Fed keeps the party going

September 19, 2013 — Mitul Kotecha

The party goes on! The Fed decided to play on the side of caution by not acquiescing to market expectations. The FOMC maintained its current USD 85 billion of asset purchases wanting to see more evidence of economic recovery before pulling the trigger. Market expectations centred on a USD 10-15 billion paring back of asset purchases. Clearly worried about a rise in market interest rates Fed Chairman Bernanke strengthened the Fed’s forward guidance by highlighting that the first rate increase may not come until the unemployment rate is “considerably below” 6.5%. A downgrade in the Fed’s economic forecasts will also have helped to justify the inaction by the FOMC.

Clearly risk assets loved what they saw, with equities and commodities rallying and US Treasury yields dropping. Gold prices in particular jumped on the news while the VIX ‘fear gauge’ dropped. The USD was a major casualty losing ground to most currencies, with notably EUR/USD spiking above 1.35 and GBP/USD to above 1.60. High beta emerging market currencies were big winners, given the positive impact of lower US yields and prospects of ongoing capital inflows. While the Fed has merely delayed tapering this will not stop markets from following through on the positive dynamic today. The positive tone will be reinforced across Asian and European markets.

The sharp drop in US Treasury yields hit the USD hard and it is likely to remain under pressure over the short term against a variety of currencies. Although the drop in US yields is likely to prove temporary it is difficult to go against the move in the near term. In order to identify which currencies will benefit the most versus USD I have looked at their sensitivity to US 10 year Treasury yields. The biggest beneficiaries will be Asian currencies given that they register the strongest correlations. The IDR, THB, MYR and INR are at the top of the list in this respect. In any case Asia was already experiencing a resumption of capital inflow as tapering expectations were being priced in and the Fed inaction will reinforce this trend.

GBP bounced following the unanimous vote for no policy shift revealed in the Sep 3-4 Bank of England MPC meeting minutes. Its gains were reinforced by Fed inaction overnight, with GBP/USD breaking through key levels above 1.60. Although the MPC’s 9-0 vote for no change was in line with expectations there was a minority looking for one of two MPC members to have voted for increased asset purchases. Citing upside risks to the growth outlook the BoE appears more confident about the UK’s economy. However, this all but makes a mockery of “forward guidance” and attempts to cap market interest rates. A further test for GBP will come from today’s August retail sales release. There are downside risks to consensus but even this may prove to a temporary stumbling block to a resurgent GBP.

The Swiss National Bank is widely expected to keep policy unchanged today and will make no changes to the CHF ceiling. The desire to keep the ceiling in place remains strong even though the economy is showing signs of recovery, deflationary pressures are receding and capital inflows from the Eurozone have diminished and in fact showing signs of reversing, albeit slowly. Reflecting this SNB reserves growth has slowed while Swiss banks’ foreign liabilities have decreased. The fact that the currency remains overvalued however, means that there is only an extremely slim chance that the ceiling will be removed over coming months. Although the SNB will likely revise upwards its growth forecasts, expect a cautious tone to emerge from the meeting. Accordingly EUR/CHF is set to remains capped around 1.2400 over the near term.

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Dollar undermined by outflows, while flows return to Asia

September 17, 2013 — Mitul Kotecha

The Lawrence Summers’ effect (ie his withdrawal from the race to be next Fed Chairman) rippled through markets, with risk appetite improving, buoying equities as well as bonds. As noted yesterday he is perceived to be less in favour of quantitative easing compared to the other leading contender Yellen. Commodity prices including gold prices slipped while the USD remained under pressure. Meanwhile, keep an eye on the Baltic dry index which has risen sharply since the beginning of September, indicating a positive bias for global economic activity in the months ahead.

As markets brace for the Fed to announce modest tapering plans tomorrow risk assets are set to remain supported, especially given expectations that the Fed will counter tapering with reinforced forward guidance. Effectively this means that the negative impact on the market from less Fed asset purchases will be offset by more reassurance that policy will not be tightened too quickly. Additionally helping the tone of positive risk sentiment is the expectation that a deal on Syrian chemical weapons is moving ahead.

The USD has been undermined by capital outflows from the US, improving risk appetite and US data disappointments. While we do not expect the USD to slide much further it is likely to remain under pressure over the short term before resuming appreciation later into Q4 and next year. The USD has failed to benefit from the rise in US Treasury yields over recent months due to foreign sales of Treasuries. The Fed FOMC meeting tomorrow is unlikely to offer the USD any support.

Further evidence of Treasury outflows is likely to be revealed in today’s releaser of the August US Treasury TIC flows data. Eventually I expect higher US yields to attract foreign flows, especially from Japan as life insurance companies etc, boost their holdings of US Treasuries, but over the near term the USD will be undermined by capital outflows.

GBP has rallied strongly over recent weeks both against the USD and EUR but the currency faces some risks from August CPI inflation data today and Bank of England Monetary Policy Committee minutes tomorrow. While a series of positive data surprises has made the job of the MPC harder in terms of establishing its forward guidance, a slight dip in CPI and possible shift of a couple of MPC members to restart voting for more asset purchases (no votes for further purchases at the last meeting) likely to be revealed in the minutes of the September meeting, could provoke some profit taking and act as a short term cap on GBP.

Despite the ongoing pressure on the USD, the rally in Asian currencies appears to have stalled although they continue to remain well supported amid a generally positive risk environment. Returning portfolio investment flows have helped, with the INR in particular benefitting from renewed inflows. The INR took the above consensus August WPI inflation reading in its stride although the data did reinforce the view that the central bank (RBI) will refrain from shifting policy rates at its meeting later this week.

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Summers’ departs Fed race, risk assets supported

September 16, 2013 — Mitul Kotecha

Another weaker than forecast US economic release, namely August retail sales has obscured the picture ahead of the mid week Fed FOMC meeting. Moreover, the data alongside news that one of the leading candidates to take over as Fed Chairman, Lawrence Summers, has withdrawn his candidacy has helped to undermine the USD. Summers is perceived as relatively hawkish and less in favour of quantitative easing than the other leading contender Janet Yellen.

Summer’s departure from the Fed race will help to buoy risk assets and cap US bond yields. His candidacy faced increased resistance from both sides of the political spectrum, with an “acrimonious” confirmation ahead of him. Yellen is now the clear front runner in the race although she may still face competition from former vice-chairman Donald Kohn.

Ahead of the FOMC meeting there is likely to be little directional bias for markets, with the Fed expected to announce USD 10 billion in tapering in an even split between Treasuries and mortgage backed securities. Additionally the Fed is set to strengthen its forward bias in order to soothe markets and this ought to alleviate some of the impact some of the potential pressure on risk assets from the announcement of tapering.

In Europe politics will be in focus, with Senate hearings on the Berlusconi case in Italy continuing, heightening cross party tensions and maintaining the threat of a government collapse. Meanwhile in Germany Chancellor Merkel gained some momentum ahead of national elections as her ally, the CSU took an absolute majority in Bavaria.

However, the fact that her Federal government partner the Free Domocrats failed to reach the 5% threshold to enter the Bavarian parliament, means that Merkel still faces the prospect of having to enter into a grand coalition if they record a similar performance in national elections. EUR may face some restrain given the uncertainty around political events in Europe.

In Asia currencies are likely to find further support from the news that Summer’s has pulled out of the Fed race. Already over recent weeks there was strong evidence of a resumption of equity capital inflows to the region, helping to steady many Asian currencies. If the Fed attempts to counter any pressure from tapering news with reinforced forward guidance it ought to leave Asian currencies supported in the near term.

The INR has been the outperformer so far this month and will benefit further over the short term although the Reserve Bank of India policy meeting under new governor Rajan this week will give further clues on the direction of the currency.

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Watch to watch this week

September 9, 2013 — Mitul Kotecha

While the world awaits US Congress’ vote on military action in Syria there is at least some distraction on the data front. Friday’s US August employment report contributed a further layer of uncertainty to the Fed tapering debate. Payrolls came in lower than forecast, with downward revisions to previous months. The unemployment rate dropped 7.3% but this was largely due to less people looking for jobs, something that the Fed will take into consideration.

It is doubtful that the jobs data will prevent tapering beginning at the September 17-18 FOMC meeting but it does support the view of a smaller (USD 10 billion) taper. In any case, data this week will if anything reinforce expectations that the Fed will commence tapering asset purchases this month, with a solid August retail sales reading forecast. Consequently the USD is set to maintain a firm tone into this week.

Eurozone markets may be dented by ongoing political issues, with Italian politics in particular legal action against former PM Berlusconi in focus. Meanwhile, worried that its forward guidance is having less impact than hoped for as core bond yields rise the Eurozone Central Bank sounded decidedly dovish at its policy meeting last week. The dovish cause will be supported by a contraction in Eurozone industrial production. As a result, the EUR will remain capped over the coming days.

Similarly the Bank of England has had little success in containing the rise in gilt yields with its forward guidance given the positive run of UK data releases over recent weeks and a likely firm UK September jobs report will make the job even more difficult. Outperformance of UK data continues to support relative GBP strength especially against EUR.

Elsewhere news that Japan has been awarded the rights to host the 2020 Olympics has boosted growth expectations and hit the JPY even as the debate over whether to increase the consumption tax grow. An upward revision to Japanese Q2 GDP releases this morning supports the view that the economy will be able to withstand the tax hike.

Meanwhile Australian markets will be buoyed by the election victory of Tony Abbott’s Liberal-National Coalition although notably it will have to deal with a host of minority parties to pass legislation through the Senate. AUD will likely see a post election boost in the short term.

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Respite for Asian currencies

August 26, 2013 — Mitul Kotecha

Pressure on policymakers in developed economies to orchestrate more predictable exits from unconventional monetary policies has intensified as reflected in comments at the Jackson Hole symposium the wake of the intense volatility in emerging market assets over recent weeks. While it is unlikely that a crisis is looming there is no doubt that mixed messages and lack of clarity over exit policies is having a demonstrable impact on EM assets.

Such clarity is unlikely to come this week. However, a pull back in core bond yields from recent highs will likely contribute to a calmer tone to markets at the turn of the week and some further near retracement in a positive direction for risk assets. Whether this lasts will depend on the clarity of the message from central bankers and in this respect speeches by four Fed officials over coming days, ECB’s Weidmann today and BoE governer Carney on Wednesday, will be scrtutinized.

The data slate is not particularly heavy but looks skewed towards relatively more positive Eurozone releases. In the US a likely drop in July durable goods orders today and pull back in consumer confidence tomorrow will provide little support to US asset markets including the USD while the trend of positive data surprises in Europe including likely gains in August economic sentiment indices and German IFO will add further evidence that growth will turn positive in Q3.

In Japan labor market data will reveal relative strength, with a low unemployment rate, helping to support the consumer. Inflation is set to rise further too, suggesting that policy measures are garnering some success. However, the upward trend in inflation is by no means guaranteed and ultimately renewed aggressiveness on the JPY will be needed as inflation tops out.

How will this leave currency markets? The USD is likely to continue to fare poorly against the EUR and GBP especially given the less than impressive data releases expected this week while the JPY is likely to remain on the back foot, pressured in part by firmer risk tone.

On the Asian currency front, further short term retracement is likely, especially for those currencies that have been beat up the most, namely INR and IDR. However, gains will likely prove limited, with tapering concerns and capital outflows showing little sign of reversing. Additionally, a likely disappointing Q2 GDP release in India at the end of the week will be unhelpful for the INR.

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