Euro and yen downside risks

February 15, 2012 — Mitul Kotecha

The lack of progress on a second bailout for Greece will keep markets nervous, leaving risk assets vulnerable to further slippage. The USD will be a beneficiary in this environment. Weak Eurozone GDP data for Q4 2011 released today will contrast with relatively firm data including industrial production and the Empire manufacturing survey in the US, leaving the story of US economic outperformance intact.

EUR has lost steam and looks vulnerable to a further correction lower. The fact that EU finance ministers have cancelled a meeting due to be held today means that markets will have to prolong their wait for an agreement on a second bailout package for Greece.

News that Greece’s political leaders will send a commitment to European officials today that they will implement further austerity measures will give some reassurance that things are moving in the right direction but a looming deadline for debt redemption in March will mean heightened nervousness.

Admittedly the market is still short EUR but positioning has moved close to its 3-month average suggesting a less potential for aggressive short covering. Following the downgrade of ratings of several Eurozone countries yesterday and a likely drop in Q4 2011 Eurozone GDP today, caution will be the prevalent theme today, leaving EUR/USD on the back foot and opening the door for a test of technical support around 1.3026.

The Bank of Japan’s decision to increase its asset purchase program and set an inflation goal had an immediate negative impact on the JPY. A sharp drop in GDP growth in Q4 last year, persistent deflation pressures and more aggressive action from other central banks pushed the BoJ into action.

Will there be any follow through on the JPY? USD/JPY had already been under some upward pressure in the wake of the widening in US bond yields versus Japan. The move by the BoJ will result in even more of a widening in yield differentials especially given that the BoJ actions means there will be an increase in official purchases of Japanese government bonds, helping to suppress JGB yields.

In the near term USD/JPY has broken above its 200 day moving average level, paving the way for a test of the 31 October 2011 high around 79.55. Further out, our bond forecasts show that both US and Eurozone 2-year bond yields will increase relative to Japanese yields over the coming months, supporting our forecasts of USD and EUR appreciation versus JPY.

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Dollar, euro and yen view

February 13, 2012 — Mitul Kotecha

Pressure on the US dollar was maintained last week but there were definite signs that selling momentum is slowing. The lack of major US data releases meant that the key focus for the USD was events in Europe. This week there will be some return of attention back to the domestic front, with heavyweight releases such January retail sales, manufacturing surveys, industrial production and inflation data.

On balance the data will provide more evidence of US recovery but as we have noted previously this is not necessarily positive for the USD. Firmer US data helps to boost risk appetite, which in turn plays negatively for the USD. This could be counterbalanced if US interest rate expectations turn more hawkish but the Fed has effectively ruled out such a prospect, with its commitment to maintain easy policy.

Europe has some important data releases over coming days including the German February ZEW survey and GDP data across the Eurozone. The data will be less encouraging, especially the Eurozone GDP data, compared to the US and is unlikely to give any support to the EUR. Instead events surrounding Greece will be crucial for EUR sentiment. EUR/USD appeared to lose some traction at the end of the week but the EUR remained firm against other currencies.

Greece’s approval of austerity measures overnight will bode well for markets but the tough stance of EU officials towards Greek austerity implementation means that focus will turn to yet another extraordinary meeting of European officials on Wednesday. Even assuming that some form debt deal and second bailout package is ironed out it is questionable how much the EUR will rally as so much good news is already in the price.

The JPY for a change managed to register relatively big moves, with USD/JPY pushing higher over the past week. The revelation that ‘stealth’ FX intervention was carried out by the authorities in Japan taken together with verbal warnings threatening more intervention helped to exacerbate JPY moves.

Speculation that the Bank of Japan is pondering further easing steps at its policy meeting on Tuesday may also be contributing to the softer tone in the JPY. Such hopes may be disappointed however, as we expect the BoJ to retain its current policy settings. The biggest factor explaining the move in USD/JPY is the fact that US bond yields moved higher relative to Japan, with the yield differential ending the week at its highest so far this year.

Posted in Currencies, FX, Greece, US. Tags: , , , , . Leave a Comment »

Agreement at last!

February 10, 2012 — Mitul Kotecha

Greek politicians finally agreed on further austerity cuts totalling EUR 3.3 billion in order to secure a second bailout package. European official discussions now centre on the details of the bail out package, targeting a cut in Greece’s debt to GDP ratio to 120%.

However, the fact European Finance Ministers have withheld more funds for Greece until the austerity measures begin to be implemented suggests further uncertainty on the horizon. A Greek parliamentary vote set to begin this weekend may see some progress but markets will trade cautiously ahead of the vote.

EUR/USD rallied to a high of around 1.3322 but failed to break above its 100 day moving average at 1.3332 following the agreement. As expected the ECB offered no help to the EUR, with market attention continuing to centre on the second 3-year LTRO on 29 February.

The fact that there are still various issues to be resolved means that upside for EUR will be limited in the short term. In any case the currency was already pricing in a lot of good news. EUR/USD will face major resistance around 1.3388.

Notably risk measures are edging higher once again, implying some pressure on risk assets in the near term. Markets today will digest the status Quo from the European Central Bank and an additional but expected injection of GBP 50 billion in quantitative easing from the Bank of England. December US trade data and February Michigan confidence are the only data of note suggesting limited price action ahead of the Greek parliamentary vote.

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Euro pricing in a lot of good news

February 9, 2012 — Mitul Kotecha

Markets remain in limbo ahead of a potential Greek debt deal although US equities managed to eek out small gains overnight. Stocks in the US have entered a bull market helped by the dovish stance of major central banks.

The Federal Reserve’s commitment to maintain accommodative policy until the end of 2014 and the European Central Bank’s (ECB)3 year LTRO have been drivers of the rally in risk assets. The BoE will contribute to the easy stance of central banks, with an increase in UK quantitative easing set to be announced today. The ECB in contrast is set to remain in status quo.

Will it be a buy on rumour, sell on fact reaction for the EUR to a Greek debt deal? Over recent days anticipation has grown that a deal on debt writedowns and in turn a second bailout package will emerge soon. This has helped to propel EUR/USD higher, with the currency hitting a high of 1.3289 overnight.

So far a deal has been lacking but leaders are expected to approve a draft agreement on fresh austerity measures between the main Greek political parties today. This should pave the way a deal on debt restructuring and a new loan package for the country due to be discussed today between Eurozone finance officials.

However, the EUR has already priced in a lot of good news on this front and even agreements on the issues above may not see the currency push much higher, with strong resistance around EUR/USD 1.3388. Separately today’s ECB meeting is unlikely to provide much direction for the EUR, with the Bank set to maintain current policy settings.

USD/JPY has managed a recovery of sorts but still remains in the middle of multi month 75.5-78.5 range. Nonetheless, the momentum over the short term will continue to be for USD/JPY upside, with resistance around 77.49 targeted. News that the Japanese authorities conducted ‘stealth intervention’ to weaken the JPY in late October/early November will have emboldened JPY bears.

However, at the same time they should also be worried as it is clear that even after all the intervention the JPY remains overly strong. Reflecting this is the fact that speculative and margin trading JPY positioning is at a very high level.

Moreover, while much has been made of the deterioration in Japan’s current account balance over recent months and the potentially negative impact on the JPY it should be noted that Japan’s basic balance (sum of direct investment + current account + portfolio flows) position remains healthy (for now) and is acting as an obstacle to JPY weakness.

Posted in Currencies, ECB, Economy, eurozone, Federal Reserve, FX, Japan. Tags: , , , . Leave a Comment »

Why is the Swiss franc so strong?

February 7, 2012 — Mitul Kotecha

All eyes remain focussed on Greek developments today as the country vacillates towards acceptance of further austerity measures in order to gain the Troika’s (EU, IMF, ECB) approval for a second bailout for the country. The stakes are high with a potential disorderly default and Eurozone exit on the cards should no agreement be reached.

Against this background market nervousness is intensifying as reflected in the slippage in global equity markets and drop in risk assets in general overnight. The data and events slate today includes an RBA policy meeting and German industrial production, but neither of these will be significant enough to deflect attention and calm fraying nerves as markets await further Greek developments.

Contrary to many commentaries, the fall in EUR/CHF cannot be attributed to higher risk aversion (it has had a low correlation with my Risk Aversion Barometer over recent weeks). Instead, EUR/CHF is another currency pair that is highly correlated with interest rate differentials. Indeed, its high sensitivity provides a strong explanation for the drop in EUR/CHF since mid December 2011. This move has occurred despite an improvement in risk appetite over this period, a factor that would normally be associated with CHF weakness.

The implied interest rate futures yield advantage of the Eurozone over Switzerland has narrowed by around 47 basis points since mid December 2011. This is a problem for the Swiss National Bank, who will increasingly be forced to defend its 1.20 line in the sand for EUR/CHF. However, given that the drop in EUR/CHF has closely tracked yield differentials, any intervention is likely to have a limited impact unless there is renewed widening in the yield gap.

Posted in eurozone, FX, Greece, Switzerland. Tags: , , , , , . Leave a Comment »
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