Tarnishing The Euro

February 11, 2010 — Mitul Kotecha

I am just finishing up a client trip in Japan and waiting to take a flight back to Hong Kong. The time ahead of the flight has allowed some reflection on my meetings here. One thing that has been particularly evident is the strong interest in all events European. Some I have spoken to have wondered out loud whether this the beginning of the end of the European project.  At the least it is evident that fiscal/debt problems in Greece and elsewhere in Europe have tarnished the image of the EUR.

Markets continue to gyrate on any news about Greece and the potential for support from the Europe Union and/or IMF. The divergent views between European countries about how to deal with the problem has intensified, suggesting that reaching an agreement will not be easy. Some countries including the UK and Sweden have suggested enrolling the help of the IMF but this has been resisted by other European countries. Germany and France are trying to rally support ahead of today’s crucial meeting of European officials.

The EUR reacted positively to news that some form of support package is being considered but nothing concrete has appeared yet, leaving markets on edge. The EUR has been heavily sold over recent weeks; speculative market positioning reached a record low in the latest week’s CFTC Commitment of Traders’ IMM report. The fact that EUR positioning has become so negative suggests that the EUR could rebound sharply in the event that some support package for Greece is announced.

Any package will not come without strings attached, however, as European officials will want to avoid any moral hazard. A couple of options hinted at by German officials include fresh loans or some form of plan to purchase Greek debt. Either way, any solution to Greece’s problems will not be quick and will likely result in a sharp contraction in economic activity as the government cuts spending especially as Greece does not have the option of the old remedy of devaluing its currency. Meanwhile, strikes and social tensions in the country could escalate further. A solution for Greece will only constitutes around 2.5% of eurozone GDP will also not prevent focus from continuing to shift to Portugal, Spain and other countries with fiscal problems despite comments by Moody’s ratings agency to differentiate between the countries.

Even if the EUR rebounds on any positive news about support for Greece any relief is likely to prove temporary and will provide better levels to sell into to play for a medium term decline in the currency. Ongoing fiscal concerns, a likely slower pace of economic recovery, divergencies in views of European officials, and the fact that the EUR is still overvalued suggests that the currency will depreciate over much of 2010, with a move to around EUR/USD 1.30 or below in prospect over coming months.

Posted in Bond markets, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Germany, Greece, Japan. Tags: , , , , , , , , , , , , , , , , , . Leave a Comment »

What To Watch This Week

February 7, 2010 — Mitul Kotecha

As usual the G7 meeting will leave markets with little to chew on. G7 officials maintained their commitment to stimulus measures and timely exit strategies but there was little of note for FX markets aside from the usual comments about wanting to avoid excess FX volatility. There was certainly know step up in pressure on China to strengthen though a report prepared for the meeting did push for countries with inflexible currencies to make adjustments. Meanwhile US officials mouthed the usual “strong dollar” mantra.

Where does this leave markets this week? Well I must admit my bullish view on risk currencies is clearly suffering after a positive start to the year. The pullback in high beta currencies (those with the highest sensitivity to risk aversion) has been dramatic. I have highlighted many of the factors weighing on sentiment in previous posts and whilst I still think the US dollar will find itself under renewed pressure over coming months the current environment remains conducive to more USD and JPY buying and selling of currencies such as the AUD, NZD, CAD, GBP, NOK, SEK, ZAR etc.

Ironically the US and Japan have arguably more severe deficit/debt concerns than some of the European countries under pressure but as most of Japan’s debt is held domestically there is little worry of a collapse in JGBs. Unlike Japan foreign investors hold over half of US debt but are not yet losing confidence with US Treasuries though this may not last unless there is some tangible sign that the burgeoning US budget deficit is being reduced. For now, attention remains firmly focussed on Greece, Spain, Portugal and to a lesser extent Italy.

Like the G7 meeting the US January jobs report released at the end of last week will give little direction for markets. Although the 20k drop in payrolls and revisions to past months were slightly disappointing the surprise drop in the unemployment rate was better news. This week’s data highlights include the January US retail sales report and December trade balance. The sales data is likely to help allay some concerns about faltering economic recovery, with retail sales forecast to rise over the month despite a likely pull back in autos spending.

How will this play out for currencies this week? Overall, the risk off tone is set to continue though the moves are looking increasingly stretched. The USD, JPY and CHF will remain on the front foot whilst risk currencies will remain under pressure. The EUR is set to continue to struggle against the background of eurozone deficit concerns and after its dive through 1.40 last week 1.35 now looms large. Meanwhile, the AUD may also struggle following the recent reassessment of interest rate expectations after the recent Reserve Bank of Australia (RBA) meeting in which interest rates were left unchanged.

UK markets will focus on the Quarterly Inflation Report from the Bank of England though the political situation may hold some interesting implications for GBP if polls continue to show that the gap between the governing Labour party and Conservative opposition continues to narrow. Prospects of a hung parliament will hardly hold any positive implications for GBP, a prospect which could limit any potential for GBP to recover ahead of May elections. The drop below 1.60 for Cable (GBP/USD) could extend further, especially as the BoE has kept the door open to further asset purchases if needed.

Posted in Australia, Bond markets, central banks, Currencies, Economics, Economy, Europe, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Japan, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Currency Tensions Intensify Ahead of G7

February 5, 2010 — Mitul Kotecha

Portugal, Greece and Spain remain firmly in the spotlight but it may not be long before the light broadens to include UK, US and many other countries facing similar difficulties on the fiscal front. Portuguese, Greek and Spanish equities were smashed in the wake of growing concerns and sentiment looks like it will get worse before it gets any better.

Events in each of these countries are not helping matters. In Portugal, parliament began to vote on a bill on financial transfers to the regions, which could damage the ability of the government to reduce the deficit whilst speculation that the Prime Minister is about to resign has intensified. In Greece tax collectors have started a 48-hour strike as social unrest worsens in the wake of the implementation of deficit cutting measures.

Although European officials pour cold water on the idea that the whole EMU Project could unravel bond markets are not taking any chances whilst the EUR looks destined to languish at ever weaker levels until there is a semblance of calm. Meanwhile. the European Central Bank (ECB) has clearly stated that does not want to get involved.

The G7 meeting in Canada will move rapidly into focus this weekend, with a joint press conference expected on Saturday. Sovereign debt concerns and restrictions and banks will likely be addressed whilst the not insignificant matter of China’s currency will also likely be discussed.

US pressure on China to strengthen the CNY has increased as has tensions between the two countries following US arms sales to Taiwan and a scheduled meeting between President Obama and the Dalai Lama.

There is growing speculation that the upcoming US Treasury report in April will label China as a currency manipulator which could result in tensions ratcheting up to a higher level. China holds the cards given the US reliance on Chinese money but with mid-term elections looming in the US and Obama’s promise to double US exports within five years, US pressure on China will intensify as will likely resistance from China.

Posted in Asia, Bond markets, central banks, China, Currencies, Europe, Financial crisis, Fiscal/Budget, FX, Greece, US. Tags: , , , , , , , , , , , , . Leave a Comment »

Selling Risk Trades On Rallies

February 4, 2010 — Mitul Kotecha

Disappointing earnings as well as a weaker than expected outcome for data on the health of the US service sector (the ISM non-manufacturing index failed to match expectations, coming in at 50.5 in January versus consensus of 51.0) has weighed on markets, undoing the boost received from the generally positive manufacturing purchasing managers (PMIs) indices earlier in the week. It was not all bad news however, as earnings from Cisco Systems beat expectations Meanwhile US ADP jobs data fell less than expected, dropping 22k whilst data for December was upwardly revised. These are consistent with a flat outcome for January non-farm payrolls.

Various concerns are still weighing on confidence. Sovereign ratings/fiscal concerns remain high amongst these and although much has been made of the narrowing in Greek debt spreads, attention now seems to be turning towards Portugal. Greece is also far from being out of the woods, and whilst the European Commission accepted Greece’s economic plans the country would be placed under much greater scrutiny by the EC.

The US has not escaped either, with Moody’s warning that the US AAA credit rating would come under pressure unless more stringent actions were taken to reduce the country’s burgeoning budget deficit. The move follows the US administration’s forecast of a $1.565 billion budget deficit for 2010, the highest as a proportion of GDP since the second world war, with the overall debt to GDP ratio also forecast to rise further.

The current environment remains negative for risk trades and the pullback in high beta currencies has been particularly sharp over recent weeks. Sentiment for the NZD was dealt a further blow from a surprisingly weak Q4 jobs report in New Zealand. Unemployment rose to a decade high of 7.3% over the quarter whilst employment growth contracted by 0.1%. The pull back in wage pressures will also be noted by interest rate markets, as it takes some of the pressure off the RBNZ to raise rates anytime soon.

Data in Australia will not help sentiment for the AUD too. Australian retail sales dropped by 0.7% in December, a worse than expected outcome. The data will only serve to reinforce market expectations that the RBA will no hike interest rates as quickly as previously expected. Nonetheless, I would caution reading too much into the data, with real retail sales volumes rising by a solid 1.1% over Q4 whilst other data showed a strong 2.2% jump in building approvals.

The overall strategy against this background is to sell risk trades on rallies. There are still too many concerns to point to a sustained improve in risk appetite. Moreover, the market is still long in many major risk currencies. Asian currencies have so far proven more resilient to the recent rise in risk aversion however, a reflection of the fact that a lot of concerns are emanating from the US and Europe. However, Asian currencies will continue to remain susceptible to events in China, especially to any further measures to tighten policy.

Further USD strength against this background is likely, which could see EUR/USD testing support around 1.3748, AUD/USD support around 0.8735, and NZD/USD support around 0.6916.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, equity markets, Europe, Financial crisis, Fiscal/Budget, FX, Interest rates, Monetary Policy, US, US administration. Tags: , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

Central banks in the spotlight

February 1, 2010 — Mitul Kotecha

The market mood continues to be weighed down by a combination of worries including monetary tightening in China and Greece’s debt woes. Consequently, risk aversion has taken a turn for the worse over the last couple of weeks. Measures of currency and equity market volatility have also spiked. Meanwhile, risk currencies have remained under pressure, especially those that are most sensitive to risk aversion including AUD, NZD, CAD, and a long list of emerging market currencies.

Greece’s problems remain a major drag on the EUR, with speculative sentiment for the currency dropping close to the all time low recorded in September 2008, according to the CFTC IMM data. Further developments including news that the European Commission will officially recommend that Greece should implement more severe cuts on public sector spending are unlikely to help to reverse negative sentiment for the currency. A lack of confidence and scepticism over Greece’s ability to cut its budget deficit suggest little respite for the EUR in the weeks ahead.

Markets will have plenty of other things to focus on this week, with various manufacturing and service sector PMIs, four major central bank decisions, and the January US non-farm payrolls report, due for release. The PMIs are likely to confirm that output in both manufacturing and service industries remains expansionary but only consistent with limited growth rather than the rapid rebound in activity seen following past recessions.

The most interesting central bank decision this week is likely to be that of the Reserve Bank of Australia. Recent data has if anything given more reason for the central bank to raise interest rates, including the latest release which was the TD Securities inflation gauge, which jumped 0.8% in January, the biggest increase in 6-months. Although a hike is now largely discounted, some hawkish rhetoric from the RBA could be sufficient to give the AUD some support.

Although the UK Bank of England is unlikely to shift policy at its meeting on Thursday the statement will be scrutinized for clues as to whether quantitative easing is over. Any indication that there will be no further QE measures will play positively for GBP given that it has been restrained by speculation that the BoE will increase asset purchases. No change is also expected by the ECB but once again Greece will likely dominate the press conference. Meanwhile Norway’s Norges Bank is likely to pause in its policy of gradual tightening.

Clearly the funding currency of choice, the USD, has been one of the main beneficiaries of higher risk aversion and this has been reflected in the latest CFTC Commitment of Traders report, which shows that net short aggregate USD speculative positions have dropped sharply, with USD positioning close to flat again. Similarly, the other beneficiary, namely the JPY, has also seen a significant shift in positioning as shorts have been covered. Expect more to come.

Appetite for carry trades was not be helped by the news that the UK’s Lord Turner has signalled a regulatory crackdown on FX carry trades. The report in the UK press fuelled a sell of in JPY crosses but is unlikely to have more than a short term market impact given the practical difficulties in regulating carry trades. Nonetheless, the fact that speculative positioning is still quite long in the AUD, NZD and CAD suggest scope for more downside in such currencies in the current risk averse environment.

Posted in Asia, Australia, central banks, China, Currencies, Economics, Economy, emerging markets, Europe, Financial crisis, Fiscal/Budget, FX, Greece, Interest rates, Monetary Policy, US. Tags: , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »
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