US dollar on the rise

June 27, 2011 — Mitul Kotecha

Risk aversion is on the rise as uncertainties about Greece and worries about weaker economic data weigh on sentiment. A number of key events rather than data will be the main drivers this week. First and foremost amongst these is the vote in the Greek parliament on the country’s budget reform plan, which if passed will pave the way for the way for a disbursement of EUR 12 billion from the European Union / IMF and a new bailout package.

Meanwhile in the US talks on raising the debt ceiling are likely to resume in earnest, with the market likely to become increasingly nervous about the lack of resolution on the issue. Nonetheless, it is Europe that will dominate the headlines and on this front even if the reform plan is passed any market relief is likely to be limited given the ongoing uncertainty about private sector participation in any Greek debt roll over. This suggests that the EUR will remain under pressure over the week despite reassuring comments from Chinese Premier Wen.

Data releases will be relegated to background noise but what there is will not help sentiment. Signs of slowing activity remain evident as revealed in disappointing eurozone manufacturing surveys last week and this will be echoed in the US ISM manufacturing survey at the end of this week. Economic sentiment gauges in Europe are also set to reveal a decline. Given the lack of ammunition and/or unwillingness to risk using further stimulus from the Fed, the sensitivity of markets to weak data will be high, keeping risk aversion elevated.

Indeed, although well flagged the end of the Fed’s QE2 this week will mark a major shift in market dynamics, especially in currency markets where the USD will finally see a massive weight lifted from its shoulders. As indicated by Fed Chairman Bernanke following the FOMC meeting the Fed is not considering a further round of asset purchases, a fact that will help the USD to find firmer support.

Notably the USD index moved has above its 100-day moving average providing a positive technical signal given that it has failed on its last two attempts. The USD index now looks set to break its April high around 76.610.

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Fed’s status quo fuels caution

June 23, 2011 — Mitul Kotecha

The Fed’s status quo did little to stir markets overnight although there was a decidedly negative tone to equities and commodities, perhaps spurred by the downgrading of US growth forecasts. The fact that the Fed did not indicate that it is considering further asset purchases but instead will keep its balance sheet at around $,2800 billion also acted as a drag on markets.

The major concern for markets remains the depth and length of the current ‘soft patch’. The Fed believes it will be temporary and we concur, but clearly the slide in equity markets over recent weeks, suggests that there has been a divergence between stock market expectations and reality. The USD however, may actually be finding a medium term bottom, with the fact that the Fed is not considering QE3,

The downbeat Fed stance combined with a cautious reaction to the Greek government’s passage of a confidence motion indicates that markets will remain cautious over the near term. Indeed, comments by the Greek opposition that they will not support further austerity measures dashed any hopes of unity and will add another obstacle towards an easing in Greek tensions.

As it is the continued wrangling between European officials over private sector participation in any debt rollover as well as uncertainty over how ratings agencies will react, threatens to keep sentiment under pressure. The EUR has remained surprisingly resilient but its muted reaction to the passage of the confidence motion has given way to some weakness and the currency remains a sell on rallies.

GBP was a major underperformer weighed down by the relatively dovish Bank of England MPC minutes in which some members were even discussing further asset purchases. The currency faces further risks from a the CBI reported sales data for June where a decline in sales is likely to be reported. GBP/USD looks vulnerable to a drop below its 200 day moving average around 1.6027.

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Euro unimpressed by Greek confidence vote

June 22, 2011 — Mitul Kotecha

News that the Greek government won a confidence vote has left the EUR unimpressed and gains will be limited ahead of the June 28 vote on the country’s 5-year austerity plan. The EUR was in any case rallying ahead of the vote, which the government won by 155-143 votes, and has actually lost a little ground following the vote.

EUR sentiment is likely to remain somewhat fragile given the ongoing uncertainties, but now that the first hurdle has been passed markets there is at least a better prospect of Greece receiving the next EUR 12 billion aid tranche before the July 15 “do or default” deadline. Over the near term EUR/USD upside is likely to remain capped around the 1.4451 resistance level (15 June high).

The next key event for markets is the Fed FOMC meeting outcome and press conference. This is unlikely to bode particularly well for the USD given that the Fed is set to downgrade its growth forecasts, with the comments on the economy likely to sound a little more downbeat given the loss of momentum recently as reflected in a string of disappointing data releases.

Nonetheless, monetary settings are unlikely to be changed, with the Fed committed to ending QE2 by the end of June. I remain positive on the USD’s prospects but its recovery is fragile due to the fact that US bond yields remain at ultra low levels.

Whilst only AUD/USD and USD/JPY have maintained significant correlations with bond yield differentials over the past three months, it will eventually require US bond yields to move higher in relative terms for the USD to find its legs again on a more sustainable basis.

In the meantime the approach of the end of QE2 by the end of June will on balance play positively for the USD as at least the Fed’s balance sheet will no longer be expanding even if the reinvestment of principle from its holdings of US Treasuries suggest that there will not be a quick or immediate reduction in the size of the balance sheet anytime soon.

There is little appetite to intervene to weaken the JPY at present, with the Japanese authorities blaming the strengthening in the JPY versus USD on the latter’s weakness rather than the former’s strength. Until yield differentials widen, USD/JPY will continue to languish at current levels or even lower.

GBP will garner direction from the release of the Bank of England Monetary Policy Committee meeting minutes. Whilst GBP has edged higher against the USD it has remained vulnerable against EUR. A likely dovish set of minutes reflecting some weak activity data, easing core inflation and soft wage growth, suggests little support for GBP over the short term.

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Greek Decision Delayed

June 20, 2011 — Mitul Kotecha

European Union Finance Ministers have agreed that additional funding for Greece will come from both official and private investors, with the later likely through a voluntary rollover of existing Greek debt as per the ‘Vienna Initiative’ of 2009 applied at the time to Emerging Europe. Agreement was reached following the decision by Germany to ease its demands for private sector participation in a debt restructuring. The news brought some relief to markets on Friday.

However, the announcement today that a final decision on a further tranche of aid and a second bailout package will not take place until early July will come as a blow to markets and likely lead to a more cautious start to this week. The onus is now on Greek Prime Minister Papandreou to gain approval for further austerity measures following the recent government cabinet reshuffle and in the face of a no confidence vote tomorrow. Failure to pass the confidence motion could provoke a political crisis, leading to likely contagion across Europe.

Europe has given the Greek government until the end of this month to implement measures including budget cuts and asset sales, with failure to pass further austerity measures likely to lead to a delay of any further aid. There will be plenty of noise surrounding Greece over coming days, with the issue likely to dominate the EU summit in Brussels on June 23-24. In the meantime the EUR/USD looks like it will settle into a range over the short-term, with support around the 100 day moving average of 1.4165.

EUR speculative positioning is currently around its 3-month average, with the market continuing to hold a sizeable long position in EUR/USD according to the CFTC IMM data. The risks remain skewed to the downside as nervousness about a Greek deal grows. Should the Greek Prime Minister pass a no confidence motion there will be some short term relief but tensions are likely to persist for a long while yet. Moreover, other eurozone countries are not in the clear yet as reflected by Moody’s announcement that Italy’s AA2 government bond rating is on review for possible downgrade.

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US Ratings Under Threat

June 3, 2011 — Mitul Kotecha

The USD succumbed to further pressure overnight as Moody’s Investor Service threatened to place the US Aaa rating on review for downgrade if there is no agreement reached on raising the US debt ceiling. Although the news prompted a rise in US Treasury yields it did little for the USD.

News that the Federal Reserve’s balance sheet expanded to a record $2.772 trillion in the week ending June 1 highlights the ongoing headwinds to the USD from Fed asset purchases. The fact that there is even talk of QE3 in the wake of weak US data suggests that the headwinds will not dissipate quickly.

Direction today will come from the US May jobs report though this is unlikely to deliver any good news for the USD. Forecasts for non-farm payrolls have likely been revised lower to sub 100k compared to the published consensus forecast of 165k following the weaker indications from the May ADP jobs report and ISM data this week. A weak payrolls outcome will only intensify worries about the depth and length of the US ‘soft patch’.

Although market expectations are also likely to have been downwardly revised, something that may cushion the blow to the USD, it will be difficult to get away from the fact that growth in Q2 is weaker than many had thought.

EUR was well supported overnight, boosted by a relatively successful Spanish bond auction yesterday and reports that officials have agreed in principle to a 3-year adjustment plan for Greece covering funding needs to 2013 although there was no confirmation of such an agreement.

As a result, EUR/USD tested 1.45 and looks supported ahead of today’s US payrolls data. EUR’s recovery in general has been impressive but gains above 1.45 are likely to prove more difficult even if an agreement on Greece is close to being achieved.

As usual Japan’s political gyrations are having little impact on the JPY as the currency is instead buffeted by risk aversion swings and yield differentials. In fact USD/JPY has been rather well behaved over recent weeks as indicated by implied options volatility.

Prime Minister Kan’s success in winning a no-confidence motion came at a cost and may provide very little political stability. Kan said will resign as soon as post-earthquake recovery efforts are completed and once he is gone there is likely to be some realignment of existing political parties.

As for the JPY it will remain unscathed by political events. Over the near term USD/JPY is likely to cling to the 81 handle but we maintain our bearish view on the JPY in the medium term under the assumption that there is a sharp widening in US – Japan bond yield differentials.

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