Risk currencies flying high

February 1, 2012 — Mitul Kotecha

The first month of 2012 passed rather more positively than anticipated and clearly was a good month for risky assets. Even the beleaguered EUR strengthened despite calls for an extended decline. Assets that were most heavily sold over 2011 were the biggest winners over January. Further signs of improvement in US economic data, receding fears of a China growth crash and even signs of tentative progress in the Eurozone debt crisis mean that sentiment may have finally turned a corner. This has been reinforced by the Fed’s commitment to maintain accommodative monetary policy until the end of 2014 and the ECB’s long term LTRO. I’m not entirely convinced but it wouldn’t pay to buck market optimism just yet.

Interestingly currency markets aren’t necessarily behaving as one would expect. In particular the JPY and CHF, both safe haven currencies, have not weakened despite an improvement in risk appetite. In contrast they have actually strengthened. Other currencies are behaving much as would be expected, especially high beta (risk sensitive) currencies, including AUD, NZD and many emerging market currencies, which have rebounded. Even the EUR has jumped past the 1.30 mark against the USD. Even the slow progress in agreeing on the magnitude of Greek writedowns has failed to dent confidence, with Eurozone peripheral bond yields dropping. Risk / high beta currencies are set to remain well supported over the short term.

Looking ahead the outcome of the US January jobs report at the end of the week as well as a final agreement on Greek debt will help determine whether the positive sentiment for risk assets will be maintained into next week. Meanwhile the USD looks as though it will remain under pressure especially given the continued downward pressure on US bond yields, which only continues to reinforce its role as a funding currency. This explains why both the JPY and CHF have stubbornly refused to weaken as narrowing US versus Japanese and Swiss bond yield differentials have kept these currencies under upward pressure. However, risks of FX intervention by both the Japanese and Swiss authorities suggests that upside may be limited.

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EUR slips, Yen gains

January 31, 2012 — Mitul Kotecha

There has been good and bad news in Europe, with leaders’ rubber stamping the permanent bailout mechanism (ESM) and 25 out of 27 EU countries agreeing on the fiscal discipline treaty. Finally, EU leaders agreed that it was not all about austerity, with growth orientated policies as yet undefined, also required.

The bad news is that there has still been no final agreement on Greek debt restructuring and in turn a second Greek aid package said to total around EUR 130 billion while Portugal is increasingly moving into focus as the next casualty. Unsurprisingly the EUR has lost steam so far this week but markets remain short and any downside looks limited at technical support around 1.3077.

A cautious tone will prevail today, with risk assets likely to remain under mild pressure. Developments in Greece and the Eurozone will continue to garner most attention although US data in the form of the January Chicago PMI manufacturing survey and consumer confidence data will also be in focus.

Both surveys will reveal further improvement in confidence as the US economy continues to show signs of gradual recovery. This was supported overnight by a relatively positive Federal Loan Officers survey which revealed an increase in demand for business loans at banks in Q4 2011. Although the USD has been somewhat restrained by a dovish Fed stance the risk off tone to markets will likely bode well for the currency over the short term.

JPY is benefiting from the risk off market tone despite comments by Japanese Finance Minister Azumi who warned about action being taken to combat JPY strength. The JPY has benefited from the Fed’s dovish tone last week which has weighed on US bond yields relative to Japan. While FX intervention risks have increased, officials will remain wary given the underlying upward pressure on the JPY. The near term risk is for USD/JPY to retest the 2011 low around 75.38.

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US dollar remains under pressure

January 30, 2012 — Mitul Kotecha

Hopes of progress on the Eurozone debt crisis and encouraging data in the US have helped boost market confidence. However, the slightly disappointing US Q4 GDP report (2.8% Qoq annualised growth) revealed the markets continued vulnerability while Fitch’s downgrade of six Eurozone countries’ sovereign ratings brought a dose of reality back to the region.

Nonetheless, the Eurozone Central Bank (ECB) unlimited 3-year loans to banks and Fed hints at quantitative easing (QE3) have provided markets with a fillip and will help underpin risk assets over coming weeks. If Greek debt talks are wrapped up this week markets will take further solace but the European Union (EU) Summit beginning today will need to deliver on rubber stamping recent agreements for positive sentiment to be maintained.

This is a big week for US data releases and in turn the USD. Heavy weight data including January non-farm payrolls, ISM manufacturing confidence and consumer confidence readings are on tap over coming days. Although payrolls will not be as strong as in December the trend of data releases will continue to be one of improvement as likely to be revealed in the forward looking confidence surveys this week.

The USD may not benefit as much as it would otherwise have done given that the Fed has committed to easy monetary policy for a long while to come to end 2014. It is becoming increasingly clear that firmer activity data may still not prevent a further round of quantitative easing and attendant USD downside risks. Against this background a cautious stance on the USD over coming days is warranted, with the USD index likely to remain under near term pressure.

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Australian and NZ Dollar Outperform

January 27, 2012 — Mitul Kotecha

The boost to EUR following the dovish tone of the Fed FOMC statement on Wednesday has faded although the EUR looks well supported against the USD, JPY and GBP. Further gains against the USD will however, be limited to around 1.3201 (21 December 2011 high and 61.8% retracement from its 1.3553 high).

Reports overnight that Greek private lenders were willing to accept a coupon rate below 4% helped to boost confidence of an imminent deal with regard to Greek debt restructruing. Ahead of next week’s EU Summit the EUR will consolidate its gains, with attention focussing on a meeting between German Chancellor Merkel, Italian Prime Minister Monti, and French President Sarkozy on Monday.

USD/JPY has become insensitive to moves in most of its usual drivers. Bond yield differentials have lost influence over recent months despite a very strong relationship in the past. Similarly USD/JPY is also not particularly sensitive to moves in the USD index or risk aversion, with these relationships also breaking down lately according to my correlation calculations. Net foreign portfolio flows should in theory be playing negative for the JPY with outflows from bond and equity flows recorded in 8 of the last 10 weeks.

However, the reality is that USD/JPY remains stubbornly entrenched in a narrow 77-78 range. While a base appears to have been formed around the 77.00 level the upside momentum for the currency pair is weak. I stand by my view of USD/JPY ending the quarter around current levels given the loss of influence of its usual drivers but still look for an eventual move higher.

AUD and NZD have performed extremely well over recent weeks recording the biggest gains among major currencies so far this year. Both currencies have been boosted by improving risk appetite and receding growth worries in China. AUD in particular looks attractive in the wake of the dovish Fed and relative high AUD yield. I continue to believe markets are too dovish on Australian policy rate expectations, with markets pricing in more rate cuts this year beginning in February. Any reversal in easing expectations will support AUD.

AUD is also benefiting from diversification flows, with Russia’s central bank noting that it may begin to buy AUD in February. Nonetheless, AUD/USD gains look overly aggressive in a short space of time, with positioning turning increasingly long. AUD/USD will face strong resistance around 1.0753 over coming days.

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Beware of EUR short covering

January 11, 2012 — Mitul Kotecha

Europe has plenty of events to focus on over the next couple of days including the European Central Bank (ECB) Council meeting, and debt auctions in Spain and Italy. While I am by no means a EUR bull the risk is skewed towards some short term recovery or at least stabilization around EUR/USD 1.28. The speculative market is extremely short EUR while policy makers, specifically German Chancellor Merkel and French President Sarkozy are making the right noises. it appears to have finally dawned on Eurozone officials that its not just about austerity but also about growth and reform.

News that Fitch ratings is unlikely to downgrade France’s ratings this year has provided a boost to Eurozone confidence. Greece could yet spoil the party given the ongoing discussion with the Troika (Euuropean Commission, International Monetary Fund and ECB) to finalise the second bailout package for the country. Opposition resistance within Greece suggests that more austerity may not be easy to implement. Meanwhile there are ongoing questions about the extent of writedowns that Greek debt will undergo. Despite these issues it appears that markets are becoming somewhat more immune to events in the Eurozone. While still high bond yields for Italy and other debt still point to ongoing trouble, risk appetite has firmed.

One factor that is helping to boost sentiment is the encouraging news out of the US. Although the Q4 earnings season has not began particularly well data releases look somewhat more positive. Not only has positive impact of last week’s US December jobs report continued to filter through the market but so has other news such as a pick up in small business confidence and a rise in consumer credit. These lesser watched data highlight the gradual recovery process underway in the US and the growing divergence with the Eurozone economy and support the view of medium term USD outperformance versus EUR.

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