US dollar tracking Treasury yields

May 2, 2012 — Mitul Kotecha

Despite the firmer tone to risk appetite the USD index moved higher tracking the move in US Treasury yields. Indeed, the USD’s reaction was actually opposite to what would be expected given the rally in risk assets but its move clearly reflects the growing influence of yields.

The surprisingly robust April ISM manufacturing survey following the disappointing Chicago PMI for the same month highlights that recovery is not straightforward, suggesting that USD gains will also not be straightforward.

March factory orders are on tap today but the bigger focus will be on the April ADP jobs report, which will give important clues to Friday’s payrolls data. Expectations centre on a 170k outcome for the ADP report, a smaller increase than the 209k registered in March. In the meantime I expect the USD to hold its gains.

As noted at the start of the week EUR/USD was poised to edge higher despite the bad economic news emerging from the region. EUR/USD has continued to strengthen over recent weeks despite the release of data showing Eurozone economic underperformance relative to the US. A case in point is the April Eurozone purchasing manager’s data to be released today, which will reveal further weakness, especially in peripheral countries.

Some easing in peripheral bond yields has helped to support sentiment for the EUR leading to further short covering in the currency but further gains are expected to be limited. EUR/USD now sits around the middle of its 1.30-1.35 range but further upside will be restricted ahead of the key US jobs data on Friday. EUR/USD resistance is seen around the 1.3385 level.

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AUD risks, CHF speculation, CAD upside

April 18, 2012 — Mitul Kotecha

News that the IMF revised up its global growth forecasts, decent demand for a Spanish bill auction and a stronger than expected reading in the April German ZEW investor confidence survey helped to calm market nerves overnight. Some solid US Q1 earnings also supported equities too.

Weaker readings for US industrial production and housing starts were largely ignored. Hopes of an expansion of IMF funds were boosted by the news that Japan will be provide an extra $60 billion. High beta currencies rallied overnight but notably the EUR failed to register gains despite a narrowing in peripheral Eurozone bond yields.

AUD has undergone some major gyrations. The boost from by a strong jobs report last week was quickly undone by a relatively dovish set of RBA minutes, which appeared to confirm the view that a rate cut would take place in May. Of course, as the RBA pointed out the April 24 Q1 inflation report would be essential to provide the final clues to the rate decision.

As a rate cut is already priced in, an upside inflation surprise may actually result in a bounce in the AUD but any positive impetus will have to contend with a more fragile risk environment, yesterday’s risk rally not withstanding. AUD is one of the most highly sensitive currencies to risk aversion and bounced overnight as risk appetite improved but we suspect the risk rally will fade in the short term putting the AUD under renewed downward pressure.

EUR/CHF continues to track the 1.20 ‘line in the sand’ closely, but rumours of a shift in the floor continue to do the rounds. Swiss officials have not confirmed such speculation but have highlighted the impact of a strong CHF in fuelling deflation pressures. The case for a move higher in the CHF ceiling is therefore quite high, but the cost could also be high if speculators test the resolve of the Swiss authorities.

Although the Swiss economy continues to suffer it appears that the pain of a strong CHF is lessening slightly although not enough to ease concerns about the strength of the currency. The March KoF Swiss leading indicator revealed a second straight increase, albeit from a low level. Further gains may be limited however, given the ongoing downward pressure emanating from weaker growth in the Eurozone.

The Bank of Canada left policy rates unchanged at 1% but the accompanying statement appeared to pave the way for higher interest rates. Consequently expectations of rate hikes have been brought forward, with the CAD rallying due to its strong correlation with interest rate differentials. Firmer commodity prices also helped to boost CAD.

Our quantitative models show scope for further CAD gains over the short term, suggesting more gains ahead. Further direction will come from the BoC Monetary Policy Report today, with USD/CAD setting its sights on a test of technical support around 0.9766 in the near term.

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Calm Returns

April 12, 2012 — Mitul Kotecha

Returning from being out over the last couple of weeks it seems as though global markets look in a much worse state than when I left. Nonetheless, a semblance of calm returned to markets overnight helped in part by comments from European Central Bank council member Coeure that the ECB may restart its Securities Market Purchases (SMP) programme to support Spanish bonds while Spanish Prime Minister Rajoy denied any need for a Greek style bailout.

Consequently equity markets have firmed helped also by a solid start to the US earnings season from Alcoa. The lack of any fresh positive fundamental news suggests that any risk rally will be fragile. Renewed Spanish and Italian debt worries will not fade quickly while growth concerns have been reignited by last week’s weaker than expected US jobs report.

This leaves currencies in a state of limbo. After having dropped over the last couple of weeks the EUR has stabilised at a weaker level versus USD. In contrast as warned previously the risk of a pull back in the JPY was very high and subsequently it has strengthened sharply from its lows close to 84.00 against the USD. However, comments from the Bank of Japan’s Shirakawa that the BoJ will continue to pursue “powerful” monetary easing may help to limit the bounce in the JPY to technical support around 80.69.

AUD has been on a downward trajectory as the yield differential with the US has narrowed but the currency benefited from a strong March employment report in which the number of jobs added (+44k) was far more than forecast. As a result expectations of further rate cuts from the Reserve Bank of Australia have been pared back. Much will depend on the Q1 CPI release on April 24 to provide further clarity on the prospects of a May move. China’s GDP data tomorrow will provide further direction and will help to determine whether the bounce in AUD can be sustained.

An upcoming Italian bond auction today as well as US Q1 earnings will garner most attention in the absence of first tier data releases. The main event of the week will be tomorrow’s GDP release in China, however. It will require positive results for all of the above to maintain the rally in risk currencies and consequently downward pressure on the USD. However, it seems that markets are in corrective mode and fresh Eurozone and global worries will likely limit any risk rally, leaving the USD well supported.

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FX volatility declining, AUD still vulnerable

March 29, 2012 — Mitul Kotecha

FX options appear to be increasingly comfortable with the current lack of movement in currencies. For example, 3-month EUR/USD implied volatility has dropped to multi-year lows while my measure of G3 implied volatility has been at very low levels over recent months.

This has corresponded with the drop in risk aversion as market fears over US growth and Eurozone debt issues recede. Over the short term there appears to be little to jolt markets out of their stupor and if anything EUR/USD is likely to continue to drift higher according to our short term quantitative models.

Indeed, firmer risk appetite, despite the odd hiccup, plays positively for the EUR while the pull back in US bond yields has restrained the USD. The Ecofin meeting beginning tomorrow will likely give further support to the EUR, if as expected, ministers bolster the Eurozone ‘firewall’.

It has been a one step forwards, two steps back motion for AUD/USD over recent weeks as it continues to edge lower. Although US bond yields have pulled back Australian yields have pulled back relatively more, reducing Australia’s yield advantage and weighing on the AUD in the process.

Over recent weeks speculative AUD positioning has also fallen, reflecting deteriorating sentiment for the currency, but the fact that the market is still long suggests scope for further short term downside.

Aside from yield differentials most of the usual correlations with AUD have broken down suggesting that the AUD is getting a dose of independent weakness. However, China news remains a key focal point for AUD and the decline in the Shanghai composite stock index has become an interesting lead indicator for AUD performance. Over the near term AUD will likely continue to weaken in jagged steps.

Dear readers please note that there will be very limited updates of econometer.org over the next couple of weeks due to my Easter vacation.

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Weak USD will not persist, CHF to drop eventually

March 28, 2012 — Mitul Kotecha

Risk appetite has deteriorated slightly since the Bernanke fuelled bounce earlier this week but there does not appear to be much of a directional bias for markets either way. Interestingly Treasury yields continue to pull back even while equity markets have softened overnight.

Data has been mixed, with US consumer confidence dipping in March albeit not as much as expected while US house prices also did not drop by as much as anticipated. Data releases on tap today include monetary aggregates in the Eurozone and durable goods orders in the US. The tone will likely continue to be slightly ‘risk off’.

The USD has come under growing pressure since its mid March high, with the EUR in particular taking advantage of its vulnerability. A combination of improving risk appetite and a correction lower in US Treasury yields in the wake of relatively Fed comments have been sufficient to deal the USD a blow.

However, the outlook for the USD is mixed today as on the one hand it will be helped by a reduction in risk appetite but hit on the other by a drop in US Treasury yields overnight. Data today should be a little more constructive for the USD, with a likely bounce back in durable good orders in February.

Overall, I do not expect the weak USD bias to persist especially as it is based on unrealistic expectations that the Fed will still implement more quantitative easing. Indeed, while further Fed easing is possible it may not need to involve an expansion of the Fed’s balance sheet.

EUR/CHF remains pinned to the 1.20 ‘line in the sand’ imposed by the Swiss National Bank while the CHF has strengthened over recent weeks against the USD. Economic data has deteriorated over recent months, with the forward looking Swiss KoF leading indicator pointing to a further weakening.

We will get further news on this front on Friday with the latest KoF release, with a slight a bounce expected. In turn, bad news on the economic front is adding to pressure for CHF weakness. Market positioning in CHF is negative but there is plenty of scope to increase short positioning in the months ahead given that short CHF positions remain well off their all time highs.

Eventually as risk appetite improves and the US yield advantage widens against Switzerland, both EUR/CHF and USD/CHF will move higher.

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