USD clambering up the fiscal cliff

November 12, 2012 — Mitul Kotecha

Following US elections the reality of the task ahead to resolve the looming fiscal cliff has cast a long shadow of markets, leaving risk assets under pressure. Despite comments from the US administration and Congressional leaders of a willingness to compromise, markets remain unconvinced, especially given the unchanged underling stance of both Democrats and Republicans, the former towards taxing the wealthiest and the latter towards no tax hikes.

US data and events will not help risk appetite, with a drop in retail sales, moderate gains in manufacturing surveys and a small gain in October industrial production expected. The main highlight will be the FOMC minutes. Perversely the USD will continue to benefit even though much of the rise in risk aversion and subsequent safe haven demand is US orientated.

News that Greece passed its 2013 budget over the weekend will do little to assuage concerns over the country’s precarious financing position. It will also not guarantee that the Eurogroup meeting will approve Greece’s next loan tranche today given disagreements over the country’s debt sustainability, with a decision only likely by the end of the month.

Greece’s ability to handle a EUR 5 billion debt repayment this week via a treasury bill auction tomorrow will be the immediate focal point for markets given the difficulty for the country to obtain financing. At least economic data in the Eurozone will be slightly less negative, with upside risks to preliminary Q3 GDP and a likely third straight gain in the German ZEW investor confidence index expected in October. None of this will offer much respite for the EUR which looks set to slip further on its way towards its 100 day moving average around 1.2639.

In Japan the release of Q3 GDP data this morning which revealed the first negative reading in 3 quarters and broad based weakness in GDP components adds to the pressure on Japanese officials, in particular the Bank of Japan to intensify its stimulus efforts. The likelihood of another negative reading in Q4 and therefore a technical recession also highlights the need to weaken the JPY in such efforts. However, as we have been warning the move in USD/JPY above the 80 level proved short lived, with the currency pair undermined by a drop in US bond yields and to a lesser extent higher risk aversion. We see little chance of USD/JPY sustaining a break back above 80 in the current environment.

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USD buffeted, JPY firming, AUD risks receding

October 9, 2012 — Mitul Kotecha

A lacklustre day for equity markets yesterday saw many indices close lower and risk aversion edge higher, with the VIX ‘fear gauge’ being a prime mover, Some encouraging signs for global activity continue to emerge from the rise in the Baltic Dry Index but market growth fears remain high. Attention remains firmly focussed on events in Europe, with the Ecofin meeting today likely to see further discussions on a wide range of issues. As yet there is no breakthrough regarding a Spanish bailout or next tranche of Greek loan disbursement, with the latter only likely to be confirmed in November. A visit by German Chancellor Merkel to Athens today is unlikely to result in any breakthroughs. US corporate earnings will also garner greater attention as the week goes on, with Alcoa set to begin the earnings season tomorrow.

The USD is being buffeted by conflicting factors at present. QE3 is likely to cap any gains in the currency but the expansion of balance sheets by other central banks suggests that a weaker USD outlook is by no means a foregone conclusion. Moreover, from a growth perspective the USD comes out on top. Even though US recovery is a weak one by historical standards the economic outlook still looks better than in Europe, notwithstanding the looming US fiscal cliff. Further evidence of recovery will be gauged from the release of the September small business optimism survey today. A likely third straight gain will provide encouraging news although the survey still remains lower than levels it was at earlier in the year. Over coming days I expect the USD to edge higher as it capitalizes on the various strands of uncertainty in the Eurozone.

As Japan returns from an extended weekend USD/JPY has reversed its recent break higher and is verging on another test of 78.00. There seems little in terms of directional influences to give any major impetus to the currency pair especially as many JPY correlations have broken down lately. JPY speculative long positions remain relatively high suggesting scope for some reduction and JPY selling but I suspect that USD/JPY will remain stuck in its current 77.77 – 79.00 range for some time to come. Nonetheless, JPY bears may be encouraged by recent signs of strong bond outflows adding to data showing equity outflows over recent weeks. Indeed, in the week to 28 September 2012 Japan registered its biggest net equity and bond outflows since early May.

AUD has been a major underperformer this month, with pressure intensifying following last week’s surprise RBA rate cut. Although a further sharp drop appears unlikely hefty long speculative positioning suggests that upside traction will be limited. Nonetheless, my quantitative models show that the AUD is looking increasingly oversold against the USD. The market is already pricing in another RBA rate cut by the end of the year suggesting that the reaction to upcoming data will be asymmetric. In other words the AUD will rally more in the wake of positive data than it will weaken in the wake of soft data. Business and consumer confidence indicators will provide further direction over coming days, but the main driver will come from the September jobs report on Thursday where a further drop in employment is expected. I continue to look for strong support for AUD/USD around the 1.0100 level, with 1.0285 a barrier to any upside break.

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Euro slipping ahead of Eurogroup meeting

October 8, 2012 — Mitul Kotecha

The US September jobs report released last Friday will provide some encouraging news for markets to digest this week but holidays in the US and Japan today will keep trading relatively subdued. The jobs report itself was in any case somewhat mixed, and while the unemployment rate dropped to 7.8%, the actual increase in payrolls was relatively soft at 114k although there were revisions higher to past months.

The US jobs report does not necessarily change the picture regarding US quantitative easing. The Fed and subsequently markets will not change their expectations based on one month’s data. In this respect, any benefit to the USD will be limited although the increase in US 2-year bond yields has already exhibited itself in a firmer USD/JPY exchange rate. Nonetheless, this week’s US data will help maintain the assessment of gradual US recovery, with the Beige Book, trade data and Michigan confidence in the spotlight. US data will continue to look relatively better than in Europe.

Most attention will remain on Europe and the Eurogroup meeting beginning today. The reluctance of Spain to request a formal bailout will be a negative factor for European markets, although Portuguese austerity measures likely to be approved today, negotiations between Greece and the Troika (EU, IMF and ECB) on the next tranche of loan disbursements for the country, as well as potential for Cyprus and Slovenia to request a bailout will also come under scrutiny at the meeting.

Currencies are generally range bound, although EUR/USD is verging on another drop below 1.3000. Spain’s refusal to request for a formal bailout holds risks to the EUR especially if peripheral including Spanish bond yields move higher again. While ECB President Draghi’s commitment to OMT (Outright Monetary Purchases) reinforced last week, will provide some solace to the EUR, it will prove meaningless unless moves ahead with a bailout.

Two of the biggest FX losers so far into October have been the NZD and AUD. The AUD in particular has been struck by the surprise RBA rate cut and faltering commodity prices. AUD/USD looks set for a test of 1.0100 technical support, but direction this week business and consumer confidence data over the next couple of days ands the September jobs report on Thursday.

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US dollar finding some support

September 25, 2012 — Mitul Kotecha

Global growth concerns are contributing to undermine commodity prices, with most commodities dropping overnight. Gold was the biggest loser. Risk measures continue to creep higher as a host of worries especially the lack of traction in the Eurozone towards a Spanish agreement on a bailout and inability of Greece to agree on deficit cuts, afflicted markets.

The near term outlook is likely to remain one of caution until some progress in the Eurozone is in evidence. However, growth concerns suggest any improvement in sentiment will be tenuous at best.

On a more positive note, there at least appears to be some movement in the US towards finding a solution towards avoiding the fiscal cliff from taking effect as a bipartisan group of senators have agreed to formulate a deficit reduction plan.

The USD index has rallied over recent days despite expectations for weakness in the wake of the Fed;s announcement of QE3. It almost appears to be a case of sell on rumour, buy on fact. Admittedly the USD usually does weaken following QE with the USD index falling during the full periods of both QE1 and QE2 (-4.6% and -2.9%, respectively).

The counter argument in support of a firmer USD which we believe is supported by the massive deterioration in USD positioning over recent weeks and over 5% drop in the USD since 24 July is that the market has already priced in a lot of QE expectations into the currency.

Another factor that will likely play positive for the USD is the fact that the Fed is not alone in expanding its balance sheet. Many central banks are vying to maintain very easy monetary policy. The implication of this is that there is a battle of the balance sheets in progress that does not necessarily involve the USD being the loser.

EUR/USD has fallen well off its recent highs around 1.3173, with sentiment for the currency souring due to inaction by the authorities in Spain on requesting a bailout and disagreements over how to proceed on various issues including banking supervision. The drop in the September German IFO business climate survey, the fifth in a row, did little to help the EUR, with the survey adding to Eurozone growth worries.

Increasingly it looks as though EUR short covering is running its course and while there may yet be a further bounce in the EUR should the ECB begin its bond purchase programme, the near term outlook is more fragile. Business and consumer confidence surveys in Germany and France today will echo the weakness of the IFO in contrast to a likely firming in September US consumer confidence, contributing to a weaker EUR. A test of support around 1.2848 looms

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Reality Check

September 24, 2012 — Mitul Kotecha

Markets face a reality check going into this week. The euphoria emanating from recent Fed, ECB and BoJ actions is fading quickly. The reality of weak growth and underlying structural tensions is coming back to haunt markets, suggesting much more limited upside for risk assets over coming weeks.

While there are some positive indications that the growth outlook may not have much further to deteriorate, such as the bounce in the Baltic Dry Index, scepticism about the ability of central banks to reflate economies is growing. In this respect, its worth highlighting that the rally in gold prices failed to extent much further last week although in part this may be due to an options expiry tomorrow.

Renewed tensions are creeping back into the market psyche, especially with regard to Europe. Procrastination from Spain about a formal bailout threatens to weigh on markets in the days ahead as some officials suggest that the EUR 100 billion received for Spanish banks will be sufficient for the country to avoid needing further aid. Bank stress test results, a Moody’s review on Spanish ratings and the country’s 2013 budget will all be scrutinised over coming days.

Meanwhile, disagreement between Germany and France over the timing of introducing banking union and supervision is accentuating tensions in the region. Greece remains in the limelight too, as the government continued to find further budget cuts in order to receive the next tranche of loans. The only good news appeared to come from a German press report that the ESM permanent bailout fund’s firepower will be leveraged up to EUR 2 trillion.

The EUR has lost momentum following its initial surge higher and looks constrained on any move above 1.3000. While EUR short positions have continued to be pared back according to IMM data the scope for short covering is becoming more limited. Developments in Spain and Greece will provide further guidance for the currency, but any upside in EUR/USD will be limited to resistance around 1.3180. It seems more likely that having failed to sustain gains, the EUR will continue to drift lower.

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