Awaiting the Fed

October 30, 2013 — Mitul Kotecha

Another positive day for US equities overnight reflected the ongoing gradual but steady improvement in risk sentiment. The USD also managed to shake off some of its malaise, rising against most major currencies although US Treasuries continued to flat line. Data in the US did little to change expectations for the Fed FOMC policy decision tonight; headline retail sales dropped (-0.1%) in September but core orders looked healthier (0.4%), while US consumer confidence slipped by more than expected in October (71.2) and US house prices rose (0.93%) in August.

Direction will be limited ahead of the Fed outcome where markets hope to garner some clues on the timing of the beginning of tapering. However, given that the consensus has clearly shifted to a March 2014 beginning of tapering it is difficult to see how the Fed could build on already dovish market expectations. Ahead of the Fed decision we will be able to assess further evidence on the state of the private sector jobs market, with October ADP jobs scheduled for release.

Given the risk / reward around today’s Fed meeting we remain constructive on the USD, with further albeit gradual recovery ahead. Indeed, it is encouraging that the EUR failed to hold onto gains even after ECB member Nowotny effectively gave the green light for further EUR strength when he noted that policy makers `have to live with` a strong EUR. EUR will continue to look a sell on rallies above 1.3800.

Nototny’s sanguine tone is not shared elsewhere as reflected in attempts by RBA Governor Stevens to talk down the AUD this week or by NZ’s central bank, noting that the strength of the NZD could give scope to delay interest rate hikes. GBP also seems to be failing to shake off the after effects of relative dovish comments by Bank of England MPC members over recent days. The overall winner appears to the USD especially as a lot of dovishness is already priced into the currency.

The USD is also set to take a firmer tone against Asian currencies over the short term. Asian currencies most sensitive to USD strength are SGD, MYR and PHP and these currencies will be most exposed in the short term to further downside risks. IDR also looks vulnerable given the continued outflows of equity portfolio capital from Indonesia over recent weeks (month to date outflows USD 175 million). KRW looks more stable although disappointing September industrial production data released this morning will put a firm cap on the currency.

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US dollar stable, yen primed for weakness, Aussie dollar slips

October 29, 2013 — Mitul Kotecha

The USD index looks to have settled at a relatively weak level around 79.00 aided by the stabilisation of US Treasury yields (10 year around 2.5%). Upside for the USD will be restricted given a likely run of softer economic releases this week including September retail sales, and October consumer confidence today.

The data may help to support expectations that Fed tapering may not take place until March / April next year although the Fed FOMC decision later this week will hopefully give more clues on this front. In any case the USD may already have priced in softer data and delayed tapering expectations, suggesting that the risk / reward will increasingly turn more USD positive over the coming weeks.

USD/JPY looks set to move higher over coming weeks breaking out of its recent range. Relatively higher US Treasury yields versus Japanese JGBs yields, improving risk appetite and improving technicals (USD/JPY remaining above its 200 day moving average) will be supportive for renewed upside in the currency pair.

While the Bank of Japan is unlikely to act this week on policy the risks of further action will only increase over the coming months as it becomes apparent that reaching and sticking to its 2% inflation target will not be possible given current settings. In turn, the JPY is set for further downward pressure.

Does the slippage in AUD over recent days presage a strengthening in the USD? AUD and USD (index) have registered a strong negative correlation over the past three months, with the former benefitting from weakness in the latter. Over recent days the USD appears to have stabilised while AUD has lost steam, with pressure intensifying in the wake of comments by RBA Governor Stevens who attempted to talk the currency down.

I doubt the AUD will fall much from current levels but the absence of key domestic data (only private sector credit growth and building approvals on tap this week) will focus attention on external factors, namely the Fed FOMC outcome and in particular Chinese manufacturing confidence at the end of the week.

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Asian currencies benefit from weaker US jobs data

October 23, 2013 — Mitul Kotecha

Weaker than forecast US September jobs data, delayed in the wake of the government shutdown, spurred risk appetite overnight pushing equities higher helped further by encouraging US Q3 earnings. The employment report revealed that jobs growth slowed to 148,000 while the unemployment rate declined slightly to 7.2%.

In contrast to the reaction in risk assets, 10 year US Treasury yields dropped to around 2.5% and the USD took another hit as the data was perceived to provide more concrete evidence that the Fed will only begin to slow its asset purchases next year, with many now looking for tapering to only begin in March 2014.

Unfortunately for the USD this effectively means its attraction as a funding currency may continue for longer than previously expected. Consequently gold prices rallied benefiting from both the drop in yields and weaker USD.

Data today (Bank of England MPC minutes, Bank of Canada rate decision, terms of the European Central Bank’s Asset Quality Review) will not be as important for markets but it is clear that fundamentals are taking a bigger grip on market direction after a period of being relegated to the sidelines in the wake of US political mayhem.

Asian currencies have benefitted from the drop in the USD overnight and the potential further delay in tapering to Mach next year. The main gainers of recent weeks are those that stand most to gain from delayed tapering (ie those with external funding requirements and that are most sensitive to US Treasury yields). In this respect the IDR, MYR and INR have been the best performing Asian currencies so far this month and look best placed to benefit in the short term from the consequences of the weaker US jobs report.

Against the backdrop of delayed tapering equity capital inflows to Asia have continued their steep recovery since the beginning of September, providing another layer of support to Asian FX. India, Korea and Taiwan have been major winners in this respect, with a surge in equity flows registered to these countries. However, the INR’s ability to benefit is partly negated by continued outflows from India’s bond markets.

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US dollar languishing at multi month lows

October 21, 2013 — Mitul Kotecha

Following the resolution to the uncertainty and stress surrounding the political conflict on raising the US debt ceiling and thereby avoiding a US debt default markets will likely take a more upbeat tone this week extending last week’s rally in risk assets. We will also be able to scrutinise delayed US data releases, in particular the US September employment report which will be released tomorrow and possibly September US retail sales this week.

These and other US data may however, take some of the shine off buoyant equity markets given that they are unlikely to be particularly impressive. Indeed, clues will now be sought to determine exactly what impact the government shutdown and protracted political friction will have had on the economy but the news may not be particularly good in terms of US recovery hopes.

On the plus side and as reflected by the bull flattening in US interest rate markets, markets appear to be pushing back expectations of Fed tapering especially as US politicians will likely gear up for another fight over coming months when the debt ceiling / budget will need renewed agreement.

Fed tapering by December now looks highly unlikely unless the US delivers a series of very positive data surprises. The net impact on the USD is clearly a negative one, with the currency continuing to languish at multi month lows and showing little sign of turning around over the near term.

Elsewhere, in Europe the data will be a little more encouraging, with the ‘flash’ purchasing managers’ indices and the Germany IFO business confidence survey expected to show further improvement while in the UK a healthy reading for Q3 GDP is likely to add to the view that further Bank of England asset purchases are moving off the table. The EUR will likely benefit from the weakness in the USD and relatively better data releases although the sharp increase in EUR positioning suggests that further upside momentum may slow.

Asian currencies will continue to benefit from a double dose of good news from the US debt ceiling agreement as well as a run of positive Chinese releases over recent weeks. This is set to continue this week, with solid Chinese purchasing managers indices (PMI) data expected on Thursday and firm Q3 Korean GDP data on Friday. Meanwhile the central bank BSP in the Philippines is likely to keep policy on hold this week given the well behaved inflation backdrop.

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US budget impasse deepens

October 7, 2013 — Mitul Kotecha

There has been no sign of agreement between the US administration/Democrats and Republicans over resolving the budget impasse that has caused a partial government shutdown as well as havoc with the timing of government data releases. If anything both sides have become more entrenched in their positions, implying that any agreement on raising the debt ceiling required by October 17 also looks out of reach.

Market reaction so far has been relatively muted in the expectation of an agreement but such hopes may prove optimistic. Following the delay in the US employment report which was originally scheduled for release last Friday markets will also be scrambling for clues as to the impact on the timing of any Fed tapering.

US data releases will not help the market mood or the USD, with consumer confidence set to soften, which will play for further delay in tapering. US September retail sales and August trade data are likely to be delayed although the Federal Reserve FOMC minutes of the last meeting will hopefully provide some clues to the timing of tapering.

Markets are set to become increasingly nervous over coming days suggesting an increase in risk aversion. Consequently pressure on risk assets is likely unless some sign of rapprochement is seen. So far US Treasury yields are holding above 2.6% while the USD index has stabilised around the 80.00 level.

Surprisingly gold has failed to benefit from the lack of budget agreement in the US. The VIX ‘fear gauge’ dropped slightly but none of this will last if Congress does not get its act together. A deal soon would minimise the economic impact but a protracted impasse would be much more negative for growth. Either way the beginning of Fed tapering looks to have been pushed into next year.

USD pressure is set to extend further against most major currencies, with safe havens, in particular JPY and CHF set to be well supported in the days ahead. The drop in US Treasury yields will help yield sensitive currencies especially the likes of the INR but higher risk aversion will counter any positive impact on high beta currencies.

The EUR meanwhile, looks well placed to take advantage of further USD weakness, especially given the prospects of firmer data releases this week including a series of industrial production data.

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