G7 Intervention Hits Japanese Yen

March 18, 2011 — Mitul Kotecha

One could imagine that it was not difficult for Japan to garner G7 support for joint intervention in currency markets given the terrible disaster that has hit the country. Given expectations of huge repatriation flows into Japan and a possible surge in the JPY Japanese and G7 officials want to ensure currency stability and lower volatility. Moreover, as noted in the G7 statement today officials wanted to show their solidarity with Japan, with intervention just one means of showing such support.

Although Japanese Finance Minister Noda stated that officials are not targeting specific levels, the psychologically important level of 80.00 will likely stick out as a key level to defend. Note that the last intervention took place on 15 September 2010 around 83.00 and USD/JPY was trading below this level even before the earthquake struck. The amount of intervention then was around JPY 2.1 trillion and at least this amount was utilised today. The last joint G7 intervention took place in September 2000.

Unlike the one off FX intervention in September 2010, further intervention is likely over coming days and weeks by Japan and the Federal Reserve, Bank of France, Bundesbank, Bank of England, Bank of Canada and other G7 nations. The timing of the move today clearly was aimed at avoiding a further dramatic drop in USD/JPY, with Thursday’s illiquid and stop loss driven drop to around 76.25 adding to the urgency for intervention. USD/JPY will find some resistance around the March high of 83.30, with a break above this level likely to help maintain the upside momentum.

The JPY has become increasingly overvalued over recent years as reflected in a variety of valuation measures. Prior to today’s intervention the JPY was over 40% overvalued against the USD according to the Purchasing Power Parity measure, a much bigger overvaluation than any other Asian and many major currencies. The trade weighted JPY exchange rate has appreciated by around 56% since June 2007. In other words there was plenty of justification for intervention even before the recent post earthquake surge in JPY

Although Japanese exporters had become comfortable with USD/JPY just above the 80 level over recent months, whilst many have significant overseas operations, the reality is that a sustained drop in USD/JPY inflicts significant pain on an economy and many Japanese exporters at a time when export momentum is slowing. Japan’s Cabinet office’s annual survey in March revealed that Japanese companies would remain profitable if USD/JPY is above 86.30. Even at current levels it implies many Japanese companies profits are suffering.

Upward pressure on the JPY will remain in place, suggesting a battle in prospect for the authorities to weaken the currency going forward. Round 1 has gone to the Japanese Ministry of Finance and G7, but there is still a long way to go, with prospects of huge repatriation flows likely to make the task of weakening the JPY a difficult one. The fact that there is joint intervention will ensure some success, however and expect more follow up by other G7 countries today to push the JPY even weaker over the short-term.

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US Dollar On A Slippery Path

March 7, 2011 — Mitul Kotecha

The USD has been a on a slippery path over recent weeks, weighed down by adverse interest rate differentials despite improving US economic data. Adding to the run of encouraging US data releases the February jobs report revealed a 192k increase in jobs and a drop in the unemployment rate to 8.9%.

In particular the Fed’s dovish tone highlights that whilst asset purchases under QE2 will stop at the end of June, the failure to hit the Fed’s dual mandate of maximum employment and stable prices, implies that the Fed Funds rate will not be hiked for a long while yet. This dovish slant has undermined the USD to the extent that USD speculative positioning as reflected in the CFTC IMM data dropped to all time low in the week to 1 March. There is certainly plenty of scope for short-covering but the market is no mood to buy the USD yet.

This week’s releases will provide less direction, with a slight widening in the trade deficit likely in January, a healthy gain in February retail sales and a small drop in the preliminary reading of March Michigan sentiment.

In contrast, even the generally hawkish market expectations for the European Central Bank (ECB) proved too timid at last week’s Council meeting as Trichet & Co. strongly implied via “strong vigilance” that the refi rate would be hiked by 25bps in April. EUR/USD lurched higher after the ECB bombshell breaking the psychologically important 1.4000 barrier but appeared to lose some momentum at this level. Should EUR/USD sustain a break of 1.4000, the next level of resistance is at 1.4281 (November high), with support seen around 1.3747.

The lack of major eurozone data releases this week, with only industrial production data in Germany and France of interest, suggests that EUR may consolidate over the short-term with the main interest on the informal Heads of State meeting at the end of the week to determine whether credible plans can be drawn up to restore confidence in the periphery.

This week it is the turn of the Bank of England (BoE) to decide on monetary policy but unlike the ECB we do not expect any surprises with an unchanged decision likely. Further clues will only be available in the Monetary Policy Committee (MPC) minutes on 23 March. However, markets may be nervous given that it could feasibly only take another two voters aside from the three hawkish dissenters last month, to result in a policy rate hike. Notably one possible hawkish dissenter, Charles Bean did not sound overly keen on higher rates in a speech last week, a factor that weighed on GBP alongside some weaker service sector Purchasing Managers Index (PMI) data.

UK manufacturing data will be the main data highlight of the calendar but this will be overshadowed by the BoE meeting. GBP/USD could continue to lag the EUR and given a generally bullish EUR backdrop, our preferred method of playing GBP downside remains via a long EUR/GBP position.

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The Week Ahead

February 20, 2011 — Mitul Kotecha

Housing and durable goods orders data will form the highlights of the US calendar this week. Speeches from several Fed speakers will also give some further guidance to the appetite for completing the Fed’s $600 billion in asset purchases. Overall it will be a slow start for FX markets with liquidity thinned by the Presidents Day holiday and as a result currencies are likely to remain in relatively tight ranges. The heavy tone of the USD seen last week is likely to persist over coming days given the absence of driving factors. Even the unrest in the Middle East has been unable to derail the improving trend in risk appetite, another factor dampening USD sentiment.

The EUR held up well last week recouping its early week losses to end on a firm note. The ability of the EUR to shake off various bits of bad news was impressive but whether it can continue to do so is debatable. Data releases are unlikely to provide much of a boost. Whilst eurozone business surveys set to remain at high levels, consistent with a rebound in Q1 GDP growth, further improvements are unlikely. The week kicks off with the February German IFO business confidence survey but at best this will reveal stable reading. The EUR may find some support from signs of higher and in Germany and an above consensus reading for M3 money supply growth though this is not usually a market mover. The data will likely feed nervousness about European Central Bank (ECB) tightening. Ireland could rock the boat however, with general elections likely to keep markets nervous about potential renegotiations of Ireland’s bailout terms.

Although deflationary pressures are easing in Japan there is a long way before the spectre of inflation will emerge. Nonetheless, the Bank of Japan (BoJ) revised up its growth outlook last week, suggesting that the likelihood of more aggressive measures to combat deflation is narrowing. A reminder of ongoing deflation will come with the release of January CPI data this week whilst trade data will be watched to determine what impact the strength of the JPY is having on exports. Both EUR/JPY and USD/JPY are close to the top of their recent ranges and the data are unlikely to provoke a break higher. USD/JPY will likely remain capped around 84.51 whilst EUR/JPY will find tough resistance around 114.02.

GBP performed even better than the EUR last week helped by an even more hawkish sounding than usual BoE Monetary Policy Committee (MPC) member Sentance and a letter from the BoE governor hinting at rate hikes. Even a relatively more slightly dovish Quarterly Inflation Report failed to halt GBP’s ascent. Further direction will come from the February MPC minutes in which we expect to see two dissenters, namely Sentence and Weale who likely voted for a rate hike. However, there is a risk that they may have been joined by at least one other, with speculation that MPC member Bean may have joined the dissenters. Such speculation alongside the jump in January UK retail sales at the end of last week will likely add to more upside potential for GBP, setting it up for another gain this week. Its upward momentum may however, be hampered by the large net long GBP positioning overhang.

Posted in central banks, Currencies, ECB, Economics, Economy, Europe, eurozone, Federal Reserve, FX, Germany, Interest rates, Ireland, Japan, Middle East, Monetary Policy, UK, US. Tags: , , , , , , , , , , , , , , , , , , , , , , , . Leave a Comment »

FX Winners and Losers

February 16, 2011 — Mitul Kotecha

There has been a sense of mean reversion in FX markets so far this year as some of last year’s winners have become losers. Namely NZD, CHF, JPY and AUD have all lost ground whilst EUR and GBP have gained ground. The odd one out is the SEK which has strengthened over 2010 and in 2011 versus USD. I expect this pattern to change and the likely winners over the next 3- months are NZD, AUD and CAD, with CHF and JPY the likely losers.

EUR held up reasonably well in the wake of slightly disappointing growth data, with eurozone GDP rising less than expected in Q4, and a smaller than expected gain in the February German ZEW investor confidence survey (economic sentiment component). My sense is that the net long EUR speculative position has already been pared back somewhat over recent days reducing the potential selling pressure on the currency in the near term.

Given that EUR/USD is one of the only major currency pairs being influenced by interest rate differentials, its direction will hinge more on policy expectations but in the near the announcement by the German Finance Minister this morning of a restructuring plan for WestLB may give the currency some support.

Perhaps one explanation for the stability of EUR/USD around the 1.3500 level is that US data was also disappointing yesterday. January retail sales rose less than forecast whilst revisions to back months suggest less momentum in Q4 consumer spending than previously envisaged. As with the eurozone data weather likely played a role in contributing to the outcome.

The net impact on currencies is that they are largely stuck within tight ranges. Further direction will come from the release of the Fed FOMC minutes for the January 26th meeting. The minutes may undermine the USD if a likely dovish slant continues to be expressed but given that the FOMC decision at that meeting to hold policy setting unchanged had no dissenters this should not come as a surprise.

Whilst the battle between the USD and EUR ended in a stalemate GBP outperformed in the wake of the increase in UK January CPI inflation and in particular the letter from the BoE governor to the Chancellor keeping open the door to a rate hike. The Quarterly Inflation Report (QIR) today will be particularly important to determine whether the bounce in GBP is justified.

I remain hesitant to build on long GBP positions given the net long speculative overhang in the currency. The risks following yesterday’s jump in GBP are asymmetric, with a hawkish QIR likely to have less impact on the currency than the negative impact from a more dovish than expected report.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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US Dollar Upside, Euro tensions

February 14, 2011 — Mitul Kotecha

Following the famine that was last week this week will see a feast of data releases, which hopefully will give some clearer direction to currency markets. The key eurozone data focus for FX markets will be the German February ZEW survey and it should highlight that investor confidence is bouncing back smartly. This will be accompanied by data showing a slight acceleration in GDP in the eurozone in Q4 2010. Good news, but the reality is that the EUR is being driven more by peripheral bond tensions and relative yields.

Although the EUR may get a brief lift from the news of the resignation of Egypt’s President Mubarak this will likely prove temporary. Given that tensions are beginning to creep higher EUR/USD may struggle to make any headway this week and will more likely slip below 1.3500 for a test of 1.3440 as sentiment sours. Even the usual sovereign interest may look a little more reluctant to provide support this week. The net long positioning overhang as reflected in the CFTC IMM data suggests some scope for a squaring in long positions, likely accelerating any downside pressure.

As usual data releases are failing to have a major impact on the JPY whilst interest rate / yield differentials suggest the JPY should be much weaker. One explanation for the stubbornly strong JPY is the strength of recent portfolio inflows to Japan, especially into its bond markets. This could reverse quickly and IMM positioning suggests that the potential for a shakeout of long positioning looms large, something that many Japanese margin traders are well positioned for according to TFX data. USD/JPY 84.51 will provide firm resistance to a move higher in the short-term.

GBP will be guided by the Bank of England Quarterly Inflation Report on Wednesday as well as the January CPI and retail sales data. The Report will reveal that inflation moderates over the medium term, even if short-term projections are shifted higher. Consequently, interest rate markets may even pare back overly hawkish expectations for UK rates, leaving GBP vulnerable. Nonetheless, markets maybe somewhat more sceptical or at least nervous in light of a likely increase in UK CPI, albeit mostly due to the increase in value added tax (VAT) at the turn of the year. Moreover, GBP may find some solace from a rebound in retail sales in January.

Overall, GBP/USD will take its cue from EUR/USD and the currency is vulnerable to a sustained drop below 1.6000 this week. The fact that GBP/USD IMM positioning is at its highest since September 2008 suggests a lot of scope for a sell-off. EUR/GBP looks like its consolidating in an even narrower range between 0.8400-0.8500.

Another positive slate of US data releases and likely more pressure on US bond markets this week suggest that the USD will find further support, with the USD index likely to take a shot at the 79.00 level. Indeed a further improvement in both the Philly Fed and Empire manufacturing surveys is expected, providing more evidence of strengthening manufacturing momentum, will be borne out in the hard data, with a healthy gain in industrial output expected. Similarly a healthy reading for US retail sales will support the evidence that the US consumer is in full recovery mode.

The positive impact on the USD may be dampened however, by benign inflation readings this week, supporting the view that US policy rates will not be raised for a long time yet. This is likely to be echoed in the Fed FOMC minutes this week. Nonetheless, speculative positioning suggests plenty of scope for short USD covering, with the latest CFTC IMM report revealing the biggest net short position since October 2010.

Econometer.org has been nominated in FXstreet.com’s Forex Best Awards 2011 in the “Best Fundamental Analysis” category. The survey is available at http://www.surveymonkey.com/s/fx_awards_2011

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