Cyprus hits EUR, GBP retracing lower, USD firm ahead of FOMC

March 18, 2013 — Mitul Kotecha

There are plenty of events and data to digest on both sides of the pond this week. In Europe, Cyprus’ bailout will be a key focus. The decision to ‘bail in’ in bank depositors aimed at raising EUR 5.8 billion by imposing a levy on deposits will be voted on today in Cyprus. While the EUR 10 billion bailout is small change compared to other Eurozone bailouts the deposit levy could have wide ranging repercussions on Eurozone bank deposits in other peripheral countries despite Cyprus’ case being labelled as “unique”.

Meanwhile, politics in Italy remains unpredictable, with discussions tomorrow between the President and political parties to try and form a government. There is little to suggest a deal is in the offing with the risk skewed towards protracted negotiations and fresh elections.

Data in the Eurozone is expected to a little more encouraging, with gains in Eurozone manufacturing confidence (albeit still in contraction territory), German ZEW investor confidence and IFO business confidence surveys likely. Also of note this week is the Bank of England MPC minutes and UK 2013 Budget and in particularly any change to the BoE’s mandate contained within the budget.

Markets likely to tread water ahead of Fed FOMC outcome. While no change to the USD 85 billion asset purchase program is likely the Fed may actually revise slightly lower their near term growth forecasts due mainly to fiscal policy developments despite recent encouraging data. It seems unlikely that the Fed will hint at any tapering off of QE but nonetheless, it will be difficult for the Fed to ignore recent positive data. On the data front, housing data in the form of housing starts and existing home sales will reinforce evidence of recovery in the housing market.

The EUR has already come under pressure as a result of Cyprus concerns and will struggle to reverse its losses. EUR/USD 1.2876 will offer some support in the near term and the fact that the speculative market has been short EUR over recent weeks may also limit some of the downside pressure. Nonetheless, any gains are likely to be sold into.

GBP/USD is also set to retrace lower, especially if the MPC minutes reveal a more dovish bias and/or any new mandate for the BoE is perceived to enable more policy easing. All of this leaves the USD in good form, with the USD index setting its sights on the psychologically important 83.00 level.

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USD buoyant

March 13, 2013 — Mitul Kotecha

After finally returning from a two week trip visiting clients across North America it appears that the USD continues to remain in buoyant mood. I have been highlighting the prospects for a stronger USD against major currencies for some time and this has been borne out by the strong USD performance since early February.

Despite a lackluster performance for US stocks overnight overall sentiment remains largely upbeat as reflected by the fact that my risk barometer has breached its lower threshold and has moved into risk loving territory. Similarly the VIX fear gauge is trading at multi year lows although it did move higher overnight.

The sharp drop in UK industrial production and a warning by the Bundesbank’s Weidmann that the Eurozone crisis was not over added a dose of caution to the market. On a more positive note the Baltic Dry Index is at its highest level so far this year, sending a positive signal for global growth expectations.

While there is still much wrangling in the US over budget proposals, and in Europe, Italian political uncertainty continues, markets remain focused on the positives of improving growth against the background of highly accommodative monetary policies. Nonetheless, the divergence between the US and Europe in terms of growth is set to continue. A likely bigger than forecast increase in US February retail sales in contrast to a bigger than forecast fall in Eurozone industrial production in January will attest to this.

EUR/USD has managed to garner a semblance of stability over recent days, with the currency pair finding it difficult to sustain any decline below the psychologically important 1.3000 level. The drop in EUR/USD over much of February has been more aggressive than implied by the performance of Eurozone peripheral bonds but this is no surprise given that this is not the biggest influence on the currency.

Instead the explanation for the EUR decline is found when viewing the move in US 2 year Treasury yields relative to 2 year bunds. The strong correlation with EUR/USD highlights this relationship, reflecting the impact of lower bund yields and higher Treasury yields. The EUR’s stability over recent days is therefore a function of a slight drop in the US yield advantage.

Given that the trend of firmer US data and weaker Eurozone data is set to continue, this stability is likely to be short lived. Our quantitative model suggests EUR/USD may rally in the short term but we suggest selling into it.

GBP/USD’s decline has continued unabated and there appear to be little to stand in the way of further weakness apart perhaps from the fact that a lot of bad news is priced in. Sentiment for GBP has clearly deteriorated as reflected in the CFTC IMM data revealing four straight weeks of negative positioning. The deviation with the 3 month average positioning has widened significantly, highlighting the pace of the move but also that the drop is beginning to look excessive.

Nonetheless, the bigger than expected drop in January industrial production data revealed yesterday has helped to compound the negativity towards the currency in the wake of deteriorating economic data and in turn heightened expectations of more BoE quantitative easing. Strong technical support around GBP/USD 1.4767 may hold in the short term but momentum indicators are showing no sign of a slowing in GBP selling pressure.

For GBP bulls (if there any left) there may be more value in looking to eventually re-enter long positions against EUR but we would not rush into this trade. .

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Setting the cat among the pigeons

February 22, 2013 — Mitul Kotecha

The Fed’s FOMC minutes which raised the spectre of an earlier than anticipated tapering off of asset purchases have really set the cat amongst the pigeons, fuelling selling in equities, commodities and various currencies against the USD. The impact was reinforced overnight following relatively hawkish comments from the Fed’s Bullard and Fisher.

US Treasuries rallied however, as risk aversion crept back into the market following weaker data releases in the Eurozone (manufacturing and service sector purchasing managers indices) and in the US (February Philly Fed manufacturing survey and higher than forecast weekly jobless claims).

The German IFO business survey is the main event on the data calendar today, with a small gain expected. The second 3 year LTRO payback to be announced today and the Italian elections will also be in focus.

In the US attention will turn to a meeting between President Obama and Japanese Prime Minister Abe. Given the IMF’s tacit approval of Japanese policy it is unlikely that any criticism of Japanese FX policy will be forthcoming at the meeting.

Markets are set to trade cautiously around these events but the main theme will be the overriding impact of this week’s Fed minutes, which has really changed the dynamic in markets, especially for currencies, with the risk / reward of selling USDs now looking much less attractive.

USD is set to continue to trade with a firm tone and EUR in particular looks vulnerable. The continued fall out from Fed FOMC minutes, disappointing PMIs yesterday, Italian election uncertainty and likely lower than expected ECB LTRO repayments today suggests that EUR/USD will face more downside risks. Look for a test of support around 1.3140, which if broken will open the door for the psychologically important 1.30 level.

USD/JPY is likely to consolidate further awaiting the announcement of a new Bank of Japan governor, with JPY selling momentum continuing to abate. AUD was lifted by RBA governor Steven’s comments which did not indicate an urgency to cut policy rates further nor to intervene to lower the value of the currency. AUD/NZD continues to look constructive on the upside given the contrasting comments on the AUD and NZD from both central banks.

Please note my blog posts will be a bit sporadic over the next couple of weeks a I am will be traveling.

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Contrasting Fed and BoE stance

February 21, 2013 — Mitul Kotecha

A contrasting stance in the minutes of the Fed and Bank of England impacted FX markets. Firstly the Fed minutes revealed some unease among officials about maintaining current quantitative easing settings as the economic outlook improved. In contrast the BoE minutes revealed a more dovish than anticipated 6-3 vote in favour of further easing. Consequently GBP/USD dropped sharply while the USD made broad gains. It will take a move higher in US bond yields to reinforce USD strength and notably 10 year Treasury yields have yet to break the 2.0634 high reached on 14 February.

While the JPY is likely to continue to weaken over coming months I maintain the view that the bulk of its cyclical decline has already taken place, with the risks much more balanced. My models continue to show that the magnitude of JPY weakness is not justified by its usual drivers. Risks of a short term JPY correction higher notwithstanding I expect any further weakness to be much more gradual in the months ahead.

Consistent with my model output, the feeling on the ground in Japan is that the currency has indeed fallen too far, too quickly, while there is plenty of scepticism about the fact that so far there has actually been little in terms of actual policy measures to justify the drop in the JPY. In the meantime the new central bank governor will be scrutinised to determine whether he will be sufficiently aggressive to warrant the drop in the JPY. A decision may take place very soon. Whatever the decision USD/JPY looks set to struggle to break above 94.00 in the short term.

Markets will be very data-dependent in terms of determining AUD direction in the weeks ahead. A further batch of soft data will reinforce expectations of further RBA rate cuts and undermine the AUD further. I do not expect this to occur, with some stabilisation in economic data likely, an outcome which ought to restrain AUD bears. My quantitative model suggests that AUD/USD is now looking relatively cheap, with the regression estimate at around 1.07.

AUD’s drop against NZD has been particularly sharp. I do not believe the drop is justified and yesterday’s jump in AUD/NZD based in large part on comments by RBNZ governor Wheeler warning about FX intervention to weaken the kiwi in my view marks a shift in the fortunes of the currency pair. Such comments should not be surprising given the failure of the G20 to chastise Japan on its FX stance. Expect more FX jawboning in the weeks ahead from other central banks.

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EUR/JPY ascent shows no sign of stopping

February 4, 2013 — Mitul Kotecha

Data releases globally continue to show that economic conditions are strengthening. The latest indicator to lend support to this view was the January US jobs report, which taken together with past revisions revealed that job market conditions were better than previously thought over recent months. The report labelled as a “goldilocks” outcome also revealed a slight rise in the unemployment report, implying that there is little chance of any consequent shift in the Fed’s highly accommodative stance.

More broadly global manufacturing confidence indices also revealed gains (albeit with some divergence in Europe) and point to expansion in output in the months ahead in many countries. The data also suggest that weakening in economic indicators in Q4 last year including the surprise drop in US Q4 GDP was merely a setback rather than a renewed slide into recession. All of this leaves markets in rather buoyant mood as reflected in the ongoing gains in risk assets over the past few weeks and positive end to last week.

All is not rosy however, and politicians may yet ruin the day as political frictions in the US over spending cuts and a new budget have yet to be resolved. Meanwhile, elections in Italy on 24/25 February will provoke more nervousness as they approach. The EU Summit on 7/8 February will also be in focus as politicians attempt to salvage a deal on the EU budget after talks broke down in November 2012.

A light data calendar this week will mean that central bank decisions will garner most attention over coming days although I expect no change in policy from the European Central Bank, Bank of England and Reserve Bank of Australia. Risk assets will therefore not find any support from central banks this week. In particular the ECB’s stance of contracting its balance sheet continues to run counter to the more aggressive easing from other central banks, with the pain on an already weak Eurozone economy accentuated by a stronger EUR. Indeed, commercial banks’ LTRO repayments to the ECB may have helped to propel the EUR even higher.

Despite the ongoing upward momentum of USD/JPY the USD looks set to remain under downward pressure in general although there was notably some short covering according to the latest CFTC IMM report. The JPY shows no sign of reversing its losses as a combination of official rhetoric, improving risk appetite and growing use as a funding currency intensify the pressure on the currency. In particular, EUR/JPY’s ascent shows not sign of stalling into this week, with speculative longs in this currency pair at their highest level since May 2007.

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