Euro weaker despite hawkish ECB

June 10, 2011 — Mitul Kotecha

The bounce in EUR/USD following the European Central Bank (ECB) press statement following its unchanged rate decision proved short-lived with the currency dropping sharply as longs were quickly unwound, with EUR/USD hitting a low around 1.4478. The sell off occurred despite the fact that the ECB delivered on expectations that it would flag a July rate hike, with the insertion of “strong vigilance” in the press statement.

The reaction was a classic ‘buy on rumour, sell on fact’ outcome and highlights just how long EUR the market was ahead of the ECB meeting. Interestingly the interest rate differential (2nd futures contract) has not widened versus the USD despite the hawkish ECB message and in any case interest rate differentials are not driving EUR/USD at present as reflected in low correlations.

This leaves the EUR susceptible to Greek developments and the news on this front is less positive. ECB President Trichet ruled out any direct participation (ie no rollover of ECB Greek debt holdings) in a second Greek bailout whilst potentially accepting a plan of voluntary private participation in any debt rollover. The ECB’s stance is at odds with that put forward by German Finance Minister Schaeuble pressuring investors to accept longer maturities on their Greek debt holdings.

In contrast the USD appears to be finding growing relief from the fact that the Federal Reserve is putting up a high hurdle before QE3 is considered. As highlighted by Fed Chairman Bernanke earlier this week the Fed is not considering QE3 despite a spate of weak US data. This was echoed overnight by the Fed’s Lockhart and Plosser, with the former noting that there would need to be a substantially weaker economy and the latter noting that there would have to be a “pretty extraordinary” deterioration in the economy to support QE3.

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Euro Resilience To Fade

May 31, 2011 — Mitul Kotecha

There will at least be a little more liquidity in FX markets today following yesterday’s public holidays in the US and UK. Whether this means that there will be a break out of recent ranges is another matter. Clearly global growth worries as well as eurozone peripheral debt concerns are having an important impact on market dynamics but are also providing conflicting signals.

On the one hand the USD ought to garner support from Europe’s problems but on the other, safe haven demand and growth concerns is bolstering demand for US Treasuries keeping US bond yields at very low levels despite the lack of progress on increasing the US debt ceiling and agreeing on medium to long term deficit reduction.

In the wake of a run of US data disappointments including April durable goods orders, Q1 GDP and weekly jobless claims last week, fears of a loss of momentum in the US economy have intensified. Manufacturing and consumer confidence surveys in the form of the May Chicago PMI and Conference Board consumer confidence survey today will be closely scrutinised to determine whether the ‘soft patch’ in the US economy will persist.

This will have important implications for the USD as worries about growth may feed into expectations that the Fed’s ultra loose monetary policy will be sustained for longer. As it is US 2-year bond yields have dropped to their lowest level this year.

Fortunately for the USD only USD/JPY and USD/CHF have maintained a statistically strong correlation with bond yield differentials although we expect the break in relationship for other currencies to prove temporary. In the case of USD/JPY, yield differentials have narrowed between the US and Japan, a factor playing for JPY appreciation.

Perhaps the fact that unlike the US Japanese data has on balance been beating expectations notwithstanding disappointing April household spending and industrial output data has helped to narrow the yield gap with the US. One explanation is that that worst fears of post earthquake weakness have not been borne out, suggesting that economic expectations have been overly pessimistic. In any case, USD/JPY 80 is still a major line in the sand for the currency pair.

The EUR continues to show impressive resistance, with EUR/USD breaking technical resistance around 1.4345, which opens up a test of 1.4423. Reports that Greece had failed to meet any of its fiscal targets and of harsh conditions set by European officials for further aid have failed to dent the EUR. Whether the market is simply becoming fatigued or complacent will be important to determine if the EUR can gain further.

A report in the WSJ that Germany is considering dropping its push for early rescheduling of Greek debt has given some support to the EUR too. Ongoing discussions this week are unlikely to prove conclusive however, with attention turning to meetings of European officials on 20th and 24th June. I still believe EUR gains will limited, with the break above 1.4345 likely to prove shortlived.

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US Dollar Ugly But Not Hideous

May 24, 2011 — Mitul Kotecha

The USD has strengthened by around 5% since the beginning of the month. The move has been particularly sharp this week as higher risk aversion and intensifying fears about the eurozone periphery have given the currency a boost, albeit with the USD remaining one of the least ugly currencies amongst a fairly hideous bunch.

Eurozone country and overall ‘flash’ May purchasing managers indices (PMI) managed to further sour an already fragile mood yesterday, with the data revealing bigger than expected declines, albeit still at levels that are high in absolute terms. Data today is unlikely to result in any improvement in sentiment for eurozone assets, with the Germany IFO Business Climate index likely to slip, albeit from a relatively high level.

The EUR doesn’t need much of an excuse to sell off at present, with a softer IFO likely to provide further reason for investors to offload long positions in the currency. Against this background EUR/USD is likely to sustain a drop below the 1.4000 level, with the 100 day moving average level of 1.3972 likely to be breached shortly.

More importantly in terms of sentiment drivers the malaise in the eurozone periphery especially Greece remains the biggest risk for the EUR. As much as officials in Europe and Greece deny speculation of debt restructuring the market is far from convinced as reflected in the widening in peripheral debt spreads.

Greece’s Prime Minister Papandreou’s attempt to push through austerity measures in the Greek parliament yesterday by announcing accelerated asset sale plan and EUR 6 billion in budget cuts have done little to turn market sentiment despite the fact that at the least it shows a willingness to stick to the plan in the face of growing domestic resistance.

The USD has also edged higher against the JPY over recent days despite a rise in risk aversion. As revealed in the latest IMM data markets have been net long JPY over the past couple of weeks, with positioning well above the 3-month average, suggesting some scope for a liquidation of long positions. Nonetheless, the rise in USD/JPY has occurred despite 2-year US / Japan yield differentials remaining at a relatively low level suggesting that the USD may lose momentum, with USD/JPY resistance around 82.74 likely to cap gains.

GBP has also slid suffering in the wake of a resurgent USD and unconfirmed reports that Moody’s ratings agency is expected to announce that is placing 14 out of 18 UK banks on review for a downgrade. GBP is likely to trade nervously ahead of UK data releases today including public finances and CBI data, with further downside risks opening up. A drop below GBP/USD 1.6000 could see the currency pair test support around 1.5972.

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US Dollar On The Rise

May 16, 2011 — Mitul Kotecha

There are plenty of US releases on tap this week but perhaps the most important for the USD will be the minutes of the April 26-27 Fed FOMC meeting. Taken together with speeches by Fed officials including Bernanke, FX markets will attempt to gauge clues to Fed policy post the end of QE2. The Fed’s stance at this point will be the major determinant of whether the USD can sustain its rally over the medium term. The lack of back up in US bond yields suggests that USD momentum could slow, with markets likely to move into wide ranges over coming weeks.

It is worth considering which currencies will suffer more in the event that the USD extends its gains. The correlation between the USD index and EUR/USD is extremely strong (even accounting for the fact that the EUR is a large part of the USD index) suggesting that the USDs gains are largely a result of the EUR’s woes. Aside from the EUR, GBP, AUD and CAD are the most sensitive major currencies to USD strength whilst many emerging market currencies including ZAR, TRY, SGD, KRW, THB, IDR, BRL and MXN, are all highly susceptible to the impact of a stronger USD.

Robust Q1 GDP growth readings in both Germany and France helped to spur gains in the EUR but this proved short-lived. Sentiment for the currency has soured and as reflected in the CFTC IMM data long positions are being scaled back. Nonetheless, there is still plenty of scope for more EUR selling given ongoing worries about the eurozone periphery, which are finally taking their toll on the EUR. A break below EUR/USD 1.4021 would open the door for a test of 1.3980.

The eurogroup and ecofin meetings will be of interest to markets this week but any additional support for Greece is unlikely to be announced at this time. However, likely approval of Portugal’s bailout may alleviate some pressure on the EUR but any positive impetus will be limited. Even on the data front, markets will not be impressed with the German ZEW index of investor confidence likely to register a further decline in May.

Japanese officials have been shying away from further FX intervention by blaming the drop in USD/JPY over recent weeks on general USD weakness despite the move towards 80. However, this view is not really backed up by correlation analysis which shows that there is only a very low sensitivity of USD/JPY to general USD moves over recent months. One explanation for the strength of the JPY is strong flows of portfolio capital into Japan, with both bond and equity markets registering net inflows over the past four straight weeks.

This is not the only explanation, however. One of the main JPY drivers has been a narrowing in yield differentials. This is unlikely to persist with yield differentials set to widen sharply over coming months resulting in a sharply higher USD/JPY. As usual data releases are unlikely to have a big impact on the JPY this week but if anything, a further decline in consumer confidence, and a negative reading for Q1 GDP, will maintain the pressure for a weaker JPY and more aggressive Bank of Japan (BoJ) action although the BoJ is unlikely to shift policy this week.

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Position Unwinding Boosts USD

May 9, 2011 — Mitul Kotecha

The USD’s multi-month fall has come to an abrupt halt, with the currency registering gains in reaction to what appears to be a major position unwinding across asset markets, led by a drop in commodity prices.

Will it continue? Whilst I am amongst the more bullish forecasters on the USD over the medium term, the current rally could prove to be short-lived in the absence of a shift in Federal Reserve rhetoric or end to quantitative easing (QE2). Nonetheless, the market had got itself very short USDs (as reflected in the CFTC IMM data as of early last week which showed an increase in net short positions) and the rally in the USD last week was likely spurred by major short-covering which could extend further into this week.

The move in the USD gained momentum as European Central Bank (ECB) President Trichet proved to be less hawkish than many expected in the press conference following last Thursday’s ECB meeting. Moreover, renewed worries about Greece at the end of last week, with a report in the German Der Spiegel, later denied by Greek officials, that the country was planning to leave the Eurozone dented the EUR,

Taken together with the improving trend in US April non-farm payrolls (April registered +244k increase, with private payrolls 268k), these factors colluded to provide further positive stimulus to the USD and negative fallout on the EUR. The room for EUR downside is evident in the net long EUR speculative position, which rose to its highest since December 2007 as of 3rd May.

This week’s batch of US releases including March trade data, April retail sales and CPI, are unlikely to result in a reversal in last week’s trend though a trend like reading for core CPI, with the annual rate below the Fed’s comfort zone will reinforce expectations of dovish Fed policy being maintained, which could inject a dose of caution into the USD’s rally.

Against the background of a likely widening in the US trade deficit in March there will plenty of attention on the annual strategic and economic dialogue beginning today, with markets interested in discussions on Chinese worries about the gaping US fiscal deficit and US concerns about China’s exchange rate policy.

Greece’s denial of plans to leave the eurozone and discussions over a further adjustment to Greece’s bail out package, may help limit any drop in the EUR this week though it will by no means mark the end of such speculation about the periphery especially with this weeks’ Q1 GDP data releases across the eurozone likely to further highlight the divergence between the core and the periphery even if the headline eurozone reading rebounds strongly as we expect.

In the UK the Bank of England Quarterly Inflation Report will be the main influence on GBP. Downward growth revisions will play into the view that inflation will eventually moderate, capping expectation of higher interest rates over the coming months. However, the likely upward revision to near term inflation forecasts will help limit any damage to GBP.

GBP has lost ground to the USD but it should be noted that it has outperformed the EUR over recent days, reversing some of the recent run up in EUR/GBP. Given that EUR sentiment is likely to remain fragile this week, GBP may continue to capitalise, with a test of EUR/GBP 0.8672 on the cards.

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