Bernanke and Eurogroup awaited

July 16, 2012 — Mitul Kotecha

Two main events will garner most attention this week. These are Fed Chairman Bernanke’s Monetary Policy Report to Congress on Wednesday and the Eurogroup meeting on Friday. Ahead of these events trading is likely to be restrained. While a solid close to US and European equity markets at the end of last week suggest at least a firm start to the week for risk assets the many and varied uncertainties afflicting markets suggest that positive momentum will be very limited. US data should generally outperform compared to Europe this week with June retail sales, July Empire manufacturing, May industrial production and June housing starts are set to post gains. In contrast, the German July ZEW survey is set to decline further.

Wide ranging uncertainties in Europe including the inability to seal the deal on the main elements of the recent EU Summit, downgrade of Italy’s sovereign ratings by Moody’s, uncertainty of Greece’s austerity programme, delay in the German Constitutional Court’s verdict on the ESM bailout fund, the hard line stance of German Chancellor Merkel towards banking supervision, disagreement within France’s majority government on how to ratify the Fiscal Pact as well as objections from the Netherlands and Finland on the use of the rescue funds, highlight just some of the difficulties remaining in turning around confidence in Europe. All of this suggests that the EUR will remain under downward pressure while Eurozone peripheral bond spreads will see limited compression.

Aside from a relatively weak EUR which we expect to push lower initially to support around 1.2151 versus USD and then towards the psychologically important 1.200 other risk / high beta currencies will remain relatively resilient. Asian currencies will likely begin the week in positive mood helped by expectation of more stimulus from China but unless risk appetite improves significantly any upward bias will be limited. Although there may be some disappointment from a lack of progress in Europe on resolving its crisis and also from Bernanke’s testimony in which he is unlikely to indicate a greater bias towards more quantitative easing, risk appetite is unlikely to sour too much, especially given thin summer trading conditions and hopes of more policy stimulus out of China.

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No respite for the Euro

July 11, 2012 — Mitul Kotecha

Following a relatively positive session for European stocks yesterday, the enthusiasm did not carry through to US markets which registered losses overnight. Commodity prices dropped led by gold while equity volatility rose.

Marginal progress at the meeting of European Finance officials, with the decision to furnish Spain with the first EUR 30 billion of funds for its banks, helped sentiment in Europe. Moreover, officials edged closer to purchasing bonds in the secondary market by agreeing a separate accord to use the European Central Bank (ECB) as a buying agent for bond purchases by the bailout funds.

However, questions such as how Greece would get through next month’s bond redemptions following a delay in a loan tranche for the country were left unanswered while the timing of setting up a single banking supervisor was also unclear. Meanwhile, the German constitutional court hearings on complaints about the ESM bailout fund mean that the ESM’s implementation continues to be delayed.

All-in-all, despite the marginal progress made yesterday there is a long climb ahead before markets can be appeased. Coupled with growing concerns about the US earnings outlook following several profit warnings by US companies market sentiment will remain fragile, with little headway likely for risk assets. Hopes of further Fed stimulus may offer some solace to markets but the reality is that the Fed is unlikely to be close to a further round of quantitative easing.

High beta / risk currencies remain pressured although it is notable that there is at least a little relative resistance from the likes of the AUD as indicated by the drop in EUR/AUD. European officials are doing just enough to prevent the EUR from gapping lower but not enough to enable the currency to rally. Having already dropped by around 3% against the USD since the start of the month EUR/USD looks set to test tech technical support around 1.2193 before next support around 1.2151.

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Germany feeling the pressure

June 14, 2012 — Mitul Kotecha

Stocks fell back into negative territory following yet more soft US economic data. The 0.4% drop in US retail sales ex-autos was particularly disappointing, once again raising expectations that the Fed may need to deliver another round of quantitative easing. The rally in gold prices overnight was in part related to such expectations. Continued pressure on peripheral Eurozone debt reflects another angle of market pressure, not helped by the downgrading of Spain’s credit ratings by Moodys which effectively highlighted that Spain’s call for external help was a sign of weakness.

A further test of sentiment will be in the form of Italian bond auctions today. Perhaps more worrying is the sell off in German debt over recent sessions, indicating that investors are finally realising that Germany will not be spared from a “Grexit”. Whether this prompts Mrs Merkel into some form of action to help stem the crisis is another question entirely. Ahead of Greek elections on June 17 markets will enter into a state of limbo but the bias remains for elevated risk aversion.

FX markets are similarly rangebound, with the USD capped by hopes/expectations of more Fed QE and the EUR capped by peripheral Eurozone tensions. As a result EUR/USD has struggled to sustain break above resistance around 1.2624 and will continue to fail to the topside given the uncertainty around the Greek elections on June 17th. Bad news in the form of the Spanish debt downgrade and peripheral debt pressures, suggest that the EUR will remain under pressure over coming sessions, making it increasingly difficult to hold above the psychologically important 1.25 level.

The main focus today will be on the Swiss National Bank policy decision. While no policy action is expected attention will focus on the SNB’s stance on its 1.20 EUR/CHF floor. Upward pressure on the CHF has intensified over recent weeks as the situation in the Eurozone has worsened, and latest reserves data highlighted a big jump in reserves during May as the SNB had to buy EUR against the CHF. A shift in the EUR/CHF floor looks unlikely but the recent upward pressure on CHF could pale into insignificant compared to any upward pressure following a Greek Euro exit.

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EUR rallies, AUD and CAD eye rate meetings

June 5, 2012 — Mitul Kotecha

Some consolidation and even slightly more upbeat tone have helped risks assets to settle and the outlook today is for more of the same. The respite looks temporary unless followed by concrete measures out of the Eurozone to stem the crisis, however. Attention will focus on today’s emergency teleconference between G7 leaders in which they are expected to put more pressure on European leaders to act.

However, continuing stalemate in Europe, with Spain’s push for an injection of funds from the Eurozone bailout fund into its banks facing resistance from Germany who believe that any funding should come as part of a formal bailout package. Despite the lack of traction in Europe, the EUR has managed to eek out further gains, with the rebound from the lows around 1.2287 versus USD gaining traction. Near term resistance is seen around 1.2625.

There has been a change of heart by many ahead of today’s Reserve Bank of Australia (RBA) meeting. Weaker global data in particular in China, with both the manufacturing and non manufacturing purchasing managers indices (PMI) coming in weaker than expected, have added to worries about the path of the Australian economy.

Taken together with some deterioration in Australian money market conditions, weaker commodity prices and growing European contagion risks, the RBA will probably want to shield the domestic economy, with another 25bps rate cut. Talk of a 50bps easing today has done the rounds but this seems excessive given that it would fall hot on the heels of 50bps rate cut at the beginning of May.

The AUD has priced in some easing and a likely 25bps rate cut is unlikely to put much pressure on the currency but much will depend on the accompanying statement. In any case, downside risks remain in the current environment.

The Bank of Canada also meets today to decide on its policy rate settings. Unlike in Australia there has been no change of heart ahead of the meeting, with the BoC set to keep its policy rate on hold at 1%. The central bank has sounded more upbeat than most and the drop in the CAD over recent weeks has in any case acted to loosen monetary conditions.

Although somewhat resilient compared to its commodity counterparts such as AUD and NZD, the CAD is playing catch up, having been the worst performing currency so far this month. Speculative positioning has drifted lower too, although it is still close its three month average. This implies room for a further reduction in long positions as the CAD fails to outperform.

Recent weakness in US economic data highlights the risks ahead for Canada and the CAD, suggesting that investors will continue to take a cautious tone towards the currency over coming weeks. A more neutral statement from the BoC will likely keep CAD sentiment subdued.

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Europe’s crunch time

May 25, 2012 — Mitul Kotecha

It’s crunch time for EU leaders and the European Central Bank (ECB). The ECB under the helm of Mario Draghi is steadfastly refusing to provide further assistance to the Eurozone periphery either directly via lower interest rates or securities market purchases or indirectly via another Long term refinancing operation (LTRO) . Any prospect of debt monetization as carried out already by other central banks including the Fed and Bank Of England is a definite non-starter. The reason for this intransigence is that the ECB does not want to let Eurozone governments off the hook, worrying that any further assistance would allow governments to slow or even renege upon promised reforms.

Whether this is true or not it’s a dangerous game to play. The fact that the previously unthinkable could happen ie a country could exit the Eurozone should have by now prompted some major action by European officials. Instead the ECB is unwilling to give ground while Germany continues to stand in the way of any move towards debt mutualisation in the form of a common Eurobond and/or other measures such as awarding a banking license to the EFSF bailout fund which would effectively allow it to help recapitalize banks and purchase peripheral debt. Germany does not want to allow peripheral countries to be let off the hook either arguing that they would benefit from Germany’s strong credit standing and lower yields without paying the costs.

To be frank, it’s too late for such brinkmanship. The situation in The Eurozone is rapidly spiraling out of control. While both the ECB and Germany may have valid arguments the bottom line is that the situation could get far worse if officials fail to act. As noted above there are various measures that could be enacted. Admittedly many of these will only buy time rather than fix the many and varied structural problems afflicting a group of countries tied together by a single currency and monetary policy and separate fiscal policies but at the moment time is what is needed the most.

It’s good to see that European officials are finally talking about boosting growth and realising that austerity is killing the patient. However, measures such as increasing trade, investment etc are all long term in nature. Europe needs action now before it’s too late. After years of keeping the Eurozone together by sheer force of political will rather than strong fundamental reasons lets hope that politicians in Europe begin to realize this before it’s too late. The lack of traction at this week’s EU summit was disappointing but with their backs to the wall ahead of Greek elections in mid June Germany and the ECB may be forced to give ground. In the meantime the beleaguered EUR looks destIned to remain under pressure.

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