Euro extends gains, yen pressured

February 24, 2012 — Mitul Kotecha

The EUR found another spurt of life following the release of the stronger than expected February German IFO business confidence survey yesterday. The data helped make up for the disappointment related to the manufacturing and service sector surveys. However, while it may have alleviated concerns about weakening growth in Germany it only serves to highlight the disparities in growth across the Eurozone.

I continue to believe the EUR may struggle to sustain gains. In the near term, after breaking above 1.3320 resistance, EUR/USD will face further resistance around 1.3460. Nonetheless, my 2012 year end forecast of EUR/USD 1.26 shows that despite growing growth pressures in the Eurozone economy the EUR will still find underlying support from a healthy external balance and continued EUR buying from Asian official investors.

Over the near term upcoming votes in various countries on the second Greek bailout deal will provoke some nervousness while Greek reform implementation risks will also act to dampen EUR sentiment.

JPY has faced significant degree of pressure since the beginning of February. As noted previously one of the biggest sources of upward pressure on USD/JPY has been the widening in US – Japan 2-year bond yield differentials. US bonds currently yield around 19 basis points above Japan, the highest gap since August 2011. The widening yield gap already appears to be prompting foreign outflows from Japanese bonds, with outflows registered in six of the seven past weeks. These outflows have helped contribute to the weakness in the JPY.

The fact that the BoJ will step up its purchases of Japanese government bonds (JGBs) will also add to the downward pressure on the JPY as it will mean a further widening in US – Japanese yield differentials. Over the short term USD/JPY may face some resistance above the 80 level and I suspect that it will lose some momentum but maintain my view that it will reach 85.0 by the end of the year.

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Greek deal reached but euro rally to fade

February 21, 2012 — Mitul Kotecha

The EUR rallied on the news of a breakthrough in talks to reach a deal to provide Greece with a second bailout of up to EUR 130 billion until 2014 and PSI (private sector involvement) in a debt swap with a nominal haircut of 53.5%. The question is whether the EUR has room to rally further. I suspect that a deal has been increasingly priced in and the room for further appreciation is set to be limited in the short term.

A stronger EUR shows some confidence in the ability of officials to move forward but will prove counter productive given the negative impact on the Eurozone economy at a time when growth is already sliding into recession. Moreover, the relative rise in US bond yields compared to bund yields will create headwinds to any further EUR appreciation. Overall, we are cautious of buying into the EUR rally at current levels.

Effectively the deal buys time for Greece to implement its stated reforms allowing the debt / GDP ratio to drop to 120.5% by 2020. The private sector debt swap procedure will be launched tomorrow. However, the deal was reached shortly after a report that suggested that Greece may need a further bailout on top of the EUR 130 billion announced.

The report which highlighted the risks of an especially deep recession in Greece and consequent risks to reducing the county’s debt / GDP ratio explains the reluctance of countries including Germany, Netherlands and Finland to agree on the proposals.

The bottom line is that the positive impact on markets may fade soon. There was already a great deal of expectation built into the rally in risk currencies over recent weeks and it is doubtful whether the final announcement of a Greek deal will be sufficient for the rally to continue.

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Euro sentiment dives to a new low

January 3, 2012 — Mitul Kotecha

Equity markets in Europe began the year in positive mood, with gains led by the German DAX index following the release of firmer than expected readings for Eurozone purchasing managers indices (PMI). Chinese data which showed an increase in its PMI also helped to boost sentiment. The Eurozone data however, remained at a weak level, contracting for a fifth month in a row, and still consistent with Eurozone recession.

It seems unlikely that equity gains will be sustained over the rest of this week, with risk aversion set to remain elevated against the background of ongoing Eurozone debt and global growth concerns. Indeed, both French and German leaders in their new-year messages warned about the risks ahead. A meeting between Germany’s Merkel and France’s Sarkozy is scheduled for January 9th ahead of an EU Finance Ministers summit on January 23rd. It is unlikely that there will be any significant policy decisions in Europe before then.

Meanwhile, press reports noting that Germany is pushing for an even bigger write down of Greek debt than previously agreed will only add to risk aversion over the short term. The report in the Greek press highlighted the prospect of a 75% write down of Greek debt a far cry from the 20% proposed some months ago. Eurozone markets continue to be haunted by the prospects of credit downgrades by major ratings agencies at a time when many countries have to issue large amounts of debt to satisfy their funding requirements.

Against this background the EUR is set to remain under pressure, with a notable drop below EUR/JPY 100, its lowest level in over a decade registered. Reflecting the deterioration in sentiment for the currency, EUR speculative position hit an all time low at the end of last year according to the CFTC IMM data. This is unlikely to reverse quickly, with sentiment set to deteriorate further over coming weeks and months as the EUR slides further.

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Risk Appetite Buoyed by Central Banks

December 1, 2011 — Mitul Kotecha

Co-ordinated central bank action led by the Federal Reserve to lower the rate on USD liquidity by 50bps was accompanied by a cut in China’s reserve requirements and an easing by Brazil of its benchmark Selic rate. Unsurprisingly risk assets have rallied strongly overnight but once the announcement effect wares off the reality that the underlying tensions in the Eurozone remain in place will see any boost to sentiment wane. The move by the Fed will be a boon to the banking sector but should actually not have been too surprising as this tool was an easy one to use and one that should have been expected given the ample room to cut pricing on USD liquidity swap arrangements.

The other boost to markets overnight was the strong November ADP jobs report, which came in at 206k in November, and will lead to upward revisions to Friday’s payrolls data. Indeed, we now look for a 175k increase in non-farm payrolls from 120k previously. The trend of better than expected US data continued with a stronger than forecast reading for November Chicago PMI at 62.6. We expect this to be echoed by an increase in the ISM manufacturing survey today and the Fed’s Beige Book, all of which will at least allay concerns of a renewed US recession.

What will be important is whether the Fed move will be followed up by other measures from governments and central banks over coming days. Although European Union (EU) leaders have agreed to enhance their bailout fund attention is centred on French and German leaders, with hints that there could be a strong announcement over coming days. At the least, the upcoming EU Summit on 8/9 December will be expected to deliver concrete results otherwise the market rout will continue.

The USD will remain under pressure following the moves by central banks in line with the improvement in risk appetite. High beta risk currencies ie those with the highest correlation to risk over the past 3-months will benefit the most. These include RUB, AUD, TRY, CNH, KRW, GBP and CAD in respective order of correlation. All of these currencies are likely to register gains over the short term, especially given anticipation of further announcements from European officials and a reasonable US jobs report tomorrow.

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Germany Caught in the Contagion

November 24, 2011 — Mitul Kotecha

Equity markets came off their lows overnight despite a 236 point drop in the Dow Jones, but sentiment remains extremely fragile and any let up in pressure on risk assets will prove temporary. A weak bond auction in Germany highlights the severity of contagion across Europe. If the core is being hit then there is no safe haven in Europe anymore. On a positive note it might just make German officials finally realise that they need to act quickly to provide solutions to the crisis.

Weak data notably outside the US adds to the malaise, with in particular China’s HSBC November weaker purchasing managers’ indices coming in below the 50 boom/bust level. Europe’s weaker purchasing managers indices highlight the prospects of looming recession while the news in Germany is not only bad on the bond front bad also on the data front. Today’s German November IFO survey will continue in the same vein, with further weakness in this business survey expected.

Bearing in mind the US Thanksgiving holiday today thin liquidity will mean that conditions are ripe for exaggerated market moves. EUR/USD has already sustained a drop below the important 1.3500 level as even the underling strong Asian demand appears to have been pulled back. More downside is expected but technicals suggests that it will be hard trudge lower, with near term support seen around 1.3285 (10 day Bollinger Band). The near term range is likely to be 1.3285-1.3505 although given the US holiday the range may be even tighter.

Aside from the IFO attention today will focus on a meeting between Chancellor Merkel, President Sarkozy and Prime Minister Monti. As usual expect a lot of hot air but little action. Also note there is a general strike in Portugal today protesting against austerity measures in the country.

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