Temporary Euro Relief

January 12, 2011 — Mitul Kotecha

Eurozone peripheral country travails continue to garner most market attention. There was at least a semblance of improvement on this front as peripheral bond spreads with German bunds narrowed on Tuesday but this was largely due to European Central Bank (ECB) bond buying than any improvement in sentiment. The fact that German bund yields also rose helped to narrow bund-peripheral spreads further.

A clearer test of sentiment will be today’s debt sales by Portugal followed by actions by Spain and Italy tomorrow. ECB buying of Portuguese bonds has given some relief to other debt, with Spanish and Italian debt spreads narrowing too. Even Greece managed to sell short term debt (EUR 1.95 bn of 26 week T-bills) but at a higher cost than the previous sale.

Perhaps a stronger boost to sentiment will come from the news that European Union (EU) governments are discussing an increase in the EUR 440 billion bailout fund in recognition of the fact that the fund may prove too small to cope if the crisis spreads to Spain. However, don’t expect a decision anytime soon, with next week’s meeting of EU finance ministers unlikely to agree to such a move. Support (or lack) of from Germany may prove to be a sticking point against the background of domestic political pressure.

Other options being considered include the possibility of the EFSF (European Financial Stability Facility) purchasing bonds in the secondary market and lowering interest rates on EFSF bailout loans. News that Japan will buy 20% of EFSF bonds this month as well as recent supportive comments from China suggest that an increase in the size of the EFSF may be easily funded by such investors. The EUR will gain some support against the background of such speculation but its upside may be restrained around its 200-day moving average at EUR/USD 1.3071.

In the US the economic news was not so positive for a change as the National Federation of Independent Business (NFIB) small business optimism survey came in weaker than expected in December, an outcome that will come as a blow given that it suggests some stuttering in the recovery process as well as hiring.

There is only secondary data scheduled today, with most attention on the Fed’s Beige Book later tonight. The survey of Federal Reserve districts will likely reveal a broad based but moderate improvement in economic conditions with the exception of housing activity. A speech by the Fed’s Fisher on Monetary policy will also be in focus. Like the Fed’s Plosser overnight he may highlight some caution about the impact of Fed quantitative easing (QE).

The AUD is increasingly feeling the impact of the flooding in Queensland Australia as the extent of economic damage is revealed. Reserve Bank of Australia (RBA) board member McKibbin estimated that it could knock off at least 1% from economic growth. This may prove too negative and although the flooding will result in a significantly negative impact on growth in Q1 rebuilding and reconstruction will mean that overall growth for 2011 will not be as significantly impacted. Nonetheless, a paring back in RBA policy tightening expectations will see the AUD come under further pressure, with a move down to around AUD/USD 0.9634 on the cards over the short-term.

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Ratings rampage hits Euro

December 20, 2010 — Mitul Kotecha

Both the data flow and market liquidity will be thin over the last couple of weeks of the year. After a bashing over much of H2 2010 it looks as though the USD will end the year in strong form having risen by over 6% since its early November low. In contrast the EUR is struggling having found no support from the meeting of European Union officials at the end of last week in which they agreed to a permanent sovereign debt resolution after 2013 but failed to agree on expanding the size of the bailout fund (EFSF). Similarly there was no traction towards a common euro bond. EUR/USD is now verging on its 200-day moving average around 1.3102, a break of which could see a drop to around 1.2960.

The failure to enlarge the size of the EFSF was disappointing given worries that it is perceived to be insufficient to cope with the bailout of larger eurozone countries if needed. It also highlight that the burden on the European Central Bank (ECB) to prop up eurozone bond markets until confidence improves. The increase in the size of ECB capital from EUR 5.8 billion to EUR 10.8 billion will help in this respect. Such support was clearly needed last week following the rampage across Europe by ratings agencies culminating in Moody’s five notch downgrade of Ireland’s credit ratings, surprising because of its severity rather than the downgrade itself. Ireland’s ratings are now just two notches above junk status and the negative outlook could mean more to come.

It was not just Ireland’s ratings that came under scrutiny. Ireland’s multi notch downgrade followed Moody’s decision to place Greece and Spain on review for a possible downgrade whilst S&P revised Belgium’s outlook to negative. Unsurprisingly peripheral debt markets came under renewed pressure as a result outweighing positive news in the form of strong flash eurozone PMI readings and firm German IFO business confidence survey. EUR did not escape and sentiment for the currency remains weak, with CFTC IMM speculative positioning data revealing a fourth straight week of net EUR short positioning in the week to 14th December.

In contrast, sentiment for the US economy continues to improve. Congress’ swift passage of President Obama’s fiscal plan will help to shore up confidence in US recovery. Data this week will be broadly positive too. On Wednesday, US Q3 GDP data is likely to be upwardly revised to a 2.8% QoQ annualized rate. Durable goods orders excluding transportation are set to increase by a healthy 2.0% (Thu) whilst both existing (Wed) and new (Thu) home sales will reveal rebounds in November following a drop in the previous month.

In the UK the main highlight is the Bank of England (BoE) MPC minutes. Another three way split is expected but this should not cause more than a ripple in FX markets. GBP/USD has slipped over recent days but there appears to be little other than general USD strength responsible for this. The currency pair looks vulnerable to a drop below 1.5500, with 1.5405 seen as the next support level. On balance, the USD will be in good form this week although the drop in US bond yields at the end of last week may take some of the wind out of its sails.

Posted in Bond markets, central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Interest rates, Ireland, Monetary Policy, UK, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

US bonds sell off, USD rallies

December 8, 2010 — Mitul Kotecha

US Treasuries didn’t like it but the compromise agreement to extend Bush era tax cuts, as well as a 13-month unfunded extension of long term unemployment benefits and a $120 billion payroll tax holiday will provide the US economy with further support and likely to lead to some upgrading of US growth forecasts. The agreement changes the dynamic of fiscal support for the US economy and means that the US is the only major country not tightening fiscal policy. It also implies less heavy lifting needed from the Federal Reserve.

Whilst some US taxpayers will not now face tax increases following the end of the year, the longer term question of fiscal adjustment and reform appears to have been postponed. US bond yields jumped on the news as the agreement effectively adds $1 trillion to US debt over the next couple of years. The contrasting fiscal stance with Europe could eventually haunt US markets as focus eventually return to US fiscal issues, with negative implications for the country’s credit ratings. However, at present, attention remains firmly fixed on European sovereign risk rather than US deficit fears.

There has been some relief to European debt markets, albeit temporarily, with debt markets ignoring the news that European Finance Ministers have not agreed to extend the size of the support fund (EFSF) and have also failed to agree on the introduction of recently touted “E-bonds”. ECB buying of peripheral bonds has given some support whilst the passage of the first votes of the Irish budget has eased tensions in its bond markets. Nonetheless as highlighted by the IMF, Europe’s ”piecemeal” response to the debt crisis in the region is insufficient to stem the crisis, suggesting that the current easing in pressure could prove short-lived.

The jump in US bond yields has given the USD some support but I wouldn’t overplay the impact on the USD of bond yields at present. Correlations reflecting the sensitivity of bond yields to various currencies remain relatively low suggesting that the influence of yield on FX is still limited. That said, the correlation is likely to increase over coming months as US yields move higher. The impact on USD/JPY is likely to be particularly sharp, with the currency pair likely to move higher over coming months. The USD has likely rallied due to the likelihood that the tax cut extensions will mean prospects of less quantitative easing by the Fed and prospects of relatively firmer US growth.

An ongoing concern for markets is the prospects of higher interest rates in China. As regular readers of Econometer many note, my blog posts have been a bit sporadic lately. This is not down to laziness but the fact that I have been on the road quite a bit travelling in Asia (and UK) visiting clients. One of the clear concerns that I have heard often repeated is the potential for China’s measures to curb real estate speculation, rising inflation, and lending, to slow China’s growth sharply and cause problems for the rest of the world. This is the topic of another post for another day, but against the background of such concerns the AUD and other high beta currencies are likely to fail to make much headway.

Posted in Australia, Bond markets, central banks, China, Currencies, Economics, Economy, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, Ireland, Monetary Policy, Spain, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Irish bailout leaves EUR unimpressed

November 29, 2010 — Mitul Kotecha

As has been the case since the beginning of the global financial crisis policy makers have found themselves under pressure to deliver a solution to a potentially destabilising or even systemic risk before the markets open for a new week in order to prevent wider contagion. Last night was no different and following urgent discussions a EUR 85 billion bailout for Ireland to be drawn down over a period of 7 ½ years was agreed whilst moves towards a permanent crisis mechanism were brought forward. As was evident over a week ago a bailout was inevitable but the terms were the main imponderable.

Importantly the financing rate for the package is lower than feared (speculation centered on a rate of 6.7%) but still relatively high at 5.8%. Moreover, no haircuts are required for holders of senior debt of Irish banks and Germany’s call for bondholders to bear the brunt of losses in future crises was watered down. The package will be composed of EUR 45 bn from European governments, EUR 22.5 bn from the IMF and EUR 17.5 bn from Ireland’s cash reserve and national pension fund.

The impact on the EUR was stark, with the currency swinging in a 120 point range and failing to hold its initial rally following the announcement. A break below the 200-day moving average for EUR/USD around 1.3131 will trigger a drop to around 1.3020 technical support. Officials will hope that the bailout offers the currency some deeper support but this already seems to be wishful thinking. The EUR reaction following the Greek bailout in early May does not offer an encouraging comparison; after an initial rally the EUR lost close to 10% of its value over the following few weeks.

Although it should be noted that the bailout appears more generous than initially expected clearly the lack of follow through in terms of EUR upside will come as a blow. The aid package has bought Ireland some breathing space but this could be short lived if Ireland’s budget on December 7 is not passed. Moreover, the bailout will not quell expectations that Portugal and perhaps even Spain will require assistance. Indeed, Portugal is the next focus and the reaction to an auction of 12-month bills on 1 December will be of particular interest.

Taken together with continued tensions on the Korean peninsular, position closing towards year end ongoing Eurozone concerns will likely see a further withdrawal from risk trades over coming weeks. For Asian currencies this spells more weakness and similarly commodity currencies such as AUD and NZD also are likely to face more pressure. The USD remains a net beneficiary even as the Fed continues to print more USDs in the form of QE2.

Data and events this week have the potential to change the markets perspective, especially the US November jobs report at the end of the week. There is no doubt that payrolls are on an improving trend (145k consensus) in line with the declining trend in jobless claims but unfortunately the unemployment rate is set to remain stubbornly high at 9.6% and this will be the bigger focus for the Fed and markets as it implies not let up in QE. As usual further clues to the payrolls will be garnered from the ADP jobs report and ISM data on Wednesday.

Posted in Bond markets, central banks, Currencies, Economics, Economy, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Germany, Greece, IMF, Interest rates, Ireland, Spain, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Edging Towards A Bailout

November 18, 2010 — Mitul Kotecha

A confluence of factors have come together to sour market sentiment although there appeared to be some relief, with a soft US inflation reading (core CPI now at 0.6% YoY) and plunge in US October housing starts reinforcing the view that the Fed will remain committed to carry out its full QE2 program, if not more.

However any market relief looks tenuous. Commodity prices remain weak, with the CRB commodities index down 7.4% in just over a week whilst the Baltic Dry Index (a pretty good forward indicator of activity and sentiment) continues to drop, down around 21% since its recent high on 27 October. Moreover, oil prices are also sharply lower. Increasingly the drop in risk assets is taking on the form of a rout and many who were looking for the rally to be sustained into year end are getting their fingers burnt.

Worries about eurozone peripheral countries debt problems remains the main cause of market angst, with plenty of attention on whether Ireland accepts a bailout rumoured to be up EUR 100 billion. Unfortunately Ireland’s reluctance to accept assistance has turned into a wider problem across the eurozone with debt in Portugal, Greece and also Spain suffering. An Irish bailout increasingly has the sense of inevitability about it. When it happens it may offer some short term relief to eurozone markets but Ireland will hardly be inspired by the fact that Greece’s bailout has had little sustainable impact on its debt markets.

Ireland remains the primary focus with discussions being enlarged to include the IMF a well as ECB and EU. What appears to be becoming clearer is that any agreement is likely to involve some form of bank restructuring, with the IMF likely to go over bank’s books during its visit. Irish banks have increasingly relied on ECB funding and a bailout would help reduce this reliance. Notably the UK which didn’t contribute to Greece’s aid package has said that it will back support for Ireland, a likely reaction to potential spillover to UK banks should the Irish situation spiral out of control. Any bailout will likely arrive quite quickly once agreed.

Although accepting a bailout may give Ireland some breathing room its and other peripheral county problems will be far from over. Uncertainties about the cost of recapitalising Ireland’s bank will remain whilst there remains no guarantee that the country’s budget on December 7 (or earlier if speculation proves correct) will be passed. Should Ireland agree to a bailout if may provide the EUR will some temporary relief but FX markets are likely to battle between attention on Fed QE2 and renewed concerns about the eurozone periphery, suggesting some volatile price action in the days and weeks ahead.

Reports of food price controls of and other measures to limit hot money inflows into China as well as prospects for further Chinese monetary tightening, are attacking sentiment from another angle. China’s markets have been hit hard over against the background of such worries, with the Shanghai Composite down around 10% over the past week whilst the impact is also being felt in many China sensitive markets across Asia as well as Australia. For instance the Hang Seng index is down around 7% since its 8 November high.

Posted in Asia, bank rescue, Bond markets, central banks, China, Commodities, Currencies, Economics, Economy, emerging markets, equity markets, Europe, eurozone, Federal Reserve, Financial crisis, Fiscal/Budget, FX, Greece, IMF, Ireland, Monetary Policy, Singapore, South Korea, Spain, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , . 1 Comment »
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