EUR to drift lower, AUD supported, JPY flatlines

August 7, 2012 — Mitul Kotecha

EUR/USD has failed to retake the 1.2400 handle and as noted yesterday looks set to gradually make its way lower again. News that the German government lent its support to the European Central Bank (ECB) bond buying plan helped to limit losses overnight, but there is likely to be little news on the policy front over coming weeks as Europe moves into full blown summer holiday mode.

No news is perhaps good news, but market patience continues to run thin and the EUR will eventually be punished should policy makers fail to deliver which has been so often the case. With only German factory orders in terms of data releases of note today, EUR/USD is set to settle into a range, but with a downside bias.

The RBA meeting today is likely to prove relatively uneventful. Almost all analysts polled expect a no change outcome from the Reserve Bank. As this is the largely priced in, the main influence on AUD will be the accompanying statement. The market is overly aggressive in pricing in 75 basis points of policy rate cuts over the coming months and in this respect it will require a particularly dovish statement to validate these expectations.

More likely, the RBA will sound neutral reflecting on relatively firm data (except the June jobs report) releases since the last meeting and a better global environment. Combined with strong attraction to ‘carry’ trades and a firmer tone to risk appetite, AUD looks well supported, with technical support seen around 1.0437.

USD/JPY continues to flat line just above the 78.00 level ahead of this week’s Bank of Japan meeting. There is unlikely to be much excitement from the BoJ meeting but the pressure to take more aggressive steps to reach their 1% inflation goal as well as to weaken the JPY remains strong. The 78.00 level appears to be an uncomfortable equilibrium for markets and Japanese policymakers.

Although low implied FX volatility suggests that there is little expectation of a move in either direction Japanese officials continue to remain concerned about the strength of the JPY. Similarly, the US Treasury bond versus Japanese JGB yield differential (2 year) remains relatively steady, suggesting little directional impetus in the short term. Given hopes / expectations of more Fed quantitative easing it seems unlikely that USD/JPY will make much traction on the upside over coming weeks.

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Risk currencies rally

August 6, 2012 — Mitul Kotecha

Following the disappointment from the lack of US Federal Reserve and European Central Bank (ECB) action last week, the US July jobs report provided a fillip for markets. The stronger than expected jump in payrolls (163k) dampened worries about the pace of jobs recovery while the increase in the unemployment rate (to 8.3%) kept alive hopes of more Fed quantitative easing.

Indeed, even the ECB’s decision and statement last week have been interpreted as merely delaying the inevitable, with stronger action expected from the central bank over coming weeks. Against this backdrop, markets will begin the week in positive tone and risk assets are likely to extend gains early in the week.

The highlights on the data calendar this week include two central bank meetings, Bank of Japan (BoJ) and Reserve Bank of Australia (RBA), and the Bannk of England (BoE) Quarterly Inflation Report (QIR). Major policy changes from the former two central banks are unlikely although the BoJ may decide to abolish the 0.1% minimum bidding rate on JGB operations.

As for the BoE QIR a dovish reading is likely which will help to support expectations of further policy action in the UK, which in turn will mean that GBP will underperform. Data releases are fairly thin on the ground, with US trade data, Q2 non farm productivity, German factory orders and industrial production releases across Europe. Overall, we see little to detract from the positive tone to asset markets.

Risk currencies begin the week on the front foot. The EUR/USD reaction to the US jobs data was particularly interesting, hitting a high of 1.2444 as stop losses were triggered on the upside. Further EUR gains will be difficult to achieve, however. Speculative market positioning reveals that EUR short positions have dropped to their lowest level in several weeks, suggesting less scope for further short covering.

The lack of major data releases over coming days within the Eurozone mean that direction will come from Spain and whether the country formally asks for financial support from the EFSF. In the meantime, EUR/USD is likely to edge back to around technical support around 1.2218.

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Hopes run high ahead of major central bank decisions

July 30, 2012 — Mitul Kotecha

Expectations are running high that central bankers will deliver on further policy steps at the Federal Reserve, European Central Bank and Bank of England meetings this week. Indeed, following strong hints by ECB President Draghi last week, which provoked a rally in global markets, there are high hopes that the ECB restarts its bond buying programme.

Opposition by Germany’s Bundesbank could result in disappointment, however. A meeting today between Draghi and Bundesbank president Weidmann will shed further light on the issue. Also on the table is the potential for the ESM bailout fund to be given a banking licence though this seems unlikely any time soon. Given the rally in risk assets at the end of last week, any lack of action by policy makers this week will provoke significant disappointment.

Similarly a run of weaker US and UK data has led to growing hopes that the Fed and BoE will also ease policy further on Wednesday and Thursday, respectively. While recent press speculation suggests that the Fed is edging closer to further balance sheet expansion the Fed FOMC may want to wait for further news on the economic front before embarking on more quantitative easing.

Meanwhile, the BoE appears to be edging towards further easing too, but rather than more QE a rate cut is looking like the preferred option. I suspect that such action at this week’s monetary policy committee (MPC) meeting is unlikely, however. Adding to the drama of this week’s events is the US July jobs report at the end of this week and yet another lacklustre report is expected, with consensus forecasts for a 100k increase in jobs.

Currency markets are likely to settle into ranges ahead of the key events above. The USD lost a fair bit of ground over recent sessions but further direction will await the ECB and Fed meetings. EUR/USD looks firmly settled above support around 1.2241 but upside traction will be limited until there is further clarification from the ECB. I suspect that last week’s short squeeze has run its course, with a further drop in peripheral Eurozone bond yields required to drive the EUR higher.

Asian currencies look well supported in the near term ahead of the major policy decisions. The SGD and KRW have led gains over the past week and their high degree of sensitivity to risk suggests that they should continue to outperform. The INR has also edged higher on the back of firming risk appetite but much will depend on the outcome of the RBI meeting tomorrow. According to my quantitative models the PHP and TWD will underperform.

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USD bulls restrained

July 26, 2012 — Mitul Kotecha

Two events over recent days have managed to inflict a degree of pain to USD bulls over recent days. Firstly the report in the press this week that the Fed is actively considering further policy stimulus steps, which taken together with softer economic data such as the 8.4% drop in new home sales registered in June but more specifically declines in the June ISM manufacturing survey and weaker jobs data, have sharply increased the speculation that the Fed will deliver new policy steps at its FOMC meeting next week.

Secondly the comments overnight from ECB board member Nowotny putting the prospects of giving the ESM bailout fund a banking licence firmly back on the table, has given a lift to the EUR. A banking licence would allow the ESM to leverage the ECB’s balance sheet, massively increasing its firepower. No wonder the markets reacted positively! The only catch is that there is significant opposition from both within the ECB council and from outside especially from Germany, suggesting that it would not be an easy step to take.

However, in a market that is extremely short EUR any slight positive news will act as a balm on the Eurozone’s wounds. Nowotny’s comments managed to overpower the impact of further drop in the German IFO survey in July which in fairness still remains at a relatively high level. The positive impact on the EUR is set to be short lived especially as a license for the ESM is a long way off while the ESM itself has yet to formally take over from the temporary bailout fund (EFSF).

Nonetheless, downside risks to the EUR will be limited ahead of the FOMC meeting next week and risks that a fresh round of Fed quantitative easing could weigh on the USD. Another complication is that there is also an ECB Council meeting next week, another factor that will play into a tone of consolidation for markets over coming days. EUR/USD is likely to face firm resistance around the 1.2181 level while downside is likely to be capped around 1.2040 in the near term. Assuming no major Fed action next week, EUR/USD remained destined for a drop below 1.2000.

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GBP vulnerable, AUD outperforms

July 19, 2012 — Mitul Kotecha

Risk assets edged higher as the Bernanke effect rippled through markets. The fact that the Fed chief maintains and easing bias as reiterated to the Senate yesterday looks sufficient to provide a floor under risk assets over coming weeks. Sentiment was helped by a 6.9% jump in June US housing starts and positive earnings while the Fed’s Beige Book highlighted that growth was “modest to moderate’.

Q2 earnings have exceeded estimates for 72% of S&P 500 companies reporting so far providing a further element of support to risk assets. Hopes of further stimulus in China have also helped. Unfortunately all of this suggests that the market is looking for more artificial stimulus rather than underlying structural improvements. The efficacy of such stimulus is likely to more limited than in the past, suggesting plenty of scope for disappointment.

GBP took a hit on the chin yesterday as the Bank of England opened the door to a rate cut in the latest set of MPC minutes which were on balance seen as dovish. The currency will face another test today in the wake of the June retail sales report which could come in weaker than consensus.

Added to the fact that my quantitative models point to downside risks for GBP both against the USD and EUR the stars are aligning in the direction of growing GBP pressure over coming weeks. I look for GBP/USD to edge back town to technical support around 1.5518 while EUR/GBP is set to re test resistance around 0.7951 in the short term.

AUD’s outperformance continues unabated and the currency is set to make further strides in the days ahead. While AUD remains a relatively high beta currency, it is also a China play. In this respect it has benefited from expectations of more stimulus measures from China. Separately my risk barometer remains in ‘risk neutral’ territory, conducive for risk currencies.

While weak Aussie jobs data last week may have instigated a degree of caution into AUD bulls the currency is likely to continue to grind higher in the absence of a bout a rising risk aversion. Q2 inflation data next week will provide further direction but to be frank the market is already pricing in around 75bps of further policy rate cuts this year, and a benign inflation reading will do little to change this. The key resistance level on the top side for AUD/USD is 1.0475.

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