higher US yields and a firmer USD.

A Japanese holiday (Emperor’s birthday) today will dampen market action although Japanese data releases over the rest of the week will highlight further progress on the economic front, with November inflation pushing higher and industrial output expanding at a healthy clip. USD/JPY retained a foot hold above 104 but the large extent of short JPY positioning highlights scope for profit taking. Even so, the rise in US Treasury yields suggest limited downside risks for USD/JPY.

There is on little on tap on the data front in the Eurozone allowing markets to digest the steps towards banking union announced last week. Consequently EUR/USD is set to remain rangebound around 1.3650-1.3750.

There may be more interest in events in China as money market conditions and confidence surveys garner interest. Tight money market conditions will weigh on regional sentiment. A likely decline in both the manufacturing and service sector purchasing managers’ indices will also act to dampen Asian currencies reinforcing the pressure already in place from a broadly stronger USD. News in Thailand that the opposition Democratic Party has decided to boycott the Feb 2 elections will add to political uncertainty and pile more pressure on the THB although the regional underperform remain the IDR.

Overall, a thinning in market conditions as both liquidity and market participants disappear for the holidays imply limited activity over coming days. The fact is that the end of the year will market a solid year for equities and a poorer year for bonds but at least the debate over Fed tapering timing has finally been put to the rest. More of the same is likely next year but notably the growth gap between developed and developing economies will narrow, which at a time of heightened competition for capital amid Fed tapering, suggests that capital flows will increasingly be steered towards developed economies.

Dear readers, this is my last post for 2013. Thank you for taking the time to read my blog posts. I wish all Econometer readers happy holidays, success, prosperity and good health in the year ahead.

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